As the situation between Russia and Ukraine has escalated from threatened invasion to an outright war, investors and consumers find themselves facing a rapid spike in oil prices. This development is nothing new. Oil prices have a long history of extreme short-term reactions to events both economic and geopolitical. We appreciate the angst investors and consumers feel from a sharp increase in oil prices. We believe that today’s elevated prices will prove similar to past spikes and move toward more moderate levels over time.
It is important to remember that oil is no different from other commodities. Its price will reflect the underlying fundamentals of supply and demand over the long-term. This also means it is not immune to the emotional forces of fear and greed in the short run. A year ago, the price of oil sat around $60 per barrel (WTI crude). The price hit a recent high just below $130 per barrel. The following chart shows the movement of oil prices over the past 30 years. Despite multiple spikes above the $100 mark, the average price during the overall period was approximately $50 per barrel.
With the current focus on disruptions brought about by the Russian invasion of Ukraine, it could be easy to forget that there are other considerations at play. In fact, oil prices had already been moving higher since the lows seen during the initial COVID lockdowns in the Spring of 2020. Additional factors contributing to the current rise in oil prices include the following:
- Oil demand rebounded quickly from the depths of the pandemic
- OPEC declined to increase production to meeting rising demand despite requests from the US and other countries
- OPEC+ has been falling short of agreed upon oil production levels
It may be tempting to believe this time is different given the current laundry list of reasons for higher oil prices, but we do not expect that to be the case. Although prices may continue to push upward in the short-term, when they reach a certain level, the forces of supply and demand will begin to influence prices lower. High prices incentivize consumers to reduce demand and producers to increase supply. These are classic conditions for a decrease in price. Ultimately, oil prices above the $100 per barrel level have not persisted for very long. Prices remain above this threshold for about 3 months on average.
The current oil price spike is neither unusual nor unique. While a resolution to the Russia/Ukraine situation remains uncertain, we expect oil price volatility to persist in the short-term. We are experiencing some temporary pain as consumers and investors, but we remain confident we will weather this storm as we have the ones before it. To paraphrase an old investing adage, “The solution to high oil prices is high oil prices.”