Overview
Oil and natural gas prices have risen steadily over the past year as resurging demand has been met with limited supply. The price of Brent Crude is comfortably above $70 a barrel after hitting an 18-year low last March, while natural gas prices are hovering around all-time highs.
Soaring gas prices could return to earth
The meteoric rise in natural gas prices can be explained by strong demand in Asia following a cold winter, coupled with very low inventory levels in Europe. The price of UK natural gas has jumped by more than 200 per cent since the start of the year, prompting fears that several domestic energy suppliers could go bust.
There are also longer-term factors at play and the rising price of carbon emissions in the EU Emissions Trading Scheme has boosted gas prices in recent months. Natural gas produces about half as much CO2 as coal when used to generate electricity and has become an increasingly cost-effective substitute in power plants.
But this dynamic has a limit. As higher demand pushes up prices, gas becomes a less attractive substitute to coal for utility companies. And with prices well above cash costs, we expect demand to weaken and producers to increase supply, putting pressure on gas prices. Although a cold winter could push gas prices higher, they are still likely to fall back to the long-term marginal cost of supply as spring returns.
Weaker demand may weigh on oil
Meanwhile the near-term drivers supporting the oil price also appear less compelling. Global growth, vigorous for much of this year, appears to be waning and any further recovery in demand depends on the trajectory of Covid-19 infections. We are now also past the summer driving season, a period of traditionally higher petrol consumption in the US.
Spare capacity is also weighing on oil prices. Shale producers have shown discipline by keeping output low and OPEC has firm control over prices and every incentive to manage market balances. However, private exploration and producers in the US are now adding rigs and barrels more quickly than anticipated, suggesting that supply could rise in the future.
Prices could be approaching a peak
Oil and gas prices have also been boosted by Hurricane Ida, which significantly disrupted production in the Gulf of Mexico. While this disruption should linger for some time, the effect on both oil and gas should start to dissipate from now. Longer-term drivers for energy prices remain intact, including the push to decarbonise which is restricting investment into new oil and gas fields. But over the short term at least it seems likely that oil and gas prices may be reaching a peak.
