Could Oil Really Hit $200?

Could Oil Really Hit $200?
Stéphane Renevier, CFA

almost 2 years ago5 mins

  • There simply isn’t enough global capacity around to offset the loss of Russian exports, which could drive up the price of the slippery elixir to the $200 mark.

  • But demand might not adjust until prices rise high enough, which could take some time unless a recession wipes out demand for oil.

  • That tilts the risk to the upside in the short term, but there are ways to use options to bet on either side of the argument.

There simply isn’t enough global capacity around to offset the loss of Russian exports, which could drive up the price of the slippery elixir to the $200 mark.

But demand might not adjust until prices rise high enough, which could take some time unless a recession wipes out demand for oil.

That tilts the risk to the upside in the short term, but there are ways to use options to bet on either side of the argument.

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Oil’s fundamentals were already bullish well before Russia attacked Ukraine: inventory levels have been running dry, and the world’s production capacity has hit multi-decade lows. Now, though, Goldman Sachs thinks we’re looking at a price of around $135 by the end of the year, while JPMorgan is predicting $185 if the US ban on Russian exports goes ahead. Hedge funds like Westbeck and Andurand have even higher expectations, making the case that $200 is on the cards. So is that really possible?

How would $200 oil happen?

There’s a big question mark over how big the gap between the supply of and demand for oil is right now. And that’s ultimately what’ll determine how high its price goes in the short term.

The supply isn’t looking good. Even if there hasn’t been any official sanction against Russia’s oil production yet, the market has already been boycotting it. Russia recently couldn’t find a buyer for a cargo of oil with a record $18-a-barrel discount, for example. And even if the country’s oil is redirected elsewhere (with China the most likely to cave in), longer trade routes will still mean there’s a short-term hold-up in supply.

Of course, another major oil-producing country could swoop in to save the day. But it seems unlikely. The actual amount of OPEC’s spare capacity is up for debate, but only Saudi Arabia and the United Arab Emirates could realistically increase short-term production by enough to meet demand. Iran’s currently subject to sanctions, even if it is showing good progress in negotiating a nuclear deal that could bring them to an end in the third quarter. Venezuela is under the thumb of sanctions too, and its support of Russia makes any negotiations pretty unlikely. And Libya – Africa’s largest oil reserve country – is facing a halt in production due to a deepening political crisis.

Now, even if Saudi Arabia and UAE do increase production (and the latest OPEC meeting shows they aren’t ready to just yet), it would completely deplete what’s left of the global market’s spare capacity, pushing its price higher until a more permanent solution is found in any case. That’s exactly what happened after the International Energy Agency (IEA) released its emergency reserves.

So OPEC is unlikely to be a game-changer anytime soon. That leaves the US, but an increase in the production of the country’s shale oil would take at least two quarters given recent supply chain issues, a tight labor market, and a lack of investment on new production. Once again, it’s unlikely to help much in the immediate future.

What would stop $200 oil from happening?

A sudden turnaround from OPEC members and a dissipation of geopolitical tensions might naturally bring the oil price down to more manageable levels. But failing that, the only cure for a high oil price might be… a high oil price.

That’s because, in the long term, it might accelerate the transition to renewable energy. Higher-than-expected demand for electric vehicles, for example, would add significant pressure by diverting demand away from the black gold. And the opposite could be true too: governments could soften their climate pledges in order to reduce the negative impact of a higher price on their consumers, leading to higher investment in the oil and gas industry, increased production, and ultimately a lower price.

In the shorter term, a high price at the pump – which has reached $6 a gallon in some regions – could incentivize people to cut back on their spending, as might more expensive goods more generally (oil’s used in pretty much everything, remember). By traveling less and reducing their spending, both the demand for and the price of oil will start to fall. Of course, that process might still take several months.

But there’s a possibility we see a lower price much more quickly: an inflationary shock could bring the economy to a recession and crash the global stock market. In fact, every time the oil price has risen as sharply as it is doing, a recession has followed. Given record positioning, liquidity issues, and a higher share of algorithmic traders, a collapse in the oil price isn’t exactly inconceivable. Oil went from $140 to $40 in just four months back in 2008, after all.

So is oil likely to hit $200?

The $200 mark is a very real possibility. In fact, given the supply constraints and lag between a higher price and lower demand, it’s arguably a lot more likely to gain $80 than lose $80 right now. The difficulty, of course, is knowing how long it’ll stay there before demand is impacted and the price starts to slide again: that depends on whether the global economy is tipped into a recession or not.

If you think there’s more upside in the oil price here, I’d recommend buying short-term out-of-the-money calloptions on the Brent price or on oil ETFs. It’s definitely not the cheapest route (the current price of a $200 strike option with a May expiry is about $2.40 a barrel), but it will mean you risk less on the trade and improve your chances of making money if your view is correct.

Buying an exchange-traded fund directly or a futures contract isn’t ideal in this environment, as you’d have to put a very wide stop-loss given the market’s extreme volatility. Risking $40 to make $50 significantly reduces your asymmetry and means you’re relying more heavily on getting your prediction right. So for most retail investors, a steep option premium might be worth every cent.

If, on the other hand, you want to take a position for oil’s eventual downfall, buying longer-dated out-of-the-money put options on the black gold’s price look quite attractive. Just be aware that this might not be available to you if your platform doesn’t allow you to trade options on futures. Or you could bet on the performance of less direct beneficiaries of high oil prices: check out Reda’s Insight for more on that.

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