Interactive Investor

Why oil prices could rocket if COP26 fails to deliver

2nd November 2021 14:44

Graeme Evans from interactive investor

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Without commitment to far-reaching plans for decarbonisation, oil could hit a 13-year high next summer, warns this expert.

The oil price squeeze feeding inflation fears will worsen in the current decade if the COP26 climate summit fails to outline an aggressive path to net-zero carbon emissions, a City bank has warned.

Without far-reaching decarbonisation commitments, Bank of America said the world will need more oil than is currently available on a forward basis to meet demand growth.

Ahead of this week's Glasgow climate conference, the Bank's analysts pointed out: “Should policy centre mostly on supply and not address demand simultaneously, a playbook similar to the one just observed in global gas markets may emerge for oil.”

Until now, the expectation that oil demand will peak this decade due to climate change pressures has kept long-dated oil within its $50-$70 a barrel range. But the bank says this could easily break into the $70-$100 range if markets see there is not enough crude oil in OECD inventories to deal with a demand surge into 2025-30.

Oil prices have recently risen above $80 a barrel due to gas-to-oil substitution and the recovery in air travel demand. The bank now forecasts that Brent crude could peak at $120 in the second quarter of 2022 and average $85 over the year, $10 higher than previously forecast.

Its new projections reflect structural oil demand as well as supply issues, particularly as some OPEC+ countries have struggled to keep up with their increased production quotas.

The longer-term position is not helped by energy companies being under pressure to return cash to shareholders rather than invest in new projects. BP (LSE:BP.) addressed the market's appetite for enhanced distributions today when it announced a share buyback of $1.25 billion and promised similar sums in the future as long as oil prices remain above $60 a barrel.

If the long-dated oil price does rise, however, Bank of America points out that this cautious position on energy industry capital expenditure could yet change.

The bank notes that investors have traditionally shied away from the energy sector on poor historical returns and ESG pressures. This week's report added: “At the moment, there is a broad array of decarbonisation scenarios for the various fuels used around the world, and making an investment decision under such future uncertainty is a very hard thing to do.

“Yet, if COP26 fails to deliver at least an "aggressive" decarbonisation path, the world will need a lot more oil to make it through the end of the decade. While we see a relatively balanced oil market in 2022 and 2023, there is very little crude oil in inventory across the OECD to deal with a sustained demand surge into 2025.”

OPEC+ ministers are meeting this week, when they will be under pressure from the US to go further than the scheduled December increase in production of 400,000 barrels a day.

UBS said this week: “Despite the price rally, OPEC+ appears keen to maintain supply control, bringing back quotas as scheduled despite consumer pressure.”

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