Following a strong recovery, how much further does oil have to go?

Brent crude oil price chart
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The Brent crude oil price has continued a dramatic recovery this year.
Brent crude last week briefly crossed $66 a barrel (where it started 2020). A recovery in demand has stoked oil prices. That demand surge is largely coming from the prospects of an acceleration in transport activity as vaccine programs roll out.
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Brent crude oil and other commodities

Oil is, of course, not alone.
Many commodities have been boosted this year by both the reality and the expectation of increased demand.
Copper has been one of the stellar performers, topping $9,000 per metric ton for the first time since 2011. This largely seems to follow on the strength of rising electric vehicle demand. As such, it seems almost counterintuitive that an investment dynamic, electrification, that is driving one commodity, copper, to decade highs is also driving oil — whose greatest threat is electrification — to also rise strongly.
But that’s commodity markets for you. One common denominator for both is perceived tight supply, for oil in the short term and copper in the longer term.

Oil in a deep deficit

According to the Financial Times, Morgan Stanley said last week that it estimated the oil market is now in a deep deficit, with demand outstripping supply by as much as 2.8 million barrels a day this year.
“The stars have aligned for the oil market even faster than expected,” the Financial Times quoted the bank as saying.
Bank of America analysts quoted in the same post said underinvestment in supply could send oil as high as $100 a barrel in the next five years. However, the analysts added such a surge would probably be temporary. They forecast the Brent crude oil price is likely to average between $50 and $70 per barrel between now and 2026.
The temptation to cash in such a steep rise would be too much for oil producers running hefty budget deficits. It would likely encourage a return of at least parts of the US shale industry, lured by price levels above $65/barrel for any sustained period.

Underinvestment and output

In speculators’ defense, the oil industry has suffered chronic underinvestment in recent years.  Hampered by a low oil price, both maintenance and new resource development have been pared back. The disconnect between a further out decline in demand due to the electrification of transport could take longer to materialize than the drop in output that will inevitably come from underinvestment.
Perception of that gap is what is currently driving speculation and will drive volatility as demand recovers. Oil demand is still at least 5 million barrels per day lower than in 2019. As vaccines roll out and economies recover – particularly the oil major users US and China – demand will recover quite quickly.
Some forecasts indicate GDP will increase by 8% in the US this year by some measures. Growth in China, which has already seen strong growth last year and this, will likely not be much less.
Prices of $100/barrel might be a stretch. However, we wouldn’t bet against further rises from current levels in the year ahead.
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