December 21, 2020 | Policy Brief

Oil Prices Reach Highest Level Since Beginning of Pandemic

December 21, 2020 | Policy Brief

Oil Prices Reach Highest Level Since Beginning of Pandemic

The Brent and West Texas Intermediate oil benchmarks are both now back up to their pre-COVID-19 lockdown levels, reaching their highest point last week since March 2020. While oil prices took a dip today with the news of new lockdowns enacted in many countries, other commodity prices are soaring, indicating anticipation of strong global economic activity. Oil’s upward trajectory is therefore likely to continue into early 2021.

The rise in oil prices is taking place even prior to widespread deployment of COVID-19 vaccines. If the vaccines are as effective as anticipated, commercial activity ought to increase over the next few months, thus boosting oil demand and putting additional upward pressure on oil prices.

Some COVID-19-related trends are likely to strengthen demand for oil. As people return to in-person work in greater numbers, they are not using public transportation at anywhere near pre-COVID-19 levels. Traffic is back to pre-COVID-19 rates in many major cities. Thus, with more miles traveled via private vehicles, demand for oil for transportation will continue to rise. Fear of using public transportation is likely to linger for a long time.

In addition, demand for oil will come from increased demand for plastic, which is likely to continue for several years due to increased use of disposable items, individually packed food servings, protective gear, and medical plastics. This will reverse the anticipated decline in demand for plastic, a trend that was factored into pre-COVID-19 projections of oil demand.

In the short term, two developments in the United States will affect global oil prices. First, the arrival of the congressional stimulus package will likely rouse additional commercial activity and create more funds for paper trades in oil, putting additional upward pressure on price.

Second, the Georgia run-off elections on January 5 will determine if Republicans maintain control of the Senate alongside Democratic control of the House. If Congress remains divided, investors are likely to expect continuity in the tax code and federal regulatory frameworks, thus spurring investments, including in oil.

In the long term, if the global oil price remains at or above $50 per barrel, as it is now, U.S. oil production, which has significantly decreased in 2020, will likely increase. This would put downward pressure on oil prices.

Geopolitical factors will also affect prices. The Organization of the Petroleum Exporting Countries (OPEC) Plus group will evaluate its oil production strategy again in January. Russia supports releasing more oil into the market in order to prevent a higher price from stimulating renewed U.S. oil production. Meanwhile, Saudi Arabia is likely to support keeping previous supply cuts in place or minor production increases in order to enjoy the heightened revenue.

A major unknown that will affect global oil prices is the long-term trend of the U.S. economy. Prior to the COVID-19 lockdowns, the U.S. economy was on an unprecedentedly long growth streak, which was likely to end at some point in 2020 or 2021. A downturn in the $20 trillion-plus U.S. economy would dampen global demand for oil, resulting in lower prices.

Now that the United States is the world’s top producer of oil, high oil prices affect it differently than in the past and have a mixed impact on the U.S. economy. Specifically, higher fuel prices raise costs in family budgets but overall provide a boost to the U.S. economy and especially to the oil producing regions of the country.

Brenda Shaffer is senior advisor for energy at the Foundation for Defense of Democracies (FDD), where she also contributes to FDD’s Center on Economic and Financial Power (CEFP). She is also a faculty member at the U.S. Naval Postgraduate School. For more analysis from Brenda and CEFP, please subscribe HERE. Follow Brenda on Twitter @ProfBShaffer. Follow FDD on Twitter @FDD and @FDD_CEFP. FDD is a Washington, DC-based, nonpartisan research institute focusing on national security and foreign policy.