Posthaste: Why higher oil prices could be the key to ending the energy crisis

The only way to tame oil prices is to “destroy demand,” says global energy consultant Wood Mackenzie Ltd.

The Scotland-based firm said global oil demand needs to fall to rebalance the market, but Brent crude (the European oil benchmark) would need to rise to “at least” US$150 to achieve that goal.

“At this price level, demand would fall through multiple channels: industrial users curtailing consumption, transport substitution away from oil-intensive modes, economic contraction reducing overall activity and consumers reducing discretionary travel,” Simon Flowers, chair and chief analyst at Wood Mackenzie, said in a report on Tuesday after oil spiked to nearly US$120 a barrel.

Wood Mackenzie’s baseline level is US$150, but he said US$200 is not outside the realm of possibility this year.

It compared the Iran conflict to Russia’s war against Ukraine, when oil prices spiked to US$150 on an inflation-adjusted basis at the start of that crisis.

“Supply volumes at risk this time are dimensionally bigger — and real,” he said.

Wood Mackenzie said three-quarters of the 20 million barrels per day produced by Gulf nations have been removed from the global market, due partly to the loss of access to the Strait of Hormuz, a critical transport route.

One-fifth of the world’s sea-borne oil exports go through the narrow body of water that fully borders Iran on one side. As storage and pipelines fill up, oil-producing juggernauts such as Saudi Arabia have had to shut down production.

“The industry has never faced a loss of supply volumes of this magnitude,” Flowers said.

On Wednesday, International Energy Agency (IEA) members agreed to release 400 million barrels of oil from the Strategic Petroleum Reserves held by 32 countries in an effort to ease some of the strain on energy markets.

But there is skepticism that will make a difference in the long term if the war in the Middle East lasts.

The strategic reserve release is “no substitute for an open Strait of Hormuz,” Hamad Hussain, climate and commodities economist at Capital Economics Ltd., said in a research note on Wednesday.

In the short term, the release could help cool crude prices, he said, pointing to their drop below US$100 a barrel when talk of the IEA acting emerged earlier this week.

“However, whether lower prices could be sustained still heavily depends on how the conflict evolves,” he said.

If the war were to end soon, it would take the oil markets a month to recover. That would come at the cost of 350 million barrels of oil supply, Capital Economics estimated. That figure slightly undershoots the IEA’s planned release, but it’s likely that the 32 member countries will struggle to release enough on a daily basis to fill the gap.

Flowers also isn’t confident the reserves can compensate for the loss of barrels.

“Strategic petroleum reserves offer some relief, but cannot fully offset the supply loss,” he said.

Flowers also doesn’t believe that alternative suppliers, such as United States producers, can boost output enough to offset the shortfall.

“With no supply solution available, demand destruction becomes the only rebalancing mechanism,” he said.

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Today’s Posthaste was written by Gigi Suhanic with additional reporting from Financial Post staff and Bloomberg.

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