Analyzing How Geopolitical Events Have Impacted Crude Oil Markets

Dean Foreman
Posted May 13, 2022

OPEC announced recently it will continue with planned modest increases in crude oil production, rebuffing the U.S. and others who for months have asked the cartel to ramp up its output. In a press release, OPEC sounded satisfied with the state of oil markets and noted the continuing effects of “geopolitical factors” and pandemic-related issues in its decision to stand pat.

Whether we are talking about a collection of state-owned companies that make up OPEC or investor-owned companies, a number of factors have shaped the global crude oil market in the past, including the role of financial markets and futures trading that are driven by expectations for weeks, months and even years ahead. It’s a big part of explaining why the different market responses to different geopolitical events.

Take the current situation, with oil markets historically volatile since Russia’s war in Ukraine escalated in late February. Between February 22 and March 8, Brent crude oil spot prices rose as high as $133.89 per barrel, their highest levels since 2014 and an increase of $37.20 per barrel, per Bloomberg – the largest two-week price increase on record since 1990. Yet, two and a half years ago, when a September 2019 missile attack on Abqaiq, Saudi Arabia, physically removed nearly 5.0 mb/d of productive capacity, the global oil price reaction was only about one-fourth as large as what occurred when Russia’s military operations intensified earlier this year.

The question is why – with no physical disruptions to the flows of Russian crude oil supplies – did oil markets recently have a historically large price reaction?

Prices ultimately reflect supply/demand fundamentals, but at the time of the 2019 attack on the Saudi oil facility the global market had a larger deficit – production below consumption – than it did in February 2022, by U.S. Energy Information Administration (EIA) estimates. One difference has been that OECD crude oil inventories in September 2019 were about 4% above their 10-year average, while those entering this year were about 8% below their 10-year average for January, per the International Energy Agency (IEA).

Another difference was in futures prices and the financial market’s reaction. The level and trajectory of prices was broadly higher in February 2022, before Russia’s war in Ukraine accelerated. And since then, global oil markets appear to have priced in substantial losses of Russian production despite no physical obstacles.

That’s one reason why we would argue that price expectations have mattered. Another is that, when we compare the positions that financial investors took anticipating higher oil prices, the price realizations – one and two weeks later over the periods of 2014 to 2019 and the first four months of 2022 – suggest that a significant direct correlation has historically existed but broke down in the wake of the COVID pandemic, and then resumed so far this year. 

Intuitively, expectations could play an important role in price formation. And, to the extent those expectations are influenced by energy policies, a lack of cogent energy policy support from Washington could be contributing to less-than-ideal capital inflows to the industry. This has contributed to lagging U.S. production compared to pre-pandemic levels, supply growth outpaced by demand growth, and impacts on prices to consumers.

Let’s delve in the details, beginning with the comparative Brent crude oil spot and futures prices at the time of the examples from 2019 and 2022, as well as two weeks following them.

The first thing to notice, based on the left-hand chart, was the relatively higher starting point for crude oil prices in February 2022 compared with September 2019.  In September 2019, spot prices averaged $62.83 per barrel and had gradually fallen from over $71 per barrel in April and May 2019, according to EIA data. By comparison, in February 2022, Brent spot prices averaged $97.13 per barrel, their highest for any month since August 2014.

Next, consider the futures strip – that is, futures prices at a point in time for delivery from one to 12 months in the future – shown by orange dotted lines starting just before the two attacks and red dotted lines for futures prices as they stood two weeks later.

In September 2019, the instantaneous market reaction was a price increase of $7.75 per barrel on the next trading day. As Saudi Arabia restored operations at the facility that had been attacked and reassured markets that the lost volumes could be replaced via inventories, oil prices gradually eased and fell back below their starting levels within 17 days, per EIA. Consequently, the price impact was short-lived and had relatively little impact on future expectations, seen in the left-hand chart’s virtually overlapping orange and red dotted lines. 

In February 2022, however, the spot price increase was larger, and future prices for one year ahead rose by more than $11 per barrel within two weeks, as shown by the difference between the 2022 orange and red dotted lines on the right side of the left-hand chart.

Furthermore, the right-hand panel plots the spot prices indexed to the day before each attack as an index value equal to 100, so percentage changes can easily be read.  While the quick 13% increase in September 2019 was significant, the 37.2% increase between Feb. 22 and March 8 was a record for any 14 days since 1990. And even after more than six weeks, as of April 27, Brent crude oil prices remained elevated by $6.80 per barrel, or about 90% of the maximum increase that occurred in September 2019. 

So, why was the recent price increase relatively larger if there was no physical disruption?

One possible explanation is that the market this year may have been relatively tighter. In our previous post, we discussed that global oil markets were at a deficit of 3.9 million barrels per day (mb/d), or 3.8% of global consumption, as of December 2021, per EIA.  With higher production and seasonally lower consumption, EIA estimates the global oil market deficit narrowed to 1.2 mb/d in February 2022, with Russia’s aggressions escalating over the last week of the month. By comparison, however, the global market deficits ran 1.4 mb/d and 1.8 mb/d in August and September 2019, respectively.

Therefore, if we compare the deficit of global oil production coming into this year with that in September 2019, the data could support the premise that the market was significantly tighter prior to December 2021 than it was in September 2019, per EIA’s Short-Term Energy Outlook. Alternatively, if we focus on the estimated balance either coincident with or just prior to the respective attacks in 2019 and 2022, then it is possible that the market actually had a greater deficit in 2019.  Yet, the recent price increase was much larger.

Another difference is that, whereas Saudi Arabia worked proactively to assuage global oil markets in September 2019, Russia has not done so. Official estimates of how much Russian oil production has been taken off global markets differ. EIA has estimated a sudden loss of 0.7 mb/d in April and 0.9 mb/d by May that gradually expands to 1.6 mb/d by the end of 2023. By contrast, the International Energy Agency (IEA) estimates a sudden loss of 1.5 mb/d from Russia in April, expanding to 3.0 mb/d in May. 

Consequently, another factor that could contribute to the relatively greater recent price response would be uncertainty over how much Russian production has been lost. Notably, however, even the largest impact estimate of IEA’s 3.0 mb/d by May was less than the roughly 5.0 mb/d that was lost with certainty in September 2019.

Next, let’s consider the historical correlation between futures market positions taken by financial investors, based on reports by the Commodities Futures Trading Commission (CFTC) and West Texas Intermediate crude oil prices from Bloomberg over three periods:  2015-2019, 2020-2021, and 2022.

Between 2014 and 2019 a higher percentage of financial investors (that is, the CFTC’s non-commercial category) that expected higher WTI crude oil prices correlated directly and positively with higher crude oil prices. 

Correlation is not causality, but between 2014 and 2019 we observed statistically significant correlations that showed that higher percentages of financial investors taking (“long”) positions in expectation of higher prices did generally correlate with higher prices in the next two weeks. Visually, we can see this in the left panel, by the curved trend line through the historical data. This correlation was not apparent in 2020-2021 (middle panel) but appears to be statistically significant again so far in 2022 (right panel).

For those inside baseball who might be interested in econometric methods, we are using a VAR framework and testing for Granger causality, and these correlations have been historically strong so far in 2022.

To be clear, even statistical testing for causality does not mean that financial markets necessarily caused higher oil prices, but rather that these financial stakeholders at least guessed correctly over the observed periods of 2014-2019 and the first four months of 2022. 

Again, intuitively, have risks to the global oil supply/demand balance in the wake of Russia-Ukraine been balanced to the upside and downside? Or perhaps were they more one-sided given OPEC recently told the EU that it is not possible to replace a loss of Russian crude oil?

The key takeaway here is that the data show that expectations have mattered to investors and therefore likely consumer prices.  A policy perspective necessitates that we ask the question whether things within the purview of energy policy could influence the market’s direction. 

API has consistently highlighted examples where energy policies matter to natural gas and oil industry investment, drilling and production (for example see here, here and here).  And to the extent that energy policies are misaligned with objectives to support production growth that is needed to meet the world’s large and growing energy needs, then they must ask whether their own policies could provide an increasingly one-sided bet to financial investors.  

Historically, prices have been likely to be relatively lower and less volatile when domestic U.S. production has been abundant.  And for this reason, perhaps now more than ever before, we need cogent policies to support an all-of-the-above approach to energy supplies.