Before Thanksgiving, President Biden announced he would be releasing 50 million barrels of oil from the U.S Strategic Petroleum Reserve to “address the lack of supply around the world.”¹ As we all know, the market sets the price for oil based on existing and expected supply and demand relationships for this commodity.

Three major factors have impacted new supplies:

1. Cancellation of federal pipeline projects
2. The focus on environmental, social, and governance (ESG) values and metrics for oil companies
3. Capital allocation strategy for larger companies to pay higher dividends and to buy back shares, as compared to drilling for new oil reserves, thus increasing supply

Of the 50 million barrels, 32 million will eventually be returned to the strategic reserve over the years ahead once (if?) fuel prices come down in a bid to ensure the reserve remains stocked, officials said. Another 18 million barrels will be released as an acceleration of an oil sale Congress had already authorized. Tuesday’s announcement was made in concert with China, India, Japan, South Korea, and the United Kingdom, which will also tap into their own strategic reserves.¹

Pipeline Cancellations

One of the first actions for the Biden Administration was to revoke a key permit needed for a U.S. stretch of the 1,200-mile project. Upon this action, owner TC Energy halted further development. The Keystone XL pipeline was expected to carry 830,000 barrels per day of Alberta oil sands crude to Nebraska.²

Environmental, Social, and Governance Values

The institution of ESG values and metrics represents a true revolution in how corporations are managed, measured, and operated. This change will continue to drive companies away from the familiar framework of short-term profits toward success that is not only defined by profitability but also by a “sustainable” and measurable contribution to the betterment of society at large.³

BlackRock is the world’s largest investment manager with $10 trillion of assets under management. According to S&P Global, as of February 2021, oil and gas represented 2.55% of its total investments, and coal and consumable fuels accounted for 0.36%.  Despite these small percentages, the investments are material and represent close to $255 billion and $36 billion, respectively, in the energy sector.  As such, when BlackRock’s CEO Larry Fink speaks, people listen, including those in the energy sector.

To that end, in a 2020 letter to investors, Larry Fink warned that “given the groundwork we have already laid engaging on disclosure, and the growing investment risks surrounding sustainability, we will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.” 

As illustrated by BlackRock’s CEO, a lack of an ESG strategy going forward will ultimately affect a company’s access to public, and increasingly private, capital.

Capital Allocation Strategy

Consistent with many of the goals of ESG, major oil companies are focused on cleaning up their portfolios and returning capital to shareholders, either through increased dividends or share buybacks. This lack of focus on new drilling, even in times of increasing oil and gas pricing, has reduced supply in light of increasing demand, moving prices higher.

In summary, I do not expect the release of 50 million barrels from the Strategic Petroleum Reserve to have much of an impact. Although small changes can be made to supply and demand determinants on the margin, the markets still control the prices, not the President or the large oil companies.

Last Friday, concern over a new variant of COVID-19 caused the Dow Jones Industrial Average to fall by 900 points, and oil prices to fall by ten dollars per barrel,⁴ illustrating that the market still controls oil and natural gas clearing prices. 

WTI Strip Prices Increase

Spot prices and futures prices for the WTI contract decreased by approximately $12.00 per barrel in the near term and approximately $7.00 per barrel over the longer term.

Oil Strip Prices - One Month Change

The oil price curve remains in “backwardation,” reflecting the market’s expectation of lower future spot prices.

Oil Price Outlook

The price distribution below shows the crude oil spot price on December 1, 2021, as well as the predicted crude oil prices based on options and futures markets. Blue lines are within one standard deviation (σ) of the mean, and red lines are within two standard deviations.

Based on these current prices, the markets indicate there is a 68% chance oil prices will range from $47.00 and $83.50 per barrel in mid-March 2022. Likewise, there is roughly a 95% chance that prices will be between $25.00 and $105.50. By mid-May 2022, the one-standard-deviation (1σ) price range is $45.00 to $88.50 per barrel, and the two-standard-deviation (2σ) range is $23.00 to $121.50 per barrel.

Key Takeaways

Remember that option prices and models reflect expected probabilities, not certain outcomes, but that does not make them any less useful. If someone asks you longingly if oil will be at $105 per barrel again soon, you now can respond that markets indicate there is about a 2.5% probability that oil prices are expected to be above that by this March, so it is not likely.

1. Biden administration to release 50 million barrels of oil from strategic reserve, The Hill
2. Keystone pipeline officially canceled after Biden revokes key permit, CNBC
3. ESG: How it Applies to the Oil & Gas Industry and Why It Matters, Womble Bond Dickinson
4. Oil pricing graphic from CNBC.com