[Choi Ji-woong's Energy War] Why Voices Calling for Oil 'Supply Shortage' Are Growing

Decline in Oil Development Since 2015
US Shale Industry Production Growth Sluggish
OPEC+ Production Quotas Not Met
Supply Capacity Limits Become Clear

Supply-Demand Imbalance Risk Increases
Uncertain Whether It Will Prolong
Top Reserve Countries Have Production Expansion Potential

Resolution of Political Conflicts in Major Oil Producers
Long-Term Oil Price Outlook Depends on Production Increase Through New Investments

Editor's NoteAsia Economy publishes a monthly series every Thursday titled "Choi Ji-woong's Energy War," diagnosing the energy industry amid a period of great transformation and examining the related changes in the international order. The author is an energy expert who joined Korea National Oil Corporation in 2008, worked in the Europe and Africa Business Division and the Stockpile Business Division, and completed an MBA in Oil and Gas at Coventry University in London in 2015. He is the author of the bestseller "The Future of the 2050 Energy Empire," which covers the present and future of energy.

[Image source=Getty Images]

After international oil prices surpassed $100 per barrel, many media outlets and experts have spoken of a supercycle in crude oil or the possibility of supply shortages. Warren Buffett's Berkshire Hathaway recently made a large purchase of shares in the U.S. oil company Occidental. What is the basis for many people claiming oil supply shortages or a supercycle?

Until 2019, just before the outbreak of COVID-19, oil consumption was steadily increasing. Over the five years leading up to the pandemic, oil consumption grew at an average annual rate of about 1.3%, and the average annual growth rate over the past 20 years was also about 1.3%. In other words, until the sudden halt caused by COVID-19, oil demand showed a consistent and robust upward trend. That trend was interrupted in 2020, the year the pandemic began. However, this was an event limited to 2020. In 2021, oil demand increased again, returning to the previous trend.

This is a natural outcome in some ways. The global energy consumption environment has not changed before and after the COVID-19 outbreak. Developing countries continue to pursue urbanization and industrialization. Approximately 70 million cars are sold annually, and no alternative transportation modes have emerged to replace ships and airplanes powered by oil. Therefore, once the pandemic subsides, it is only natural that global oil demand will return to its previous upward trajectory. Already, in the first quarter of this year, average daily oil consumption recovered to 98% of the daily average in 2019. This is notable given that jet fuel demand has not yet fully recovered. Jet fuel accounts for about 6-7% of total oil demand. Since jet fuel demand dropped by about half after the pandemic, its full recovery could increase oil consumption by approximately 2-3%.

Some raise concerns about inflation, the economic downturn caused by Russia's invasion of Ukraine, and the potential decline in crude oil demand. However, looking at past cases, it is very rare for oil demand to decrease due to a recession. Over the past 30 years, annual oil consumption declined only three times: during the financial crisis in 2008 and 2009, and during the COVID-19 pandemic in 2020. In other words, oil consumption decreased only when the global economy experienced severe shocks such as a financial crisis or a pandemic. Even in those years, the decline was not drastic: 1.26% in 2008 and 1.33% in 2009 compared to the previous year. In fact, during the first oil shock in 1974, oil consumption fell by only 1.35% compared to the previous year. These historical examples clearly demonstrate the inelasticity of oil demand.

Now, the ball in the oil market moves to the supply side. If demand continues to rise steadily as before, oil prices will be determined by how well supply can keep pace with demand. Those arguing for supply shortages point to a clear decline in production capacity. Since 2015, there has been a sharp drop in oil development, sluggish production increases in the U.S. shale industry, and OPEC+?the coalition of OPEC and non-OPEC major oil producers?failing to meet production quotas, all indicating clear limits to supply capacity. In fact, many OPEC+ member countries are not meeting their assigned production quotas.

Jiwung Choi, Researcher at Korea National Oil Corporation Smart Data Center

Some claim that production is intentionally restrained to maintain high oil prices. However, oil-producing countries are eager to stimulate their economies after the shock of COVID-19. It is nonsensical to deliberately produce below quota in this situation. Even if OPEC+ as a whole restrains production for collective benefit, they would still produce up to their quotas. The fact that quotas are not being met indicates a lack of production capacity. Currently, except for Saudi Arabia and the United Arab Emirates (UAE), member countries appear to have exhausted their capacity to increase production.

Moreover, Western efforts to reduce imports of Russian crude oil in response to Russia's invasion of Ukraine increase demand for oil from other producers, driving up prices. As the market becomes more fragmented and political considerations take precedence over economic logic, upward pressure on oil prices will intensify. Fundamentally, crude oil supply cannot be increased quickly. Even if a large oil field with reserves of about 1 billion barrels were discovered in Korea's East Sea, it would take a long time to start production. Offshore production facilities must be constructed, and pipelines laid if necessary. This process takes several years. The long lead time for oil production has caused mismatches between supply capacity and demand, which in turn have created past oil price cycles. Currently, the possibility of such a mismatch is increasing.

As described above, from a short-term perspective, the likelihood of supply-demand imbalances is growing. However, whether this will persist long-term is another matter. Countries ranked first to fourth in proven oil reserves?Venezuela, Saudi Arabia, Canada, and Iran?still have sufficient capacity to increase production. Venezuela, despite having the largest reserves, produced only about 500,000 barrels per day in 2020. Political and economic instability and U.S. sanctions continue to limit production growth. However, Venezuela has significant potential to increase production in the long term. Canada, ranked third in reserves, produced about 3 million barrels per day of unconventional oil from oil sands in 2019, accounting for over 60% of its total oil production. With technological advances and ample reserves, Canada’s oil sands are expected to support steady production increases. Iran, ranked fourth, would likely pursue active new development if U.S. sanctions are lifted.

Ultimately, the long-term direction of oil prices depends on how quickly major oil-producing countries can resolve political conflicts and increase production through new investments. At present, the geopolitical trends surrounding oil and the precise actions of major producers remain uncertain. This unprecedented uncertainty in oil supply and demand poses a significant threat to Korea, the world's fourth-largest crude oil importer. Therefore, it is necessary for Korean energy companies to actively engage in the global oil supply chain and adopt strategies that go beyond being mere buyers.

Choi Ji-woong, Researcher, Smart Data Center, Korea National Oil Corporation