Will oil prices ever truly go back to ‘normal’?

The fallout from war between the United States, Israel and Iran has dominated global oil markets. And not just because the Strait of Hormuz, which normally carries about 20% of global oil and gas, remains effectively closed^[1] to shipping traffic.

Deep uncertainty about how long the disruption will continue has added a persistent “risk premium”^[2] – an extra cost built into oil prices to account for the risk of disrupted supply.

Rising insurance costs, reduced ship traffic and longer transit routes avoiding the Middle East have all added further friction to global oil supply chains.

An optimist might say this will all be sorted out quickly and soon enough we will be back to “normal”^[3]. And oil prices have retreated^[4] back below US$100 per barrel this week, on renewed hopes of a peace deal.

But they’re still elevated. Before war broke out in the Middle East, benchmark oil prices had hovered in the range of US$70–80 a barrel^[5] since 2023. That’s near where they’ve sat, on average, in “normal” times for much of the past two decades.

But what if there is no way back to “normal”? What if the fundamental challenge now isn’t the short-term disruption in supply, but the realisation that the days of cheap oil may have come to an end^[6]?

Oil’s invisible reach

Higher oil prices have a ripple effect that typically starts at the fuel pump. Petrol, diesel and jet fuel are top of mind. Driving to work, moving goods and travelling all become more expensive.

Many fertilisers, too, are petrochemical products^[7]. That means farming around the world is exposed to a shock.

But the list of goods that rely on oil and gas goes far beyond fuel and fertiliser. According to the US Department of Energy^[8], petrochemicals (derived from oil and gas) are involved in the manufacturing of more than 6,000 everyday products.

In many cases, this is because petrochemicals are a key input in the production of plastic. But other products on the list^[10] may be surprising, such as aspirin, dishwashing liquid, toothpaste and dyes.

Building materials used in construction warrant a special mention. Asphalt, insulation, paint, pipes, membranes, fittings and other composite materials are mostly oil byproducts. Manufacturing bricks and many ceramic products is also gas-intensive.

Add transporting it all to the construction site, and the oil crisis becomes another headwind^[11] to housing affordability.

Is this the end of cheap oil?

In 1999, an article^[12] in The Economist quoted Don Huberts, who was then head of Shell Hydrogen at oil company Royal Dutch/Shell:

The stone age did not end because the world ran out of stones, and the oil age will not end because we run out of oil.

True enough, but what about cheap oil? Can that come to an end?

The world has faced many oil shocks before, some for geopolitical reasons^[13], others due to concerns demand would outstrip supply^[14].

But almost every time analysts predicted the world was about to run out of oil, price hikes were met with new discoveries, technological improvements and oil substitution.

Companies such as Chevron^[15] have pioneered new techniques, such as deepwater drilling.

Extracting oil from shale through fracking unlocked new supplies, especially in the US. This helped the US become the world’s largest producer of crude oil^[16] in the late 2010s.

This time, however, production facilities across the Middle East have suffered major damage^[17], which may take years to repair. The central question is no longer whether oil exists in the ground, but whether it can be supplied cheaply, reliably and at scale again.

Just in time vs just in case

Until 2020, global economies largely operated in “just-in-time^[18]” mode. You only take what you need, when you need it, assuming it will always be there for you. This system works efficiently – and is cheap – until something goes wrong.

Lessons from the pandemic brought back the idea of “just in case^[19]”, particularly as the war in Ukraine caused further disruption.

“Just in case” means that you keep more than you need, so if someone closes the tap, you can keep all else running. However, this creates new costs^[20].

To keep more oil and gas than you need, you don’t just have to pay for the extra stock. Countries also have to build new storage and infrastructure, and pay more in insurance.

You refine your management to make sure it all works properly, so that the extra cost added is part of a larger contingency plan. But someone must foot this bill.

References

1. ^{^} effectively closed (www.nbcnews.com)
2. ^{^} added a persistent “risk premium” (www.db.com)
3. ^{^} back to “normal” (www.bloomberg.com)
4. ^{^} retreated (www.bbc.com)
5. ^{^} US$70–80 a barrel (www.statista.com)
6. ^{^} may have come to an end (www.thetimes.com)
7. ^{^} petrochemical products (gvg-co.com)
8. ^{^} US Department of Energy (www.energy.gov)
9. ^{^} Polina Tankilevitch/Pexels (www.pexels.com)
10. ^{^} list (www.energy.gov)
11. ^{^} another headwind (theconversation.com)
12. ^{^} article (www.economist.com)
13. ^{^} geopolitical reasons (theconversation.com)
14. ^{^} concerns demand would outstrip supply (econweb.ucsd.edu)
15. ^{^} Chevron (www.chevron.com)
16. ^{^} world’s largest producer of crude oil (www.eia.gov)
17. ^{^} suffered major damage (www.afr.com)
18. ^{^} just-in-time (mag.toyota.co.uk)
19. ^{^} just in case (hbsp.harvard.edu)
20. ^{^} creates new costs (www.afr.com)
21. ^{^} Neil Hall/EPA (photos.aap.com.au)
22. ^{^} travelling less (www.independent.co.uk)
23. ^{^} more public transport (www.bbc.com)
24. ^{^} electrifying (www.theguardian.com)