Band John Kemp

LONDON, October 5 (Reuters) – What are the real level of oil prices and what signal are they currently sending to producers and consumers about the need to increase production and reduce fuel consumption?

The strength of a price signal depends on both the real level prices corrected for inflation and rate of change compared to recent years.

In terms of the pace of change, prices are already sending a strong signal about the need to increase production and reduce consumption, as the recovery in demand outstripped supply after the coronavirus-induced crisis last year. .

First-month Brent futures are currently trading above $ 82 a barrel, down from under $ 38 at the end of the same month last year, one of the fastest growing prices in terms of percentage for three decades.

Rapidly escalating prices are characteristic of the first year of a cyclical recovery, when consumption rebounds and grows above trend, as producers continue to suspend production, scarred by memories of the recent recession.

The shift from low / falling to higher / rising prices sends a signal on the need for producers to move from reducing to increasing production, and consumers to save fuel rather than shy away from fuel. indulge in lust.

But in terms of the price level, corrected for inflation, the current signal to producers and consumers is so far weaker and more ambiguous (https://tmsnrt.rs/3a91SB5).

Comparisons to oil prices in previous cycles are skewed by the impact of inflation, which has consistently eroded the value of the US dollar and has tended to increase oil futures prices over time.

The impact is relatively insignificant over periods of 2 to 3 years, small enough to be ignored, but becomes increasingly important over time horizons of 5 to 20 years.

The dollar has lost nearly a quarter of its purchasing power since oil prices peaked at over $ 140 a barrel in 2008.

If the record Brent prices in 2008 are reduced to the purchasing power of the dollar in 2021, prices have peaked at over $ 180 per barrel.

EVALUATE ACTUAL PRICES

Inflation-adjusted prices in the past were much higher than they sometimes appear in retrospect, and current prices are lower than they appear in long-term historical comparisons.

In real terms, first-month Brent prices are currently at the 72nd percentile for all months since 1990, but only at the 50th percentile for all months since 2000 and the 56th percentile for all months since 2010.

There is no ideal timeframe for evaluating actual prices.

Longer comparisons incorporate more cycles but contain older and less relevant data. Shorter timeframes are more relevant but contain fewer cycles and may be more distorted by short periods of high or low prices.

In the oil market, 30-year comparisons are skewed by the long period of very low prices in the 1990s, which proved unsustainable, and may not be relevant to decisions a quarter of a century later.

But the shorter comparisons since 2000 or 2010 are dominated by periods of very high prices in 2007-08 and 2011-14, which have proven to be equally unsustainable, and may not be relevant to decisions in the 2020s.

The four decades from 1990 to 2030 contain several real and future changes in production and consumption regimes and behaviors, making historical comparisons difficult.

Important changes include huge production overcapacity in the 1990s, the shale revolution in the early 2010s, and the advent of electric vehicles to compete with oil in the 2020s.

However, looking at the price level in all of these periods, the more conservative conclusion is that the real oil price level is currently average or moderately high.

Real prices are sending a signal to producers and consumers about the need to increase production and save more fuel, but this signal is not yet very strong.

Further significant price increases may be needed to force consumers to reduce their oil consumption and switch to cheaper alternatives and encourage producers to increase production.

Associated columns:

– OPEC + and the challenge of managing markets (Reuters, July 6)

– Soaring oil prices would speed up the US shift to electric vehicles (Reuters, July 1)

– Rising oil prices signal the need for more production (Reuters, June 16)

– Oil prices find a new equilibrium (Reuters, April 15)

(Edited by Emelia Sithole-Matarise)

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