$170 a barrel? Why crude oil prices could easily jump 50% or more

While it seems impossible that oil could jump another 50%, it’s actually quite easy. It could happen fast. Maybe even overnight.

Since December 1st, 2021, oil has gone on a monster run. Here’s the chart for USO, which tracks price movements of the WTI futures contracts.

For now, oil is having a harder time jumping higher. Which is good thing because nobody likes these gasoline prices. But high energy prices don’t just affect commuters, they affect the price of almost everything since most products are shipped by vehicles that burn fossil fuels.

Part of the reason you’re seeing all these headlines about inflation is due to the price of oil. Although an interesting thing about prices is that people seem to quickly get used to them. The first time it costs $100 to fill up your tank, you’re outraged and complaining on social media. The second time you’re depressed and complaining to your significant other. The third time you it costs $100 to fill the tank you’ve stopped caring. It’s normal now. Your spending habits have adapted to accommodate this new reality.

People also like to believe that once something bad has happened, this decreases the likelihood that it will happen again. Like when you get two monster floods in a row. “How is this possible!? They said it was a one in a hundred-year event!”

So, if you’re looking at the price of oil and thinking, “It’s impossible that this could get any worse,” let me tell you, it’s extremely possible.

Calculating the price of a good is simple. You’ve got production and distribution costs, and then mark-up, which affects how much profit you can make.

Mark-up is affected by supply and demand.

Right now, the supply of oil is artificially lower due to sanctions on Russia. Europe is trying to reduce their dependence on Russian energy. So far, they’ve agreed to reduce consumption by 90% by the end of the year.

We’re also in the summer season in the northern hemisphere, so demand for gasoline is up because people are taking vacations. They’re driving across the country. They’re driving back-and-forth to the cottage, etc.

It’s also a quiet time for Covid-19. This means demand for travel is up. Some people haven’t vacationed in years. Now that Omicron seems mild and people have their boosters and/or already been infected, they want to travel. So, demand for jet fuel is up.

When supply goes down, and demand goes up, price will go up. (Unless the price is being controlled, in which case a black market will form.)

If the price of oil jumps another 50%, we’ll see more demand destruction. That’s a given. People will consume less oil. Instead of driving across the country, some people will just drive across the state. People will start carpooling and biking more. Manufacturers that use oil will look for substitutes. For example, if it’s cheaper to make plastic straws, but then the price of plastic quadruples, then it might be cheaper to make paper straws. Substitutions are always looked for when the price of components goes up. But you can’t replace everything. Gasoline can’t be swapped with olive oil. It wouldn’t act as fuel and would taste horrible on a salad.

There is a ceiling to the maximum price of oil, but we haven’t got anywhere near it yet. And the reason is for this is that the war in Europe is still relatively contained. Russia hasn’t attacked any NATO countries so our role in this conflict is limited to sending aid to Ukraine.

Over the next year, there is a small chance this conflict expands. Sweden and Finland, for example, will be trying to join NATO. This is a real danger to Russia because Russia shares an 830-mile border with Finland.

Here is a video on how Sweden and Finland joining NATO would threaten Russia.

Russia has lot of their strategic (nuclear) assets stationed in the Kola peninsula. To get north by land, there is a railway with a long corresponding road. This track is surrounded by forest which makes it easy for special forces to operate in. In a NATO/Russia conflict, it would be child’s play for Finland to sabotage the road and rail network in multiple places. Even if Russia stationed a million troops along the road, they likely couldn’t protect it.

There are lots of videos and articles explaining why Finland and Sweden joining NATO is a major danger for Russia, but since this is an article on the price of oil, let’s get back to that.

Even though McDonald’s is gone, Russia is still lovin’ it

Oil being expensive is bad for you and me, but Russia is thrilled. They’re exporting more oil than ever before. India has gone from purchasing near zero Russian oil, to more than 800,000 barrels a day. China is now importing more oil from Russia than Saudi Arabia.

Higher sales and higher prices mean Russia is earning more than $20/billion a month. Which means if oil goes higher, Russia profits even more. For now, the cost of the war is immense, but if Russia slows down the speed of their advance and consolidates their gains, then this war will quickly pay for itself.

If Russia can keep oil prices high over the next few years, they can afford to rebuild everything they’ve lost and then some.

A higher oil price also means a higher chance that Joe Biden loses re-election. A president’s approval rate is tied to the price of oil. The lower his approval rating, the less chance he wins re-election.

Joe Biden out and Donald Trump in would be a tremendous victory for Putin.

The war doesn’t need to go nuclear for the price of oil to jump 50%

All it would take is a few attacks on some critical infrastructure. Because if the supply of oil goes down, the price of oil goes up. Like in September of 2019, when drones attacked a facility in Saudi Arabia.

About half of Saudi Arabia’s producton was taken offline. Oil jumped about 20% overnight because of this. Although the price quickly dropped because they assessed the damage to be not that bad. The Saudis also paid through the nose for engineers to repair it quickly.

Earth got lucky that time. It could have been much worse. Imagine that facility had been permanently destroyed? Then you’re looking at a 20% boost that lasts until they can rebuild it. That could take years if it’s even possible at all. (If nuclear weapons are used on critical oil infrastructure it could take decades for the price to fall.)

Yes, this was in Saudi Arabia, which is far from the war in Ukraine, and the Saudis seem more-or-less friendly with the Russians. But the Americans aren’t friendly. They’re supplying Ukraine with more weapons than anyone.

Here is a chart of military aid that that has been promised and provided to Ukraine.

The US, UK, Canada, and Norway, are in the top five. These countries are also major oil producing nations. Obviously the US and Canada are even farther away from Ukraine than Saudi Arabia is, but their infrastructure is still vulnerable to cyber attacks.

Russia has made it clear that once the gloves come off, they will commit whatever crimes they need to ensure a victory. While they haven’t directly attacked NATO, we shouldn’t assume that it’s impossible.

American military policy is often one of a measured response. For example, the US wouldn’t nuke Iran if some of Iranian proxy forces fired rockets at a US consulate in Iraq. It simply isn’t done. The response is sometimes nothing, sometimes airstrikes if the perpetrators can be identified, or someone was injured.

So, would a cyber attack that temporarily shuts down 25% of American oil production trigger World War 3 and nuclear Armageddon? Probably not.

But wait, there’s more!

Now that I’ve got you worried about extraction facilities, let me tell you there’s a lot more that could be destroyed that could trigger a jump in oil prices. You’ve got pipelines, refineries, storage facilities, etc.

You’ve also got oil tankers. You know, those giant boats that leak sometime and cause environmental disasters.

Oil tankers come in varying sizes, but the largest and most popular form of transport is the VLCC (Very Large Crude Carrier). These ships can transport about 2.2 million barrels of oil. The total size of the VLCC fleet is somewhere around 860 ships.

If someone wanted to disrupt the flow of oil for political or war-time purposes, these would be easy targets. For example, from 1984 to 1988, Iran and Iraq were engaged in what was later called the Tanker War. Hundreds of ships were damaged or destroyed.

Oil tankers have been sunk before, and they can be sunk again. If too many VLCCs are sunk or rendered inoperable it could have a disastrous effect on shipping rates.

When most people think of shipping, they think of packages. They understand the price fluctuates based on the size and weight. Call it 10 to 30 bucks to ship a box of stuff. But what if you went to a mail a Christmas gift and the clerk said, “Sorry, a bunch of our planes are damaged, and like 25% of the truck fleet is down because we can’t get the parts to fix them. So, to ship that package it’s gonna be $427.29.”

Well, first you would probably say swear, then cycle quickly through the stages of grief. It doesn’t seem possible that shipping rates could jump that much, and for packages it would probably never happen. Fixing a truck is relatively easy, and companies like Fed Ex and UPS have tens of thousands of trucks.

But there are only around 860 VLCCs. These are difficult to fix, and they are difficult to rebuild. They can only be repaired or constructed in special ports. It can take up to 15 months to build a single VLCC.

Shipping is an interesting business and a textbook example of how supply and demand influence price. If there are a few too many ships, nobody makes any money and owners end up having to scrap their older ships. But if too many ships are taken out of service, then rates can swing wildly in the other direction.

Tanker rates have fluctuated from $10,000/day to more than $270,000/day. The high end was due to new maritime regulations forcing ships to burn cleaner fuel. There was also a large spike in tanker rates when Covid-19 hit because everyone needed somewhere to store their oil when the price collapsed. Oil tankers were being used as offshore storage facilities while commodity owners waited for the price to rebound.

Just how bad could it get exactly?

Let’s say a VLCC trip is 45 days. If oil tanker rates are $10,000, this would cost the ship owner $450,000. Compared to the cost of the oil ($284,820,000), this is nothing. The landed cost is barely different so the price to the consumer is barely affected.

But if VLCC rates soar to $270,000/day then the cost to ship the oil jumps from $450,000 to $12,150,000. This would result in an increase to landed cost of about 4.3%, which of course must be passed on to the consumer.

4.3% doesn’t sound like a lot, but remember, tanker rates hit a peak during a mostly peaceful time. It wasn’t all-out war. Tankers weren’t sinking left and right. Commercial shipping hasn’t been attacked on a large scale since WW2. (The US alone lost 1,554 ships over the course of the war.)

Attacks on merchant ships could definitely happen again. Like when the war in Ukraine started, people kept saying, “We haven’t seen destruction like this since World War 2.” Thus far the war is limited in scope, but if it expands, we could be in deep trouble.

Oil tanker rates are kept in check during peace time because owners keep an eagle eye on the supply of ships. They know exactly how old these boats are and can guess when they’ll be scrapped. Scrapping removes ships from the fleet. This is offset by newbuilds, the fancy word for a brand-new ship.

Tanker companies order ships years in advance because fairly it’s easy to predict when these ships will be needed. Namely when rates are predicted to spike.

When things are normal, oil tanker rates don’t spike. War is not normal. War is unpredictable, which could cause rates to massively spike.

It gets even worse than tanker daily rates jumping past $270,000. Because if tankers are being targeted, then you need to protect them. Security costs money. Which further adds to the cost. Insurance would also skyrocket.

If a temporary supply imbalance of only 20 ships is enough to cause rates to spike to all-time highs, then what would happen if 10 or 15% of the fleet sinks to the bottom of the ocean?

I don’t know.

It would be bad. VLCC rates could soar past $1,000,000/day. That alone would increase the landed cost of shipped oil by 16%.

But it doesn’t even have to be a large chunk of the oil tanker fleet sinking that could cause a 50% jump in the price of oil. It could be a combination of things. Rocket destruction of facilities, cyber attacks, pipeline sabotage, damaged ships, etc. Drone technology makes it easy to strike targets from relative safety.

So, what happens if Russia starts sinking western oil tankers? What’s the measured response here? To sink Russian oil tankers? Destroy Russian oil infrastructure? That would exacerbate the oil crisis even further. There aren’t a lot of good options.

To summarize, I’m saying to you is this:

Our oil infrastructure is not prepared for another world war and new technology makes it easy to destroy it. Depending on the scope of the damage it could take years to rebuild. Even minor attacks could trigger a massive jump in the price of oil. This high price could last for a long time.

As a consumer of gasoline and oil-based products there isn’t much you can do here. We’re all just blades of grass watching helplessly as elephants stampede around the neighborhood.

Hopefully we don’t get trampled.

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