Economic Update

Published 25 Feb 2021

– After falling significantly in 2020, oil prices have returned to pre-pandemic levels

– The rise has been driven by OPEC+ production cuts and an improving economic climate

– Higher prices are likely to support a rebound in oil-producing emerging markets

– Further virus outbreaks or increased production would pose challenges to price stability

A combination of continued production cuts and an increase in economic activity has prompted oil prices to return to pre-pandemic levels – a factor that will be crucial to the recovery of major oil-producing countries in the Middle East and Africa.

Brent crude prices rose above $60 a barrel in early February, the first time they had exceeded pre-Covid-19 values. They have since continued to rise, going above $66 a barrel on February 24.

The ongoing increase in oil prices, which have soared by 75% since November and around 26% since the beginning of the year, marks a dramatic change from last year.

Following the closure of many national borders and the implementation of travel-related restrictions to stop the spread of the virus, demand for oil slumped globally.

In the wake of the Saudi-Russia price war in early 2020, Brent crude prices fell from around $60 a barrel in February that year to two-decade lows of $20 a barrel in late April, as supply increased and demand plummeted. The value of WTI crude – the main benchmark for oil in the US – fell to record lows of around $40 a barrel last year on the back of a lack of storage space.

While global demand for oil remains low, one factor credited with reversing the trend is the decision to make significant cuts to oil production, which subsequently tightened global supplies.

In April members of the Organisation of Petroleum Exporting Countries (OPEC), along with other oil-producing nations including Russia, Azerbaijan, Malaysia and Mexico, agreed to cut total global output by 9.7m barrels per day (bpd) – equivalent to around 10% of global production.

The 23-nation group, known as OPEC+, decided to scale back the cuts to 7.7m bpd in August, before announcing in early December that they would increase production by 500,000 bpd as of January 2021.

Concerned that the most recent decision could have led to excess oil in the market, Saudi Arabia announced that it would cut an additional 1m barrels daily between January and the end of March.

Another factor seen to be supporting the increase in oil prices is the improving economic outlook.

With the global rollout of various Covid-19 vaccines, it is hoped that the world will return to a degree of normality in 2021 in terms of travel and consumption, an outcome which would further spur demand.

In an annual outlook released in mid-February, OPEC forecast full-year oil demand to increase by 5.8m bpd compared to 2020 levels, driven partly by an improving global economic climate and significant stimulus measures from governments around the world.

“While the global economy is showing signs of a healthy recovery in 2021, oil demand is currently lagging, but is forecast to pick up in [the second half of] 2021,” the group said in a statement. “With this, a healthy rebound in oil demand, in combination with the vigilant stance and considerable efforts of the countries participating in the Declaration of Cooperation, are essential to maintaining stability in the oil market.”

As for the value of oil moving forward, in late January the IMF forecast oil prices would average $50 a barrel this year, above the 2020 average of $41.30.

However, the continued rise of prices over the first two months of the year has led to some more bullish estimates, with Dutch multinational banking firm ING predicting average annual prices of $65 per barrel, while investment bank Goldman Sachs has forecast Brent prices will rise as high as $75 a barrel in the third quarter of the year, $10 higher than earlier estimates.

Key to economic recovery

Any continued rise in oil prices would make a significant contribution to the recovery of oil-producing emerging markets.

Just as the rapid drop in prices badly affected hydrocarbons exporters last year, the rebound could play a key role in stimulating broader economic growth.

For example, in Saudi Arabia, where oil accounts for around 45% of GDP, the country expects a fiscal deficit of 4.9% of GDP this year, according to its 2021 budget, released in December.

However, a sustained rise in oil prices could significantly improve the country’s fiscal status. The IMF predicts the Kingdom’s break-even oil price will be $67.9 per barrel this year.

Furthermore, the government expects the economy to rebound from last year’s contraction of 3.7% with growth of 3.2% in 2021.

The current situation should also benefit Nigeria, which sources 10% of GDP, 57% of government revenue and 80% of its exports from oil. The country’s budget for 2021 has a benchmark oil price of $40 per barrel, well below current levels.

Similarly, in Oman analysts are hopeful the increase in oil prices can improve the country’s economic performance, with this year’s budget figures being based on average prices of $45 per barrel.

Threats to oil price stability

Although the outlook for oil-producing countries looks significantly brighter than in 2020, there are still a number of factors that could hinder a sustained rebound.

Chief among them is the potential for further outbreaks of Covid-19. Another is the possibility of delays in the rollout of vaccines, which could result in the extension of travel and general movement restrictions.

A further factor that could affect oil market stability in the short term is the upcoming OPEC+ meeting on March 4, a potentially significant event in determining policy for the rest of the year.

While a number of countries, led by Saudi Arabia, are expected to push for an extension of the production cuts, others such as Russia are likely to call for a further relaxation of the measures.

In some corners there are concerns that scaling back production cuts too early could flood the market with oil, subsequently leading to a fall in prices, while others are concerned that a failure to increase production could place extra fiscal pressure on oil-producing countries.

Indeed, with current production cuts, most OPEC+ countries are producing less oil than stipulated in their budget estimates for the coming year.