First the crux of the oil rally

Oil was undersupplied for a long time by nearly 2.5 million bpd. The markets had rallied on the back of this shortfall. What really tipped the oil price rally was the Russia-Ukraine war. Remember, Russia brings 7.50 million bpd of oil to the oil market and virtually accounts for 8% of the total oil supply in the market. The sanctions and embargoes would mean around 8-10% of the supply vanishing from the market. That is driving oil. 

Option 1: Getting much worse

Even as we write, the global oil debate is whether Brent Crude would test $100 first or $147 first. Incidentally $147 was the previous peak in 2008. The global oil markets are just about $30 away from breaching that level, so it is not too far. If Vladimir Putin continues to dig deep into Ukraine and Western world decides to deepen the sanctions on Russia, then crude could likely cross $150/bbl and possibly even much beyond that. The likes of Goldman are back with $200/bbl projection, but we have to wait and see. The bottom line is that if the war scene worsens, then the world oil market has to get prepared for substantially higher levels of crude oil prices; even $200. 

Option 2: Return to normalcy

The second option, and a fairly likely option is that Russia may choose to call a halt to hostilities. The Ukraine war will be forgotten and it will be business as usual. Russia was never interested in getting embroiled in a full-fledged war. All they wanted to do was to prove a point and keep NATO away from the borders of Ukraine. If that is taken care of, then we could see a quick return to normalcy. However, Putin has taken a big risk in planning the aggression and he may want to look like a triumphant warrior returning home. If Putin gets an honorable exit with assurances from the West, things should have a happy end. In that case, oil will normalize quickly. 

Option 3: Oil demand collapses

This would be the most frightening of the three scenarios. The world can even tolerate a brief stint with crude at $150 per barrel. What it cannot tolerate is the oil prices at above $150/bbl resulting in a virtual collapse in demand for oil as well as a prolonged recession in most parts of the world. For a global economy that is just about emerging from the pain of COVID, this would be just too much to endure. It would again imply that all the monetary policy levers will have to start turning in the opposite direction as we have been seeing for most of the last 14 years. The world has seen 2 oil demand collapses. It cannot handle a third oil demand collapse! ©