Why Are Oil Prices So High and Will They Stay That Way?

HOUSTON — Oil prices are increasing, again, casting a shadow over the economy, driving up inflation and eroding consumer confidence.

Crude prices rose more than 15 percent in January alone, with the global benchmark price crossing $90 a barrel for the first time in more than seven years, as fears of a Russian invasion of Ukraine grew.

Though the summer driving season is still months away, the average price for regular gasoline is fast approaching $3.40 a gallon, roughly a dollar higher than it was a year ago, according to AAA.

The Biden administration said in November that it would release 50 million barrels of oil from the nation’s strategic reserves to relieve the pressure on consumers, but the move hasn’t made much of a difference.

Many energy analysts predict that oil could soon touch $100 a barrel, even as electric cars become more popular and the coronavirus pandemic persists. Exxon Mobil and other oil companies that only a year ago were considered endangered dinosaurs by some Wall Street analysts are thriving, raking in their biggest profits in years.

Why are oil prices suddenly so high?

The pandemic depressed energy prices in 2020, even sending the U.S. benchmark oil price below zero for the first time ever. But prices have snapped back faster and more than many analysts had expected in large part because supply has not kept up with demand.

Western oil companies, partly under pressure from investors and environmental activists, are drilling fewer wells than they did before the pandemic to restrain the increase in supply. Industry executives say they are trying not to make the same mistake they made in the past when they pumped too much oil when prices were high, leading to a collapse in prices.

Elsewhere, in countries like Ecuador, Kazakhstan and Libya, natural disasters and political turbulence have curbed output in recent months.

“Unplanned outages have flipped what was thought to be a pivot towards surplus into a deep production gap,” said Louise Dickson, an oil markets analyst at Rystad Energy, a research and consulting firm.

On the demand side, much of the world is learning to cope with the pandemic and people are eager to shop and make other trips. Wary of coming in contact with an infectious virus, many are choosing to drive rather than taking public transportation.

But the most immediate and critical factor is geopolitical.

A potential Russian invasion of Ukraine has “the oil market on edge,” said Ben Cahill, a senior fellow at the Center for Strategic and International Studies in Washington. “In a tight market, any significant disruptions could send prices well above $100 per barrel,” Mr. Cahill wrote in a report this week.

Russia produces 10 million barrels of oil a day, or roughly one of every 10 barrels used around the world on any given day. Americans would not be directly hurt in a significant way if Russian exports stopped, because the country sends only about 700,000 barrels a day to the United States. That relatively modest amount could easily be replaced with oil from Canada and other countries.

But any interruption of Russian shipments that transit through Ukraine, or the sabotage of other pipelines in northern Europe, would cripple much of the continent and distort the global energy supply chain. That’s because, traders say, the rest of the world does not have the spare capacity to replace Russian oil.

Even if Russian oil shipments are not interrupted, the United States and its allies could impose sanctions or export controls on Russian companies, limiting their access to equipment, which could gradually reduce production in that country.

In addition, interruptions of Russian natural gas exports to Europe could force some utilities to produce more electricity by burning oil rather than gas. That would raise demand and prices worldwide.

What can the United States and its allies do if Russian production is disrupted?

The United States, Japan, European countries and even China could release more crude from their strategic reserves. Such moves could help, especially if a crisis is short-lived. But the reserves would not be nearly enough if Russian oil supplies were interrupted for months or years.

Western oil companies that have pledged not to produce too much oil are likely to change their approach if Russia was unable or unwilling to supply as much oil as it did. They would have big financial incentives — from a surging oil price — to drill more wells. That said, it would take those businesses months to ramp up production.

What is OPEC doing?

President Biden has been urging the Organization of the Petroleum Exporting Countries to pump more oil, but several members have been falling short of their monthly production quotas, and some may not have the capacity to quickly increase output. OPEC members and their allies, Russia among them, agreed on Wednesday to stick to a plan for increasing production next month by a relatively modest 400,000 barrels a day.

In addition, if Russian supplies are suddenly reduced, Washington is likely to put pressure on Saudi Arabia to raise production independently of the cartel. Analysts think that the kingdom has several million barrels of spare capacity that it could tap in a crisis.

What impact would higher oil prices have on the U.S. economy?

A big jump in oil prices would push gasoline prices even higher, and that would hurt consumers. Working-class and rural Americans would be hurt the most because they tend to drive more. They also drive older, less fuel-efficient vehicles. And energy costs tend to represent a larger percentage of their incomes, so price increases hit them harder than more affluent people or city dwellers who have access to trains and buses.

But the direct economic impact on the nation would be more modest than in previous decades because the United States produces more and imports less oil since drilling in shale fields exploded around 2010 because of hydraulic fracturing. The United States is now a net exporter of fossil fuels, and the economies of several states, particularly Texas and Louisiana, could benefit from higher prices.

What would it take for oil prices to fall?

Oil prices go up and down in cycles, and there are several reasons prices could fall in the next few months. The pandemic is far from over, and China has shut down several cities to stop the spread of the virus, slowing its economy and demand for energy. Russia and the West could reach an agreement — formal or tacit — that forestalls a full-scale invasion of Ukraine.

And the United States and its allies could restore a 2015 nuclear agreement with Iran that former President Donald J. Trump abandoned. Such a deal would allow Iran to sell oil much more easily than now. Analysts think the country could export a million or more barrels daily if the nuclear deal is revived.

Ultimately, high prices could depress demand for oil enough that prices begin to come down. One of the main financial incentives for buying electric cars, for example, is that electricity tends to be cheaper per mile than gasoline. Sales of electric cars are growing fast in Europe and China and increasingly also in the United States.