Why the price of oil fell even with restrictions on Russia

This week marked a turning point in global geopolitics, with the entry into force of a European embargo and a price cap imposed by the G7 on Russian crude oil.

Russia, faced with the humiliation of seeing Western powers dictate the price it can charge for its oil, has threatened to suspend exports to any country that adopts the price cap. In a few hours, interruptions in supply were already visible, with an accumulation of oil tankers waiting in line in the Bosphorus Strait.

All of this would normally have sent oil prices soaring, especially since just a few weeks ago the OPEC+ cartel surprised the market by announcing further deep production cuts. However, on Thursday, standard Brent oil, the international benchmark for the commodity, reached the mark of US$ 76.15 per barrel, its lowest price in 2022. What is happening?

Russian supply remains robust

The European ban on importing crude oil from Russia, the world’s biggest oil exporter, is a bona fide sanction, meant to force Moscow to redirect supplies and defuse the negative perception that arises when war-torn Ukraine’s allies funnel petrodollars to Russia. President Vladimir Putin.

But the aim of the G7 price capping plan is to alleviate the situation.

When the European Union announced that it would impose sanctions on any tanker carrying Russian crude, even ships sailing in Asian waters, concern arose in some Western capitals that the move would cause a collapse in Russian exports and a spike in oil prices. Western politicians would have to shoulder the burden of even higher inflation, and Putin could raise even more money from oil.

However, the price cap is intended to keep Russian oil flowing to buyers and prevent oil costs from skyrocketing further. Other measures linked to the price limitation were also mitigated, which gives operators some security that the flows will continue without major changes.

The United States persuaded the European Union, for example, to drop a clause in its sanctions that would have permanently banned punished ships from receiving maritime services in Europe if they violated the price cap. The punishment was reduced to a 90-day suspension.

The cap, set at $60 a barrel, is designed “to ensure that a sharp price increase is not used to divide the alliance and weaken the ability to support Ukraine.” [e] to ensure that there is not an increase in the aggressor’s income that can afford the continuation of the aggression,” said Amos Hochstein, senior adviser to President Joe Biden on energy issues.

President Vladimir Putin said on Friday that the price cap was what Russia was already selling its oil for, implying that the move would have limited impact on the Russian budget. “We will not suffer losses under any circumstances,” he said. However, “if necessary”, Russia could still choose to destabilize the oil market in response, through production cuts, he added.

Russia has refused to negotiate with any buyer who wants to use the price cap, but Western officials say the $60 level is still helping Asian refiners negotiate lower prices.

The Urals variant – Russia’s main oil variety – was trading at around $53 a barrel as of Friday afternoon, according to Reuters data.

“Russian supply remains as high on the market as at any point in the year,” said Florian Thaler, head of OilX, which tracks movements in the world oil market. Any decline would only be visible later in the first quarter of 2023, he added.

OPEC+’s Deep Cuts Aren’t So Deep

In October, when Saudi Arabia, Russia and other OPEC+ allies announced a cut of two million barrels per day in their production quotas – equivalent, in theory, to around 2% of world supply –, the reaction of the West it was fast. The White House hinted that Riyadh had sided with Russia in a global energy war. The IEA (International Energy Agency) accused the cartel of endangering the world economy.

But while inflation driven by energy prices remains a problem in Western economies, the past five weeks indicate that OPEC+ action has been relatively astute.

Oil prices did not rise, but fell, which fueled Saudi Energy Minister Prince Abdulaziz bin Salman’s argument that, in the face of a weakening world economy, preemptive cuts were needed to prevent a sharp drop in oil prices. Marketplace. OPEC+ maintained its production quotas at its meeting last Sunday.

Actual cuts made by OPEC+ were also lower than the baseline figure announced in Vienna, in part because some producers, such as Angola and Nigeria, were already struggling to meet their quotas. Rather than cutting output by two million barrels a day, the total cut is closer to a million barrels a day, analysts say — still substantial, but not enough to move the market in a bullish direction.

Demand fears outweigh supply concerns

After months of worry about supply disruptions, traders are now focused on fears of a worldwide recession, as the fallout from Russia’s invasion of Ukraine and the energy war against the European Union spreads and central banks race to raise interest rates in order to stop runaway inflation.

Wall Street banks have been making cautious projections about the economy in 2023. “When I talk to clients, they seem extremely cautious,” David Solomon, chief executive of Goldman Sachs, said this week. “A lot of CEOs are looking at the numbers and waiting to see what happens.”

The pessimistic sentiment is noticeable in the oil market’s turn from “backwardation” —a market structure in which spot prices are higher than oil futures prices— to its inverse, “contango”.

This shift suggests that traders perceive the market to be oversupplied, and the turnaround is sometimes seen as an indicator of expectations of an impending economic downturn.

The major concerns of the oil market are centered on China and the United States, the two largest consumers of energy in the world. China’s “Covid zero” policy and the country’s weakening economy mean that China’s total oil consumption this year will be lower than in 2021, according to the IEA, the number’s first annual contraction in this century.

While the US economy may be able to pull itself out of a recession, its consumers’ thirst for oil also appears to have reached a peak. Consumption this season of the year has only been as low as 2022 once in the past two decades — in 2020, when the coronavirus pandemic hit. Total oil demand in the United States has yet to return to pre-Covid levels.

But prices can still recover

The oil market believes that this all points to a cyclical and lasting drop in oil prices. But market optimists are confused. They argue that years of underinvestment in production will eventually kick in if demand continues to rise, even modestly. The slow growth of shale oil production in the United States is another risk. Any decline in Russian supply may not become visible until next year, some analysts argue. And weak demand in China won’t last, they say.

“We are basically moving from zero energy demand growth in 2022 [na China] for the equivalent of about 3 million barrels a day of additional demand for all fuels next year,” said Dan Klein of S&P Global Commodity Insights. “We’re going to see much higher demand for energy in China going forward.” .

Meanwhile, the US government is ending a months-long program of oil sales from its emergency stockpile, and plans to begin restocking the stockpile if US crude oil prices fall below $70 a barrel. West Texas Intermediate Standard Crude Oil was quoted at $71.46 on Thursday.

“At the margin, an operator that sold 200 million barrels in 2022 would become one of the biggest buyers of oil in 2023,” said Bill Smead, president of Smead Capital Management, referring to the volume of emergency stockpile oil placed on the market this year. “History would argue that we have years of higher oil and natural gas prices ahead of us.”

Translated by Paulo Migliacci