Oil prices were whipsawed this week with swings of more than 6%1 after a report from the Wall Street Journal suggested that Organisation of the Petroleum Exporting Countries (OPEC+) is looking to possibly increase output by 500,000 barrels per day (bpd). The rumour could have easily been justified by President Biden’s decision to offer sovereign immunity to the Saudi Crown Price Mohammed bin Salman in a civil lawsuit, as geopolitics could influence decisions. However, the Saudi’s shortly denied the report that OPEC+ was not considering an output increase, helping oil prices claw back losses on the day. This makes logical sense, given that OPEC+ reduced its oil production noticeably since the beginning of November, in accordance with its early October decision. The price action on 22nd November goes to show that it takes only a small amount of movement in trades to cause a large price effect in oil. The oil market remains susceptible to further volatility amidst a backdrop of low liquidity into year end.
Looking ahead, the oil market remains vulnerable to a number of key events starting with the OPEC+ meeting on Dec 4 followed by the European Union (EU) embargo on Russian oil alongside G-7 plans to launch a price cap on Russian crude sales on Dec 5.
Price cap on Russian oil is hardly bearish
Expectations are that the G-7 will soon announce the level at which they intend to set the price cap on Russian oil. The latest reports suggest a cap of US Dollar 65-70 per barrel, which would be well above Russia’s cost of production. Russia is already selling its crude at a significant discount, so a cap at these levels would likely have minimal impact on trading and inflict minimal harm to Russia. Russia’s Deputy Prime Minister Alexander Novak has once again made it clear that Russia will not supply crude oil or refined products to countries which follow the G-7 price cap. In fact, oil will either be redirected to those nations who choose to ignore the price cap or Russian output will be reduced. This appears to be more supportive for higher prices. So far, EU diplomats are locked in negotiations over how strict the Russian mechanism should be, after Poland and Greece rejected the proposal. They would prefer to see a cap closer to the cost of production at US$30. EU leaders are now expected to seek a deal at a 15-16 December summit, in follow up to the energy minister meeting this week on 24 November.
EU embargo on the import of Russian oil is approaching fast. This comes into effect on 5 December for crude oil and 5 February 2023 for oil products. In the last three months, Russia has remained the largest external supplier of diesel to the EU, delivering 540kbd2. According to IEA estimates, the EU was still importing 1.5mbd of Russian crude oil in October, which corresponded to just under 15% of total EU crude oil imports. In the coming months, the EU will need to find alternative suppliers. Replacing these supplies is not going to be easy. Russia will need to find other buyers leading to further uncertainty on the oil markets. India, Turkey and China have increased their purchases of Russian oil, thereby enabling Russia to continue exporting large quantities of oil.
Weak demand dominating sentiment on the oil market
Oil prices are down nearly 35% from its peak as sentiment remains dominated by concerns over weaking demand as the global economy enters a recession alongside an unprecedented release from the US Strategic Petroleum Reserve (SPR). Net speculative positioning in WTI crude oil futures is more than 1-standard deviation below the 5-year average underscoring extreme bearishness on the oil market3. Its worth noting that speculative positioning in oil was on a downtrend prior to the peak in oil prices. That indicates for one investors were probably taking profits on earlier holdings and higher volatility in oil market kept buyers at bay.
Although in a severe recession, oil demand can decline sharply, we are anticipating a much shallower recession for both the US and Eurozone economy. In the middle of the year, China’s oil demand was hit severely by lockdown restrictions, with demand falling below April 2020 and 2021 levels by 1-2mbd4. Although their remains uncertainty about China re-opening, we expect oil demand to recover from Q2 2023 onwards and accelerate towards year end. This should help oil demand from China grow in contrast to the prior two years.
Conclusion: The oil market still seems structurally undersupplied over the next few years. The International Energy Agency (IEA) assumes by the end of Q1 2023 oil production will be 2mbd lower than prior to the invasion of Ukraine. We expect the Chinese re-opening, Russian supply risk, the end of SPR releases and lower levels of investment in the energy sector to contribute to a tighter oil market in 2023.
Looking ahead, the oil market remains vulnerable to a number of key events starting with the OPEC+ meeting on Dec 4 followed by the European Union (EU) embargo on Russian oil alongside G-7 plans to launch a price cap on Russian crude sales on Dec 5.
Price cap on Russian oil is hardly bearish
Expectations are that the G-7 will soon announce the level at which they intend to set the price cap on Russian oil. The latest reports suggest a cap of US Dollar 65-70 per barrel, which would be well above Russia’s cost of production. Russia is already selling its crude at a significant discount, so a cap at these levels would likely have minimal impact on trading and inflict minimal harm to Russia. Russia’s Deputy Prime Minister Alexander Novak has once again made it clear that Russia will not supply crude oil or refined products to countries which follow the G-7 price cap. In fact, oil will either be redirected to those nations who choose to ignore the price cap or Russian output will be reduced. This appears to be more supportive for higher prices. So far, EU diplomats are locked in negotiations over how strict the Russian mechanism should be, after Poland and Greece rejected the proposal. They would prefer to see a cap closer to the cost of production at US$30. EU leaders are now expected to seek a deal at a 15-16 December summit, in follow up to the energy minister meeting this week on 24 November.
EU embargo on the import of Russian oil is approaching fast. This comes into effect on 5 December for crude oil and 5 February 2023 for oil products. In the last three months, Russia has remained the largest external supplier of diesel to the EU, delivering 540kbd2. According to IEA estimates, the EU was still importing 1.5mbd of Russian crude oil in October, which corresponded to just under 15% of total EU crude oil imports. In the coming months, the EU will need to find alternative suppliers. Replacing these supplies is not going to be easy. Russia will need to find other buyers leading to further uncertainty on the oil markets. India, Turkey and China have increased their purchases of Russian oil, thereby enabling Russia to continue exporting large quantities of oil.
Weak demand dominating sentiment on the oil market
Oil prices are down nearly 35% from its peak as sentiment remains dominated by concerns over weaking demand as the global economy enters a recession alongside an unprecedented release from the US Strategic Petroleum Reserve (SPR). Net speculative positioning in WTI crude oil futures is more than 1-standard deviation below the 5-year average underscoring extreme bearishness on the oil market3. Its worth noting that speculative positioning in oil was on a downtrend prior to the peak in oil prices. That indicates for one investors were probably taking profits on earlier holdings and higher volatility in oil market kept buyers at bay.
Although in a severe recession, oil demand can decline sharply, we are anticipating a much shallower recession for both the US and Eurozone economy. In the middle of the year, China’s oil demand was hit severely by lockdown restrictions, with demand falling below April 2020 and 2021 levels by 1-2mbd4. Although their remains uncertainty about China re-opening, we expect oil demand to recover from Q2 2023 onwards and accelerate towards year end. This should help oil demand from China grow in contrast to the prior two years.
Conclusion: The oil market still seems structurally undersupplied over the next few years. The International Energy Agency (IEA) assumes by the end of Q1 2023 oil production will be 2mbd lower than prior to the invasion of Ukraine. We expect the Chinese re-opening, Russian supply risk, the end of SPR releases and lower levels of investment in the energy sector to contribute to a tighter oil market in 2023.