Earlier this week, oil prices plunged to 2022 lows as energy markets panicked about demand amid COVID chaos in China that has resulted in an unexpected and extraordinary manifestation of street protests and even calls for Chinese President Xi Jinping to step down.
The market’s response to this, according to Rystad Energy, was an overreaction. Rystad believes that China’s zero-COVID policy and its new wave of lockdowns to counter a surge in new cases will have only a minor impact on its short-term oil demand.
Indeed, the market is sentimental and fickle these days, with volatility running at an all-time high. By Wednesday, oil prices were trending in the opposite direction with just as much zeal. Brent crude was up over 2.8%, to $85.37 per barrel, at 10:53 a.m. EST, and WTI was up 3.45% to $80.90 per barrel.
Suddenly forgetting its China fears despite a worsening COVID situation there, the oil markets flip-flopped mid-week to refocus on the pending EU ban on seaborne Russian oil and a G7 price cap on Urals crude next week. Gains would have been even higher were it not for rumors of OPEC+ preparing for more output cuts.
The oil markets are trading on the day’s news, and have been since earlier this year. Unable to grasp true fundamentals. Fundamentals are now a moving target thanks to Russia’s war on Ukraine, the renewed power to control the markets by OPEC+, an uncooperative American shale industry and China’s zero-COVID policy.
Wall Street is in a state of disarray, and for commodities traders, it’s either boon or bust–on a day-to-day basis.
The volatility would be far greater without OPEC, the expanded cartel suggests. In a new study published by KAPSARC (King Abdullah Petroleum Studies and Research Center), during the height of the COVID pandemic, OPEC reduced oil price volatility by 50% due to the management of its spare capacity. OPEC intervention, the report claims, boosted average oil prices during the pandemic from $18 to $54 per barrel. Now, this is serving as a justification for OPEC+’s recent decision to cut output at a time when Washington was gunning for a production increase to bring prices down.
True to form, OPEC rumors likely succeeded mid-week in calming the reversal of losses in oil price once the market decided to drop its Monday fears coming out of China and refocus on Russian oil.
So what about Wall Street?
As the Wall Street Journal notes, Wall Street is overall bullish on oil, even if that is not necessarily reflecting current prices. It’s a case of “mind the gap”.
There is a clear belief that oil prices will be much higher in 2023.
Goldman Sachs forecast $110 oil for next year, but recognizes the uncertainty. On Tuesday, Goldman Sachs’ Jeff Currie, global head of commodities, said that recent downgrades to oil prices were because of the dollar and China.
“First and foremost, it was the dollar. What is the definition of inflation? Too much money chasing … too few goods,” Currie told CNBC.
And on China’s COVID situation, Currie said “it’s big”. “It’s worth more than the OPEC cut for the month of November, let’s put it in perspective. And then the third factor is Russia is just pushing barrels on the market right now before the December 5th deadline for the export ban.”
JP Morgan now forecasts $90 oil for 2023, down from its earlier forecast of $98, “on the grounds that Russian production will fully normalize to pre-war levels by mid-2023”.
Rystad Energy also thinks the recent oil price plunge based on Chinese demand is overblown.
While it is true that in November, OPEC and the IEA both reduced their 2023 oil demand growth estimates because of what is happening in China, Rystad believes it will have far less impact than the market panic of Monday suggested.
"Oil markets may be misjudging news of China’s lockdown," said Claudio Galimberti, senior vice president at the Norway-based consultancy, as reported by Bloomberg.
The latest curbs “appear to be mimicking previous ones, with nationwide road traffic only marginally affected while selected provinces undergoing comparatively severe lockdowns try to suppress Covid outbreaks”.
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While street protests continued in China and daily infection rates surged beyond 40,000 by Tuesday, the overall effect is not worth a 4% plunge in oil prices, as we saw on Monday. And Wall Street seems to view this as a mere “gap” and not a long-term situation that will keep oil prices from JP Morgan or Goldman Sachs’ $98-$110 ranges next year.
Brent crude delivered in August next year has a 46% probability of settling more than $20 higher than its current price, WSJ notes.
China could actually end up being the icing on the oil price cake. It’s like saving up for a surge.
“The pent-up demand out of China is going to be enormous. “That could swing demand by at least a million barrels a day, and that could easily make the difference between an oil price forecast of $95 to $105 versus $120 to $130. Easily,” Amrita Sen, director of research for Energy Aspects, told WSJ.
By Alex Kimani for Oilprice.com
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The situation in China resembles the time when China exited the lockdown and with its pent-up demand pulled the global economy from the brink of collapse. Reports about the impact of the zero-COVID policy on the global oil demand are being used by some vested interests to exert strong downward pressure on oil prices. However, the world’s largest economy based on purchasing power parity (PPP) needs to function even when parts of it are under lockdown and this fact alone means that China’s economy will continue to be the driver of the global economy.
A bullish factor will soon come into action in the market, namely the EU banning Russian seaborne exports from 5 December and the proposed G7 oil price cap on Russian oil exports. If the G7 and the EU reached agreement on the cap, Russia will halt its exports to countries implementing it. This factor could push Brent crude higher than $100 before the end of this year. My view is, however, that the cap is neither viable nor enforceable and that is why it will be discarded.
EU’s ban on Russian oil exports will have very slight impact on prices because the bulk of these exports could be easily absorbed by China and India and Asian oil traders.
Once the cap is in place, OPEC+ will assess its impact. If it leads to shortages and a resurgence of oil prices, then it won’t cut production since Russia’s retaliation alone will do the job. If, however, there is need for OPEC+ to take further measures by reducing production to balance supply and demand, it will remain ready to intervene.
Anyway, 2023 is bound to have higher oil prices because of the shrinking spare production capacity. It normally takes 5-6 years before global investments in capacity expansion reach
fruition.
Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert