Decoding the 3 factors that destabilize the oil market, the most ominous originates from China
Nearly a month after Russia launched a military campaign in Ukraine, oil prices have skyrocketed. The turmoil in the markets of one of the world’s most important commodities shows little sign of ending. The price of a barrel of Brent crude was around $108 a barrel on March 18, still well above the level of about $94 when the war started.
But in the past two weeks, oil prices have plummeted from a high of 128 USD/barrel to as low as 98 USD/barrel. Excluding the 2020 pandemic-related turmoil, the OVX index, which tracks oil market volatility, which has rarely changed over the past decade, is high this month.
The swings reflect the interplay of political and economic forces in today’s world, from wars and rising interest rates to Covid-19. Not to mention the outcome of the Ukraine conflict, three major sources of instability are affecting the world oil market.
OPEC calculation
The first is what members of the Organization of the Petroleum Exporting Countries (OPEC) do when Western sanctions are imposed and Russian products are shunned. The US banned the import of Russian oil. Even with countries that do not impose sanctions, potential buyers are struggling to deal with Russian financial intermediaries and fear possible new sanctions.
On March 16, the International Energy Agency (IEA) said that the international market could face a shortfall of 3 million barrels of oil per day in April. For comparison, the world consumes about 98 million barrels. oil every day in 2021.
The disruption in global markets is best illustrated by the gap between the benchmark Brent oil price and the Urals oil. On January 31, this gap held at about 60 cents/barrel. By March 18, this price had increased to nearly 30 USD.
Brent oil price. Unit: USD/barrel
This leaves power largely in the hands of two countries capable of making up for Russia’s shortfall, Saudi Arabia and the United Arab Emirates. So far, both countries have rejected calls to increase production.
At their meeting in early March, OPEC and its allies (including Russia) only confirmed the existing plan to raise production overall, to 400,000 barrels per day. The next meeting later this month will be closely watched. Especially, when these two countries have great influence, even a small change in public statements can cause oil prices to fluctuate.
US shale oil production
The second source of uncertainty concerns the ability of the US to produce shale oil to meet supply shortfalls. During the first mining boom from 2010 to 2015, surging US production sent oil prices plummeting and decimated oil in OPEC hands.
But then conditions in the US economy changed dramatically, leading analysts and industry insiders to suspect that shale could pose challenges.
At first, financial situations were less encouraging than during the 2010-2015 boom. The US Federal Reserve is expected to raise interest rates several times in 2022 and 2023. Two-year Treasury yields are at just 2%, compared with less than 1% during most of the past boom.
Another limitation comes from the problem of the tight US labor market. The US oil and gas sector employed just over 128,000 people in February, down from 200,000 at the end of 2014. With an unemployment rate at 3.8% and employers struggling to fill Filled with vacancies, it is not easy to find thousands of workers across the United States.
Attitudes towards the industry also changed. US manufacturers and potential creditors are now more cautious about borrowing. Banks and asset managers are bound by more stringent environmental standards. That’s one factor that drives prices up.
In the last quarter of 2021, mining and energy producers reported a six-year record increase in operating lease costs (the recurring cost of running wells), according to the report. a survey by the Dallas Fed. The miners themselves, who have struggled to generate steady profits in the past, are also very concerned about capital discipline this time.
China’s Covid zero strategy
The third and perhaps the most difficult factor is demand. China’s zero Covid strategy is being implemented very strictly. The country has recorded the highest number of cases since the outbreak of the pandemic. Tens of millions of people were locked down in Shanghai and Shenzhen. These are two developed cities with important export centers.
Commodity researcher Platts Analytics suggests that these restrictions could reduce demand by 650,000 barrels per day in March. This is roughly equivalent to Venezuela’s oil production.
Even before the lockdowns, worrisome signs of a slowing Chinese economy appeared, especially in the real estate sector. Revenue from land sales fell 30% year-on-year in 2021.
The Hang Seng Mainland Properties Index of developer stocks recently hit a nearly five-year low and is down about 50% since the outbreak of the pandemic.
Meanwhile, authorities are torn between a campaign to control leverage and a desire to keep the economy growing. Any sign of a slowdown in the world’s biggest oil importer means more turmoil in commodity markets.
The calculation of OPEC, US shale oil and the health of the Chinese economy, one of these three factors is enough for oil prices to fluctuate strongly. If oil price volatility declines, the sources of volatility will also have to be reduced.
According to The Economist
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