Geopolitics look set to inject noise and uncertainty into the market for the time being. Yet the bigger picture looks unchanged. The oil market rebalances following the past months’ price spikes. We stick to our cautious view as fundamental headwinds should persist.
While geopolitics and power games are blunt and harsh on the natural gas market these days, related dynamics seem nascent on the oil market. The petro-nations decision to lower production quotas in October is difficult to justify with market conditions. Storage levels are normalizing but do not suggest the oil market is oversupplied.
The oil futures curve is downward sloping, a shape that coincides rather with scarcity not abundance of commodity supplies. That said, the quota reduction is minimal, and many producers remain below their individual levels.
Looking ahead, the petro-nations’ output could well increase incrementally despite the quota reduction. But the message is more telling and shows how the commodity producers exploit their temporary powers under market conditions such as todays. It remains to be seen if the rifts between the West and the petro-nations widen in consequence of the war in Ukraine and sanctions on Russia.
So far, the oil supply chains adjusted swiftly to the new realities and the overall loss of Russian supplies was minimal. The change in the Russian oil trade comes with broader consequences including a shift of insurance and trading activities from Europe towards the Middle East and Asia, and thus moving out of reach of the Western sphere.
The idea of an oil price cap seems difficult to implement, first to find enough willing participants and second to effectively govern its mechanisms given the loss of influence. In the end, the West and the petro-nations face similar challenges in terms of how to use their powers but without moving prices too much.
While the West is concerned about its citizens and their energy bills, the petro-nations should not want to alienate Asian buyers including China and India too much with their price-nudging politics. Our best guess is that geopolitics remains a source of market noise and a risk of short-term tit-for-tat escalation, but ultimately only a temporary price determinant. The bigger picture looks unchanged.
The past months’ price spike unleashed the market’s known self-healing mechanisms. The fundamental headwinds to prices should persist longer term on the back of the shale boom and stagnant Western world demand.
(The author is Head Economics and Next Generation Research, Julius Baer)