Brent Crude Oil Price Spikes 2.6% to $123.60 On Russian Sanctions

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Brent Crude Oil Price Spikes 2.6% to $123.60 On Russian Sanctions

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  • Russian oil export sanctions and demand resurgence post easing of China Covid lockdowns driving oil price rise
  • Oil Reserve releases adding to supply, but with little effect on global oil price
  • Rising exploration costs and expensive renewable energy alternatives are sustaining the high price of global oil   
  • Global oil prices unlikely to retreat anytime soon.

Oil price outlook

Oil prices are on a steep upward trajectory that began in May 2020 and are showing no signs of easing while current market conditions prevail. Brent Crude oil is today trading at above US$123.80 a barrel, up 2.6 percent overnight and 22 percent higher than a month ago.

The price of Brent Crude oil is widely considered to be the benchmark price for global oil prices because it is used to price about 70 percent of traded global oil supply. The Organisation of Petroleum Exporting Countries (OPEC) uses Brent Crude as its pricing benchmark. OPEC comprises 14 countries and is largely responsible for setting the global price of oil.

Recent statements from leading global investment bank, Goldman Sachs, infer that currently elevated oil prices are likely to remain at or above existing levels for the foreseeable future.

Goldman have stated that oil prices need to move beyond current prices before achieving the demand destruction necessary for market re-balancing. Just what that ‘demand destruction’ price level might be, is exercising the mind of discerning investors around the world right now. A clue is that both Goldman Sachs and Morgan Stanley have recently released oil price forecasts of US$140 and US$150 per barrel respectively, for later in 2022. This implies that oil prices may have to surge another 15 to 20 percent before existing prices show the first signs of retreat.

Global oil prices that approach this level will create ongoing inflationary pressure, exacerbating the global inflation outlook and crimping future economic growth prospects. However, this is how markets work in that the price of every commodity is ultimately determined by the prevailing demand and supply dynamic playing out at the time.

What’s driving oil prices higher today?

A confluence of factors that have intensified over the past several months are pushing the price of oil higher.

European sanctions on Russian oil exports arriving by sea are scheduled to come into effect by the end of this year. The sanctions are reportedly going to reduce the European Union nations’ oil imports arriving by sea from Russia by two thirds. This oil has to be sourced from other oil producing nations. Given that Russia is the world’s second largest oil exporter behind Saudi Arabia, this action partly explains the rise in oil prices over recent months and is likely to lead to higher prices later in the year.

China is the world’s largest importer of oil, and in 2020 imported 13 million barrels of oil daily. This compares to Europe which imported 12.6 million barrels in 2020. China has last week commenced an easing of previously imposed COVID restrictions, after being in lockdown over the past few months. This means that major cities like Beijing and Shanghai will boost demand for oil imports at a time of supply restrictions imposed on Russian oil supplies to Europe. This outcome will squeeze oil prices higher in the near-term.

Another factor driving oil prices higher is the ongoing release of petroleum supplies from strategic reserves in the US and in Europe, to help counter rising oil prices. While this may be a short-term solution at best, if not managed carefully, can lead to significantly higher oil prices over a sustained period. This is because according to the Energy Information Administration of the US (EIA), global oil and liquid fuels demand is currently about 100 million barrels per day. The problem is that global oil production in 2019 was just over 95 million barrels per day. These numbers highlight the delicate supply/demand balance and illustrate just how lower production volumes can quickly push oil prices substantially higher.

Furthermore, oil is becoming scarce and more costly to find, adding to the risk of oil exploration, which in turn diminishes the potential for new oil reserves of a global scale. This means less exploration and higher oil prices, because alternative renewable energy sources are also costly, at this early stage of the renewable energy life cycle.

The evidence available for now suggests that oil prices are likely to remain at or above their current level for the foreseeable future. An interesting fact coming out of the US Commodity Futures Trading Commission is the decline in hedging contracts taken out by producers and merchants and swap dealers from the first week in 2022 until the week ending May 2022. One possible explanation for this is that producers have been less willing to hedge production at prevailing prices, in the expectation of higher oil prices in the future.

Irrespective whether this is the basis for the decline in hedging activity, there appears little relief anytime soon from presently high oil prices around the world.

Louis Mosmann

Louis Mosmann is a Private Wealth Client and Research Assistant at KOSEC- Kodari Securities. Louis covers macroeconomic events, global markets and ASX300 company announcements, allowing clients to make more informed investment decisions. Email Louis at l.mosmann@kosec.com.au.

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