US oil hits lowest price of the year thanks to China as OPEC+ exit decision looms

US oil hits lowest price of the year thanks to China as OPEC+ exit decision looms

Benchmark oil futures in the United States touched their lowest price of 2022 on Monday, briefly erasing what had been a sizable gain since the start of the year as China’s zero COVID policy was is wreaking havoc on energy demand expectations.

The price move came less than a week ahead of a Dec. 4 decision by the Organization of the Petroleum Exporting Countries and their Russian-led allies on production levels.

“China is the engine of commodity growth and clearly the main driver of recent crude price action,” Rebecca Babin, senior energy trader at CIBC Private Wealth US, told MarketWatch. OPEC+ will be “driven by Chinese demand”.

Protests against President Xi Jinpin’s strict COVID-19 restrictions were seen in Beijing, Shanghai and other major Chinese cities over the weekend.

Oil prices were already under pressure before markets saw “widespread protests erupt across China, adding fuel to the smoldering fire on oil prices,” CFO Manish Raj told MarketWatch. Velandera Energy Partners.

“The question is, will the Chinese communist government redouble its efforts to show its authority, or will it listen to protesters’ legitimate concerns about the zero-tolerance policy?” he said.

American reference of West Texas Intermediate crude for delivery in January CLF23,
+0.88%

CL.1,
+0.88%
traded as low as $73.60 a barrel on the New York Mercantile Exchange on Monday, the lowest intraday price for a first-month contract since Dec. 27, 2021, according to Dow Jones Market Data.

This drop prompted prices to trade as much as 2.1% lower year-to-date as prices for the first month settled below $75.21 on December 31 of the year. ‘last year. WTI rose on Monday, however, to trade at $77.18. January Brent Global Benchmark BRNF23,
-0.29%
traded as low as $80.61, the lowest since January, and was last at $83.24.

The recent shutdowns are estimated to have reduced Chinese demand for oil by 900,000 barrels a day, moving the supply market “from tight to balanced”, she said. The decline in Chinese demand “almost mirrored” the amount of supply OPEC+ pulled from the market at its last meeting, Babin said.

At a meeting in October, OPEC+ agreed to cut its collective crude production levels by 2 million barrels per day from November, citing “uncertainty surrounding the global economic and oil outlook.”

Among the issues OPEC+ will most likely consider at its Sunday meeting is economic weakness stemming from China’s continued restrictive COVID-19 policies, said Greg Sharenow, managing director and portfolio manager at PIMCO. .

He believes the economic weakness of China’s restrictive COVID policies is “well telegraphed now.” He also pointed out that commodity markets have “been very strong overall despite the lack of a supportive Chinese economy.”

If the Chinese economy begins to reopen in the second quarter of 2023, or if the Chinese government further stimulates industries, any slowdown in the developed economy due to the tightening of financial conditions, which is currently priced in, would be quite supportive for oil prices. Sharenow told MarketWatch.

Complicated “decision tree” for OPEC+

The OPEC+ decision on oil production levels may soon become the biggest concern for oil traders.

The “decision tree” is quite complicated for OPEC+, in part due to the uncertainty around the loss of Russian production and the disruptive nature of marine insurance restrictions, Sharenow said.

The European Union’s ban on maritime imports of Russian oil, as well as the Group of Seven’s plan to cap Russian oil prices early next month, are set to come into effect on December 5, a day after the meeting of OPEC+.

The eighth round of EU sanctions against Russia, including a ban on imports of Russian maritime oil, lays the groundwork for the legal framework to implement the G-7 price cap. EU sanctions also include a ban on insuring ships carrying Russian oil.

Lily: Why the EU Ban and G7 Price Cap on Russian Oil Won’t Guarantee a Sustained Rally for Oil

Russia’s oil production has been “extremely resilient” to sanctions, Babin said. As the Dec. 5 sanctions approached, some buyers increased their purchases, reducing the impact on supply and bringing Russian production back to almost pre-invasion levels, she said.

If the EU agrees to a cap price range of between $65 and $70, “we don’t see an impact on additional supply from Russia until the end of 2022, as the cap price is essentially equivalent to the price at which Russia currently sells crude in the market without a cap,” Babin said.

Key to Russian supplies next year will be how the EU handles upcoming oil-related sanctions due to come into force in February, she said. The EU is expected to ban imports of Russian petroleum products from February 5.

See Barron: Europe’s price cap on Russian oil is all bark, not bite

“If the EU applies stricter maritime sanctions on Russian products, it could have a significant impact on gasoline and diesel prices,” Babin said.

For now, however, based on developments in China and “the extreme volatility in crude markets over the past few weeks, Babin believes the chances of further OPEC+ production cuts have increased.

Short-term WTI and Brent moved from backwardation to contango, giving OPEC+ “further confirmation that demand is weak and more action is needed,” she said. Forwarding refers to a situation in crude contract values ​​where the prices of oil to be delivered in the near future are higher than those for later deliveries, while in contango the prices for future deliveries exceed the spot market.

Given all that, there’s a potentially 60% chance OPEC+ will cut an additional 500,000 barrels a day next week, and a 40% chance it won’t change its production targets, Babin said.

CME of the CME Group,
-1.20%
The OPEC Watch Tool, however, currently sees a 77.7% probability of an outcome from the December OPEC meeting for “no change or [a] small increase in production”, and a probability of 12.4% for a decrease in production.

Oil outlook

Even though U.S. Oil and Brent Oil posted a more modest year-to-date gain on Monday than the market has seen for most of the year, PIMCO’s Sharenow forecasts higher oil prices.

“Certainly, slowing economic growth is the biggest headwind to oil and commodity prices in general,” he said.

However, “demonstrated greater capital discipline among oil and gas companies,” which limits “future prospects for oil supply, a key reason for PIMCO’s bullish outlook on prices,” said he declared.

Oil futures are also approaching the level at which the United States would consider buying oil to fill the Strategic Petroleum Reserve, and “the system’s buffers to deliver shocks are quite limited,” Sharenow said.

CIBC’s Babin said oil prices could recoup some of their recent losses, with WTI returning to $80 and Brent to $90, based on “the SPR releases halting and market stabilization stabilizing.” demand in China”.

Next year, crude is expected to trade slightly higher as China reopens, improving the demand profile, and as OPEC+ continues to support the market, with WTI Trading in the $85 range. at $90 and Brent in the $95-$100 range, she said.

“Downside risks to these estimates include a delayed reopening in China, a severe slowdown in the United States, or a change of course by OPEC+ on its market support plan,” Babin said.

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