Global oil prices plunged to their lowest level in 2022 after the OPEC+ alliance of OPEC and non-OPEC oil producers decided to hold output steady into the new year. The decline came even as a G-7 price cap and European Union embargo on Russian seaborne oil imports came into effect December 5. The downward move was a response to signs of weaker demand for oil rather than concern over the availability of oil supply. By the end of the week, oil prices had fallen to just over $75 per barrel, more than $50/bbl lower than the near record of $130/bbl in March.
The 23-member oil producers’ group led by Saudi Arabia and Russia held a virtual meeting December 4, a day before the coordinated action by the G-7 bloc of the world’s wealthiest countries and the EU came into force. The OPEC+ ministers agreed to leave the production quotas they had set in October unchanged and meet again in June 2023, although they left open the possibility of an earlier meeting if the market shifts. After a 20-minute conference, OPEC+ issued a statement asserting that it stood ready to “take immediate additional measures to address market developments and support the balance of the oil market and its stability.”
The OPEC+ producers, made up of the 13 members of OPEC and 10 non-OPEC producers, touted their prescience in anticipating the market’s downturn when they agreed in October to slash production quotas by 2 million barrels per day beginning in November. That decision angered Washington because of a perceived bias by Saudi Arabia and its Gulf Arab neighbors in favor of Russia. But the statement issued at the end of the December meeting reiterated the argument by OPEC+ that the quota reduction was “purely driven by market considerations and recognized in retrospect by the market participants to have been the necessary and the right course of action towards stabilizing global markets.”
However, according to secondary source estimates of OPEC+ production in November, the actual cut in supply was not as steep as the headline number. According to an S&P Global Platts survey, the combined output of the OPEC+ producers fell by only 700,000 b/d in November, when the new quotas came into effect. The group has fallen short of its quotas as output has been restored gradually to bring back the large volume of oil that was withdrawn from the market at the start of the coronavirus pandemic in 2020. Several producers were struggling with capacity constraints because of underinvestment in new capacity with Russia now also contributing to the gap between actual supply and the ceiling. The Platts survey estimated the gap in November at 1.89 mb/d.
The OPEC+ statement made no mention of the EU sanctions or the price cap. Because Russia relies on oil and gas revenue for roughly half of its budget, the purpose of the price cap is to curtail Moscow’s earnings from oil exports while keeping Russian oil flowing to the market.
The imposition of the price cap was strongly supported by Washington, but it took weeks of tough negotiations with the EU to reach agreement on a final price, which was set at $60/bbl. Poland was among EU member states that argued for a lower ceiling, while others including Greece, Malta, and Cyprus, wanted a higher ceiling to protect their maritime industries. The haggling over where to set the price gave Russia time to prepare by building up what is known as a “shadow” tanker fleet to transport its oil as the new sanctions would prohibit the provision of shipping and insurance coverage for any cargo sold above the capped price.
This type of market intervention by the Western alliance is unprecedented and may yet backfire if Russian President Vladimir Putin decides to retaliate against Ukraine’s allies by withholding more natural gas to Europe or halting pipeline crude oil exports to Europe. The price cap has already disrupted oil flows as Turkey has held up the passage of crude oil tankers through the Bosporus Strait unless they can provide proof of insurance. This has created a backlog of tankers through the waterway that is used by Russia to ship oil from its Black Sea ports to the Mediterranean and on to Asia, which has become the main market for heavily discounted Russian crude oil. Although the price cap is now in effect, it does not apply to Russian oil loaded before December 5, and tankers have 45 days to complete the journey to their respective destinations.
The EU embargo applies to seaborne Russian imports but not to oil delivered by pipeline to Europe, which made up a smaller percentage of total exports to Europe before the war in Ukraine. The United Kingdom and the United States, along with some European allies, had already introduced voluntary bans on the importation of Russian oil since the early days of the Ukraine crisis. Since December 5, no EU country will be permitted to import Russian seaborne oil even under the price cap scheme. Analysts say this will cause Russian oil exports to Europe to decline by 90%. Yet even the U.S. Energy Information Agency sees the embargo as leading to the redirection of crude oil to other markets. It stated in its Short-Term Energy Outlook on December 6 it expected “most of Russia’s crude exports that will no longer go to Europe will find a destination elsewhere.”
According to the International Energy Agency, Russia exported 2.4 mb/d of crude oil to Europe or roughly half of its total crude oil exports in 2021. Most of the crude that was previously taken by European refiners is likely to be redirected to the Asian market, where China and India have stepped up purchases of Russian oil this year as Moscow offered steep discounts to willing buyers. However, it isn’t known just how much more Russian crude oil China and India can absorb.
According to IEA estimates, Russian pipeline exports to the EU through Ukraine amounted to 750,000 b/d in 2021 and may now be weaponized by Putin in retaliation for the price cap and embargo. There have already been a number of interruptions to flows through the Druzhba, or friendship, pipeline since the start of the conflict.
The market’s response to the OPEC+ decision and the price cap so far indicates concern over weakening oil demand, particularly from China as a result of the “zero-Covid” policy, which has led to an economic slowdown in the world’s largest oil importing country. The new sanctions, which add to a series of punitive economic and energy actions by the Western powers, introduced a new element of uncertainty in a market already reeling from the repercussions of the Ukraine crisis. Further disruption could follow the introduction of an EU embargo on the importation of Russian refined oil products in February.
Ed Morse, head of commodities research at Citigroup, told Bloomberg television on November 2 that there was enough oil supply to meet even a resurgence in Chinese demand after Beijing eased some coronavirus restrictions because demand overall was on a downward trend. He said in a separate interview on November 6 that uncertainty was sending market participants “fleeing,” and reducing liquidity. This would result in “incredible volatility coming into the market,” Morse said.
The IEA, in its November 15 Oil Market Report, projected that demand growth would slow to 1.6 mb/d in 2023 compared with 2.1 mb/d in 2022 “as mounting economic headwinds impede gains.” The IEA referred to China’s “persistently weak economy,” the energy crisis in Europe, and a strong U.S. dollar as among the factors that have exerted downward pressure on oil prices. The IEA noted that world supply rose by 410,000 b/d in October but was forecast to fall by 1 mb/d for the rest of the year as the OPEC+ cuts and the EU ban came into effect.
OPEC also expects slower demand for oil in 2023 but is more optimistic than the IEA on the extent of the decline. In its November Monthly Oil Market Report, it forecast growth in oil demand by 2.2 mb/d, a slight adjustment compared with the previous month’s forecast, when it expected growth of 2.3 mb/d. It mentioned the revision was because “oil demand growth is anticipated to be challenged by uncertainties related to economic activities, COVID-19 containment measures and geopolitical developments.”