In the past 2 weeks, the price for Brent crude oil has closed as high as $96.55 per barrel and as low as $84.07, while yesterday it settled at $85.82. Volatility in oil markets is nothing new, particularly in the context of the past few years, however these recent weeks have witnessed some of the biggest price swings of the year. As has been pointed out by many commentators this year, at present the only certainty in oil prices is uncertainty. In this week’s article, we will look at 3 key risk factors that have driven the recent price moves and are contributing to the uncertain outlook for oil. Investors Exit on Dim Demand Prospects
The oil market had been on a bullish trajectory after Saudi Arabia and Russia's announcement in late August to extend their production cuts until the end of the year. This news had propelled oil prices towards the $100 per barrel mark, a level not seen since September 2022. However, a sudden shift occurred between September 27th and October 5th, as Brent crude oil prices plummeted by nearly 13%, abruptly ending the upward momentum.
The reversal was triggered by concerns about suppressed economic growth, driven by widespread apprehension about the potential impacts of prolonged high-interest rates. These fears have affected various financial markets, including bonds and stocks, leading to risk aversion and a subsequent oil market sell-off by speculative investors. According to John Kemp of Reuters, hedge funds and money managers collectively “sold the equivalent of 33 million barrels in the six most important petroleum-related futures and options contracts” in the week ending October 3rd.
This sharp decline underscores the influence of speculative money on oil prices and highlights how sensitive the market is to shifts in sentiment. The reversal reflects not only the influence of speculators on the previous rally but also the broader concerns about the global economic landscape.
Renewed Risk from Middle East
Following last week’s decline, there has been no respite from volatility for crude oil prices. Renewed conflict between Israel and the Palestinian group Hamas have exacerbated the uncertainty in oil markets. As reported by Reuters, “Hamas launched the largest military assault on Israel in decades on Saturday, while Israel pounded the Gaza Strip on Tuesday with the fiercest air strikes in the 75-year history of its conflict with the Palestinians.” Given the extent to which commodity markets were impacted by the outbreak of conflict in Europe following Russia’s invasion of Ukraine in 2022, a lot of focus has turned to the risks associated with a conflict in the Middle East and the possible impact on oil prices.
Related: IEA: Oil Market “On Tenterhooks” Over Hamas-Israel War
This escalation of hostilities has had an immediate impact on oil prices, pushing them up by around 5%. While Israel is not a major oil producer, the conflict's proximity to critical infrastructure and shipping lanes poses a risk to global oil supply chains. As the situation unfolds, it could have broader implications for global geopolitics and oil supply, especially if proxy conflicts and international divisions escalate. Many western nations, including the USA and UK, have announced their support for Israel, while Russia and China have publicly supported the Palestinian cause. The unconfirmed reports of Iran's involvement in Hamas's actions introduce an additional layer of complexity, potentially leading to changes in US restrictions on Iranian oil exports which would place significant pressure on global supply, particularly at a time when inventory levels are below historical averages.
As noted by Goldman Sachs, the conflict also reduces the prospect of an improvement in relations between Israel and Saudi Arabia, and the associated boost to Saudi production over time. This is, of course, a rapidly unfolding situation and to make any long term projections on its development and subsequent consequences would be difficult at best and foolish at worst.
Russian Price Cap
The price cap imposed on Russian oil exports by G7 countries represents another element of uncertainty in the oil market. The goal of this price cap was to curtail Russia's energy revenues, thereby undermining its efforts in the Ukraine conflict, without completely excluding Russian oil from the global market. The cap theoretically prevents firms based in the EU and G7 countries from participating in the transport of Russian oil priced above $60 a barrel.
However, reports suggest that Russia is selling oil above the price cap, and some western companies are failing to comply with the limit. For example, Reuters has reported that Russia is reported to be selling oil to India at nearly $80 per barrel, and the appeal of Russian Urals crude has increased due to a shortage of diesel and gasoline products globally.
The situation surrounding the price cap mechanism remains uncertain. It is unclear whether it will be revised, or whether G7 countries will attempt to enforce it more rigorously. Either way, this situation introduces yet another risk factor for oil markets to monitor in the coming months.
The oil market's recent price volatility and uncertainty are driven by a confluence of factors, including economic growth concerns, Middle East conflicts, and the evolving situation surrounding Russian oil exports. These risk factors remind us that the only certainty in the oil market is its inherent unpredictability.
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Market fundamentals determine oil prices aided sometimes by geopolitical risks. Therefore, it is natural for the oil and energy markets to get on edge whenever there is an escalation of tension or fighting anywhere in the Middle East. There is always a potential risk of supply disruptions.
The Western price cap was born dead and was buried immediately after. The proof is that Russia has been breaking records with its exports of crude and petroleum products and has never once used Western shipping companies, insurance companies or finance for its oil exports. Moreover, it has been selling its crudes at prices far higher than the cap.
The announcement today that the Biden administration is set to impose new sanctions on Russian oil exports after multiple reports that Russian crude was selling at a significant premium to the G7 price cap of $60 is proof enough that the price cap is dead and buried. Moreover, it contradicts the claim yesterday by US Treasury Secretary Janet Yellen that the cap is working and is reducing Russia’s oil export revenues.
Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert