U.S. oil taps its lowest price of the year thanks to China as OPEC+ output decision looms

U.S. benchmark oil futures hit their lowest price since 2022 on Monday, briefly erasing what had been a big year-to-date gain, as China’s zero-covid-19 policy destroyed expectations of for energy demand.

The price hike came less than a week before a Dec. 4 decision by the Organization of the Petroleum Exporting Countries and its allies, led by Russia, on production levels.

“China is the engine of growth for commodities and clearly the biggest driver of crude oil price action,” Rebecca Babin, senior energy trader at CIBC Private Wealth US, told MarketWatch. OPEC + will “focus on China’s demand.”

The weekend saw protests against President Xi Jinping’s strict COVID-19 restrictions in Beijing, Shanghai and other major Chinese cities.

Oil prices were already under pressure before markets saw “significant protests erupt across China, adding fuel to the fire on oil prices,” Manish Raj, chief financial officer at Velandera Energy Partners, told MarketWatch.

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

US benchmark West Texas Intermediate crude for January delivery CLF23,
+0.85%

CL.1,
+0.85%
It traded at about $73.60 on the New York Stock Exchange on Monday, the lowest intraday price for a futures contract since Dec. 27, 2021, according to Dow Jones Market Data.

The decline caused prices to trade about 2.1% lower year-to-date, as front-month prices settled below $75.21 on December 31. WTI was higher in Monday’s trading, however, trading at $77.18. The global benchmark for January crude oil Brent BRNF23,
-0.26%
It traded as low as $80.61, its lowest since January, and last traded at $83.24.

The recent shutdowns are estimated to have cut demand for Chinese oil by 900,000 barrels a day, bringing the supply market “from tight to balanced,” it said. Babin said the drop in Chinese demand “closely mirrors” the amount of supply that OPEC+ removed from the market at its last meeting.

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

Among the issues that OPEC+ is likely to consider at its meeting on Sunday is the economic weakness caused by the continuation of restrictive policies against COVID-19 in China, said Greg Sharenow, managing director and portfolio manager at PIMCO.

He believes the economic vulnerability from China’s restrictive COVID policies “has been well telegraphed so far.” He also noted that commodity markets “broadly have been very strong despite the absence of a supportive Chinese economy.”

If China’s economy restarts in the second quarter of 2023, or if the Chinese government further stimulates industries, any slowdown in the developing economy will be priced in by tighter financial conditions, which are currently priced in. will be very supportive for oil prices,” Sharenow told MarketWatch.

Complex ‘decision tree’ for OPEC+

The OPEC+ decision on oil production levels may soon be the biggest issue for oil traders.

The “decision tree” for OPEC+ is very complicated, Sharenow said, in part because of the uncertainty over the loss of Russian production and the disruptive nature of the supply insurance restrictions.

The European Union’s ban on Russian offshore oil exports, along with the Group of Seven’s plan to cut oil prices from Russia early next month, is expected to take effect on December 5, the day after the OPEC+ meeting.

The EU’s eighth package of sanctions against Russia, including a ban on Russian offshore oil imports, lays the foundation for the legal framework to implement the G-7 deal. Among the sanctions of the EU is a ban on the insurance of ships carrying Russian oil.

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Reading: Why the European Union ban and the G7 price hike on Russian oil will not guarantee continued oil supply

Babin said Russian oil production was “very resilient” to the sanctions. In the run-up to the Dec. 5 sanctions, some buyers have increased purchases, reducing the impact of supply and Russian production is almost back to pre-invasion levels, she said.

If the European Union agrees to a price between $65 and $70, “we don’t see any increase in Russian supply at the end of 2022, because the price of the cap is essentially equal to the price that Russia is currently selling crude oil on the market. Babin said.

The key for Russian supply next year will be how the EU handles sanctions related to future oil production that will take effect in February, she said. It is expected that the EU will ban the import of Russian oil products from February 5.

See Barron’s: The European price on Russian oil is all a load, no cut

“If the EU imposes tougher tariffs on Russian products, this could have a significant impact on gasoline and diesel prices,” Babin said.

However, for now, based on the developments in China and “high volatility in the oil markets in the past few weeks, Babin believes that the chance to reduce OPEC + production has increased.

Both WTI and Brent crude futures turned from bearish to contango, and OPEC+ “gave further confirmation that demand is weak and more action is needed,” it said. Backward refers to a situation in crude oil contract prices where oil prices for delivery in the near future are higher than those for future delivery, while in contango, prices for future delivery are higher than the spot market.

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All told, there’s a 60% chance OPEC+ will cut another 500,000 barrels per day next week, and a 40% chance it won’t change production targets, Babin said.

CME Group CME,
-1.20%
However, the OPEC Watchdog now has a 77.7% chance of the December OPEC meeting ending in “no change or [a] small increase in productivity,” and a 12.4% chance for a decrease in productivity.

The prospect of oil

Although U.S. crude and Brent crude were at a year-on-year low on Monday that the market has seen for most of the year, PIMCO’s Sharenow sees upside for oil prices.

“Of course, the slowdown in economic growth is the main drag on oil prices and commodities more broadly,” he said.

However, “a capital discipline among oil and gas companies showed more”, which limits the “future outlook for oil supply”, which is the main reason for PIMCO’s opinion on prices.

Oil futures are also approaching the level where the United States will buy oil to fill the Strategic Petroleum Reserve, and “the buffers in the system are too low to absorb a shock,” Sharenow said.

The CIBC analyst said oil prices may recover some of the recent losses, with WTI returning to $80 and Brent returning to $90, based on the “collapse of SPR releases and stabilization of demand in China”.

Next year, as China reopens, crude oil should trade modestly, improving the demand profile, and as OPEC+ continues to support the market, with WTI trading between $85 and $90 and Brent between $95 and 100 dollars, she said.

“The downside of these estimates is a late opening in China, a severe slowdown in the US or OPEC+ changing its plan to support the markets,” Babin said.

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