Analysis: Oil over $100 for 3 consecutive months to reach $380

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While cash and oil strapped Sri Lanka is grinding to a halt, other forces are at play that may put further distance on the country in obtaining adequate supplies. Moves and events are afoot that may drive the price of oil to “stratospheric” levels just under USD 400 for a barrel.

Short supply coupled with sustained demand has been keeping the oil price well above USD 100 per barrel for the third consecutive month. The global oil market has seen two major sources of supply placed under heavy restriction. Playing an outsize role in the oil market, Russian oil supplies has been cut short by the events in Ukraine while lack of spare capacity elsewhere to accommodate incremental global demand has affected supply and hence prices. Although Russia is only the world’s third largest oil producer, it is a dominant player in oil exports. Driven by sanctions imposed on Russia by western countries on its invasion of Ukraine, oil of Russian origin reaching the markets is restricted thereby reducing supply and impacting prices.

Restrictive production policies of OPEC plus countries are also causing supply worries. OPEC plus countries produce some 40 per cent of global crude oil. For the most part, this cartel acting in harmony matches supply and demand to balance the global oil market. By controlling supplies, prices are kept high when demand is off. Conversely, their collective effort increases supplies when demand is peaking to lower prices.

It is reported that only Saudi Arabia and UAE within the OPEC group has spare production capacity. Despite growing demand and repeated requests from the US, neither have uplifted their output levels. Other OPEC members due to underinvestment and poor maintenance are unable to assist. 

Tightening monetary policies by central banks globally, on the back of expansion to contain the impact of Covid, is expected to “destroy” demand generally including for oil. The Russian invasion in Ukraine is creating inflation worries across the globe and weighing on economic activity. Inflationary pressure has led to many central banks hiking rates to curb inflation including Sri Lanka. A strong US currency on the back of elevated rates, curtails oil demand as the US dollar denominated oil becomes more expensive for holders of other currencies.

The official ban on Russian oil and lack of more production by OPEC plus countries is likely to keep global oil prices on the boil. Equally, a strong US dollar and policy tightening measures taken by central banks are likely to restrict further rallies in oil prices. Other powerful dynamics are also reported to be in play.

The G7 leaders at their recent meeting are reported to have discussed a plan to cap the price of Russian oil to pressurise Moscow. Russia is benefiting from rising energy prices. A price cap, it was argued, would cut off funding for the ongoing invasion of Ukraine.

Equally a price exception could work through a mechanism to restrict or ban insurance or financing for Russian oil shipments above certain limits. It could prevent spill over effects to low-income countries that are struggling with high food and energy costs.

In order to accomplish these objectives, the G7 needs the support of oil-exporting nations in the OPEC and its allies in a bloc known as OPEC+, which includes Russia.

The EU still plans to ban imports of most Russian oil from the end of the year. The US, UK, Canada and Japan will also ban Russian gold imports. France also supported the move.

Such action would, however, attract retaliation.

The price of oil may rise to a “stratospheric” level if US and European sanctions lead Russia to cut its crude supply in retaliation.

Such an outcome was disclosed by JPMorgan analysts in a note to clients seen and quoted by Bloomberg in early July 2022.

JPMorgan analysts stated in their note to clients that Moscow can afford to reduce daily crude production by five million barrels without significantly harming the economy given the country’s strong budgetary situation.

Such an outcome, however, will be intolerable for a large portion of the remainder of the world. According to the analysts, a daily supply reduction of three million barrels would cause benchmark London crude prices to rise to USD 190, while a reduction of five million barrels would result in “a stratospheric” price of USD 380 a barrel.

“The most obvious and likely risk with a price cap is that Russia might choose not to participate and instead retaliate by reducing exports,” the analysts wrote. “It is likely that the government could retaliate by cutting output as a way to inflict pain on the West. The tightness of the global oil market is on Russia’s side, they noted.

By Ishara Gamage