Three weeks ago, we noted that sanctions continued to tighten on Russia and asked whether China would come to Moscow’s rescue (no it wouldn’t we concluded). However, three weeks on from the initial question and it appears that OPEC+ has instead decided to come to Russia’s aid. That may not be too surprising – Russia is of course a key member of the OPEC+ alliance which is focused on “market stability” (aka higher oil prices) and the price of Brent crude has fallen steadily by 25% ($40/bbl) over the last four months.
The initial impetus to increase prices appears to have come from Saudi Arabia, which wanted to remove 1-2 mbd from the market in stages over the next few months to support prices and believes that the outlook for the global economy is uncertain – which is hard to argue with at this stage I think. A rare OPEC meeting, with most members physically present in Vienna, was scheduled for yesterday. It was also clear that production cuts aimed at increasing prices would not be welcomed by the US both because the midterms are approaching (high gas prices play badly with US consumers and usually siphon votes away from the incumbent) and because higher oil prices translate into greater revenues available to Russia to wage its war on Ukraine, something the US is focused on preventing.
The headline cut was larger than expected, with the meeting agreeing to a reduction of 2 mbd in global output to less than 42 mbd for OPEC+ against forecast global demand of 99.7 mbd. Both Russia and Saudi Arabia each agreed to cut 0.5 mbd from their current output levels and the OPEC+ cut will remain in force until the end of 2023 (when the IEA forecasts oil demand to be 2.1 mbd higher than today’s levels). Given that a number of OPEC countries have struggled to meet their agreed production targets (including Russia), the actual reduction is likely to be closer to 1 mbd – still enough to strengthen oil markets though, which have risen by $8/bbl over October to date in anticipation of the OPEC meeting.
The US response was clear, noting that “OPEC+ was aligning with Russia”. Washington will continue to release oil from its Strategic Petroleum Reserve in an effort to moderate price rises and also raised the possibility of anti-cartel laws being introduced in the US. Normally, such a falling out between Saudi Arabia and one of its main backers would be surprising. However, politics (and oil) makes strange bedfellows and on this occasion Saudi Arabia has chosen to challenge the US in the oil market, aiming for higher revenues to Riyadh but also indirectly assisting Moscow in raising funds for its war, in direct opposition to US policy. Saudi Arabia will no doubt claim that it wants a joint approach by the producers’ group to enable it to mange any potential supply disruptions or sudden demand surges. However, given everything else happening in the world, the US is likely to continue to be unhappy with further production cuts and the resulting higher prices.
One of the events happening in the oil world are the continued discussions in the G7 around a cap on the price of Russian oil, specifically aimed at reducing Russia’s revenues available to continue the war in Ukraine. While the level of the price cap has yet to be agreed and announced by the G7 and its allies, it does now appear that the EU will join in with the G7 plan to implement the cap. The entire arrangement is quite complex on the face of it so I suspect that the implementation may need to be handled carefully to ensure its goals are achieved – maintaining Russian oil output while reducing Russian revenues.
In principle, as long as sales of Russian oil are made at or below the level of the price cap, then the shipment will be exempt from the EU ban on providing services – such as insurance – to the cargo. The services prohibition is scheduled to come into effect on 5 December at the same time as the ban on seaborne imports of crude oil into the EU becomes effective. In February 2023 a further ban on imports of products into the EU will come into effect.
The US has also been touting the benefits to oil consumers of a price cap on Russian oil and press reports suggest that the US believes that oil acquisition costs can be reduced by $160 bn annually in the fifty largest emerging markets if the proposals are adopted.
What does this all mean?
The net around the stream of Russian oil revenues is being steadily tightened and the price cap is just the latest ratcheting up of pressure on Moscow. While a number of trading companies have highlighted the difficulties around the effective implementation of the price cap, there looks to be a lot of political will behind the approach to ensure Russian-produced oil remains available to the world economy while at the same time oil-generated revenues for Russia are steadily reduced. None of us can know how Russia will respond when faced with these latest measures but the pressure on Moscow continues to build.
Global Energy Comment 