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A ceiling on the price of Russian oil? You’re late!

By Michael Lynch

Some governments are pushing for a cap on the price of oil that Russia sells to them in order to punish it for invading Ukraine. (Question: What is the Russian word for “Ukrainian invasion”? Answer: “Siberia”) The rationale is that Moscow’s dwindling oil revenues will force it to the negotiating table. Unfortunately, it seems unlikely that this move will have the slightest effect, given the structure of the proposal and the nature of the oil market.

In April, the International Energy Agency (IEA) predicted that Russian output for May would fall by 2.5 million bpd due to sanctions, both official and unofficial, but the reality proved different, with Russian oil output falling by 1 million barrels per day. Oil markets are a business. As annoying as it sounds, some Russian sales were made at a lower price of $30 a barrel. In addition, traditionally the oil market finds new customers to channel its commodities. “Uneducated” observers are shocked to learn that US imports from e.g. in Saudi Arabia have decreased or increased significantly within a month, as they are unaware that such fluctuations are common in the market.

During the 1973 oil crisis, the global oil trade was controlled primarily by the “Seven Sisters” cartel, which shifted supplies in such a way that no country suffered. Until 1990, when Iraqi and Kuwaiti oil went off the market, the price changed little, since the spot market redistributes supplies methodically and modestly. An official of the International Energy Agency later told an MIT seminar that Turkey, which was a major importer of Iraqi oil, had requested help from the Agency under the Emergency Distribution System (which was not implemented then and has not been implemented for some country never officially), and the IEA found the amount of oil that Ankara needed. But the cargo was in the US Gulf and was available at the spot price – plus freight. Finally, the Turks decided to buy spot oil on the Mediterranean market and avoid the exorbitant freight rates.

Like European sanctions that would ban imports of Russian oil, the price cap proposal would not take effect immediately, but until the end of 2022. Although oil prices have rebounded in recent days, after the collapse last week, estimates see the market gradually rebalancing in the current and next quarters, on the one hand due to reduced demand, and on the other due to a mild increase in production from OPEC+ and larger increases from oil producers such as Canada, Guyana and the USA. The International Energy Agency’s latest oil market report projects an increase in inventories in the second half of 2022 by 1.5 million barrels per day, or about 300 million barrels in total, which would bring inventories to “normal” levels, as the graph below shows.

A ceiling on the price of Russian oil?  You're late!
OECD inventories (mb) – THE AUTHOR FROM IEA DATA.

Another aspect that people struggle to understand is that prices do not only respond to market fundamentals but also to traders’ expectations. The price of oil strengthened not because Russian supply fell in April and May, but because traders expected the imposition of European sanctions on Russian oil and a cut in exports. When the sanctions are in full force, price reaction will be a thing of the past and the “Buy on the Rumor, Sell on the News” phenomenon will be unfolding ahead of us.

However, the last few days show that the impact of sanctions on Russian supplies has been overestimated and by the time they are fully in effect, the market will have adjusted to the new situation. Fears that oil prices will climb to $150 or $200 a barrel by 2022 are rather based on the expectation that by then the effects of the sanctions will be felt. But this horse has come out of the stable, run and won the race, and is now grazing. In the coming days and weeks, news from Russia, the Middle East, Libya, Venezuela and Iran will bring “wild” price swings, but the trend remains bearish as the period of market tightness has passed.

What does the next year have in store for us? Uncertainty and volatility. And more: weather phenomena, economic growth, political problems and celebrity deaths. We can consider these for sure.

Source: Capital

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