Oil prices react in a peculiar way to market signals

Fears of an oil supply deficit have increased due to the possibility of losing Russian products. The International Energy Agency believes that oil production in Russia may fall by 3 million barrels per day. Earlier the agency expected such a drop in production in April, now the deadline has shifted to May onward and the current forecast for April assumes a decline of 1.5 million bpd. 

However, this time the agency does not see this as a risk to global supply, since the decline in Russian production is most likely to be offset by weakening global demand, increased production by OPEC+, and the release of crude oil from the strategic reserves of the IEA member countries including the US. 

OPEC’s monthly market report also lowered the estimate of Russian production in 2022 by 530, 000 bpd, although growth is still expected compared to the 2021 levels. The US' Energy Information Administration expects that by the end of 2023, Russian production will decrease by 1.7 million bpd.

According to Reuters, the actual decline in Russian production for the period from April 1 to April 11 reached 0.7 million bpd. The Russian Energy Ministry from this month stopped publishing monthly oil and gas production data, so there is no official data yet. 

On the demand side, OPEC slashed its oil demand growth estimate for 2022 by 480,000 bpd to 3.7 million bpd as the recent geopolitical developments in Eastern Europe and COVID-19 lockdowns in China weigh on oil demand.

The IEA also reduced its demand growth forecast by 260,000 bpd to 99.4 million bpd reflecting the return of severe lockdowns in the world’s top oil importer, China.

Last week, the EIA reported that crude oil inventories had added 9.4 million barrels in the week to April 8, significantly surpassing analysts’ estimates of 0.863 million barrels. Whereas crude oil inventories in the SPR declined by 3.9 million barrels, which corresponds to a daily release of 557 thousand bpd. The unexpected inventory build, however, failed to move prices much lower, with both Brent and West Texas Intermediate remaining well above $100 a barrel.

On the other hand, total supplies of petroleum products in the US, an indirect indicator of demand, decreased by 1 million bpd in the week to April 8, to 18.8 million bpd. At the same time, gasoline and distillate stocks decreased by 3.7 and 2.9 million barrels respectively, which somewhat softens the negative impact on prices, if any.

The increase in crude oil inventories is largely due to a reduction in oil refineries' output and release from the SPR. The reserves moved from one storage facility to another, while products inventories decreased since the processing volume was not enough to fully replenish them.

Against this background, oil prices compensated for some of their recent losses as the US and the IEA geared up to start releasing a total of 240 million barrels from the SPR to curb oil prices over the next six months.

The main risks are now associated with oil supplies from Russia, which can quickly redirect its flows to Asia (albeit at a discount of 30-35 percent), increasing the deficit in the European market, which will lead to a new round of price increases. 

Dr. Namat Abu Al-Soof

However, OPEC countered the change in market sentiment when it rejected EU calls for more production to help check the oil prices. With the EU currently discussing potential oil sanctions on Russia, OPEC’s Secretary General Mohammed Barkindo said this could lead to the loss of more than 7 million bpd and that it would be “nearly impossible” to replace all these barrels. The statement of the OPEC’s chief looks like a diplomatic refusal to the EU to support political pressure on Russia through energy trade.

On Thursday, at the time of writing, Brent crude was trading at $111.4 a barrel, with WTI at $107 a barrel. Rising oil prices indicate that the market is not fully aligned with the official EIA statistical data and the assessments of OPEC and IEA. There are several reasons for this.

First, OPEC+ countries do not fulfill their obligations to increase production as planned. According to IEA’s estimates of OPEC+ supply, the alliance’s 19 members with quotas collectively increased oil production by just 40,000 bpd in March, compared to the 400,000 bpd planned increase, and still pumping 1.5 million bpd below its target.  

Second, the IEA’s calm attitude to the reduction of supplies from Russia causes a lot of doubts among traders. If the EU countries decide to impose sanctions on Russian oil, this could lead to an energy catastrophe, since it will not be possible to quickly replace these supplies, as Barkindo already warned on April 11.

Third, the release of oil from SPR by the IEA countries is only a short-term measure. At the moment, the release of SPR to the market is planned only in May and June, the increase will be only 1 million bpd. These volumes are not enough, since Russia supplies 7 million bpd to the world market, the bulk goes to the EU countries. 

In addition, after releasing oil from the SPR, it will eventually have to be replenished, which will lead to increased demand. 

Finally, the situation in China is also characterized by high uncertainty. Lifting the quarantine restrictions will spur the growth of energy demand again.

To sum up, there are still too many risks in the global energy market to seriously talk about imminent oil price decline. The main risks are now associated with oil supplies from Russia, which can quickly redirect its flows to Asia (albeit at a discount of 30-35 percent), increasing the deficit in the European market, which will lead to a new round of price increases. 

• Dr. Namat Al-Soof is an Iraqi oil expert with long experience in upstream and market analysis. He held senior analyst positions at OPEC, IEF in Riyadh, and OPEC FUND for International Development. Currently, he is a consultant to a number of companies in the oil industry.