Commodities Week Ahead: Oil Tracks Embargo on Russia, China COVID

  • Commodities Analysis
  • Editor's Pick
  • Oil jumps before coming off peaks on uncertainties over Russia embargo impact
  • China’s reopening of cities from lockdowns also being closely watched

OPEC+’s decision to stand pat on its production for January forms only half the narrative sought for this week by oil markets.

The other half will emerge in dribs and drabs over the coming days and weeks in the form of Europe’s ban on Russian oil and the Chinese government’s response to public demands for more relief from COVID tightening.

The European Union will need to replace Russian crude with oil from the Middle East, West Africa, and the United States, which should put a floor under oil prices at least in the near term, Wood Mackenzie vice president Ann-Louise Hittle said in a note carried by Reuters.

"Prices are currently weighed down by expectations of slow demand growth, despite the EU oil import ban on Russian crude and the G7 price cap. The adjustment to the EU ban and price cap is likely to support prices temporarily."

In China, after one tightening after another of its Zero-COVID policy since October, President Xi Jinping has been forced to loosen some of the restrictions in major Chinese cities amid fierce and rare public protests.

Crude futures jumped as much as 2% early Monday in Asian trading as several Chinese cities, including economic hubs Shanghai and Beijing, relaxed some movement and testing measures over the past week, drumming up hopes for a nationwide reversal. Reports also suggested that Beijing plans to announce more relief in the coming weeks.

Such a scenario would be largely positive for crude markets, given China’s status as the world’s largest oil importer. Dwindling demand in the country due to its strict COVID policies was a major source of selling pressure on oil markets this year.

Oil rebounded swiftly last week itself after the retreat by the Xi administration. US crude rose 5% after a 19% drop in three previous weeks as traders quickly worked out the math of mobility and energy demand returning to communities that had been suppressed for months.

Still, not all was hunky-dory on the oil front.

New York-traded West Texas Intermediate crude for January delivery, rose to a session peak of $81.81 a barrel in Asian trade on Monday, before giving back a chunk to show a gain of just 43 cents at $80.41 by 01:23 ET (06:23 GMT)

London-traded Brent crude for February, which hit a session high of $87.53 per barrel, was up just 39 cents, or 0.5%, at $85.96.

The retreat in crude’s highs came as some traders were still not entirely sure that the EU price cap of $60 per barrel imposed on Russian oil—meant to punish Moscow over its war against Ukraine—would be bullish for oil.

Crude traders had initially feared that EU countries might go for a much smaller limit of $50 a barrel or below that could sufficiently anger President Vladimir Putin and prompt him to carry out his threat of slashing Russian oil production or exports to punish Europe instead over the move. But by moving up the cap, Europe may avert any Russian retaliation—keeping Moscow’s oil supplies flowing and crude prices lower.

The Kremlin has reiterated that it will not do business with any country that tries to apply the price cap on Russian oil. But industry experts said it might not be entirely possible for Moscow to escape Western shipping and financial services that were tied to the price cap.

John Kilduff, partner at New York energy hedge fund Again Capital, said:

“It’s obvious that by keeping its production unchanged, OPEC+ is hedging on the theory that there will be a sizable and palpable shortage of oil in the market due to the EU ban and price cap on Russian oil. I’m not really sure that’s the case, and until we get the export numbers on Russian oil, I’ll stay cautious on any bullish projections for oil.”

The 23-nation OPEC+—which represents the 13-member Saudi-led Organization of the Petroleum Exporting Countries (OPEC) and 10 other oil producers steered by Russia—is counting instead on the 2 million barrels per day (bpd) production cut it ordered in October, that is to last through 2023.

There were also nagging concerns about how China’s oil demand would fare if Beijing reverts to aggressive COVID action later in December and over the coming year.

“The Chinese government sold a narrative of how it successfully defeated COVID. Then, the narrative got away from it,” Jen Kirby wrote in a column that appeared in a Thursday edition of the Vox.

“That narrative has been critical for President Xi. China’s triumphalism now looks like it had serious limitations—namely that China didn’t have a real exit plan from this strict containment strategy, especially as COVID-19 evolved and, with the omicron variants, became even more transmissible.”

The consensus among health experts and veteran China observers is that Beijing will likely loosen some of its strictest health policies and end up increasing COVID caseloads in the process. New infections from the virus hit a record high of 31,444 on Nov. 24. Some fear more dramatic spikes in a population that has a massive immunity gap for COVID compared with other nations—despite China’s relative experience in being the first to fight the global outbreak of the virus three years ago.

And the more the COVID duress on China, the more its contagion impact on oil, say analysts who predict the country could experience a demand slide of more than 1 million bpd versus the norm.

“Chinese crude imports may go below 9 million bpd in January, Amrita Sen, director of research at Energy Aspects, said in a Nov. 29 interview with Bloomberg Television.

Chinese oil imports stood at a five-month high of 10.2 million bpd in October—slightly above the pre-virus average—after the government issued an additional fuel-export quota in an attempt to help revive the country’s economy.

“Our view remains that zero-COVID will be in place through the winter,” Sen said, adding that Energy Aspects’ base case was for a China reopening from COVID in April.

Jeff Currie, global head of commodities at Goldman Sachs, told CNBC recently that “demand is probably heading south again in China given what’s going on.”

Ole Hansen, Head of Commodity Strategy at Saxo Bank, also said energy traders have been mostly focused on China’s demand for oil.

“The slowdown in demand from China will be temporary but having unsuccessfully fought COVID outbreaks with lockdowns for months, the prospect for an improvement looks months away and with the added risk of an economic slowdown reducing demand elsewhere, traders have increasingly been forced to change their short-term outlook,” Hansen said on Tuesday.

Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold positions in the commodities and securities he writes about.

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