Crude Oil Prices Continue to Struggle Amid Russia and China Woes

  • Commodities Analysis

Crude oil prices hit 10-month lows this week after Group of Seven (G7) member countries proposed a high price cap on Russian oil, easing concerns over supply constraints. Crude prices were also pushed down by a bigger-than-anticipated increase in U.S. gasoline inventories, as well as continued concerns over global demand for oil amid COVID-related restrictions in China.

The latest drop in oil prices came as an extension to Wednesday's declines when Brent and WTI benchmarks plummeted over 3% on reports that G7 is considering a price cap on Russian oil greater than current market prices.

Fundamentals Point Toward More Losses

G7 proposed a cap on Russian seaborne oil of $65-$70 a barrel, however, European Union (EU) members are yet to reach an agreement on a price. If approved, the price cap could encourage Russia to keep selling its oil and reduce the likelihood of a supply crunch in oil markets. EU governments are set to resume discussions on Thursday or Friday, EU diplomats said.

"If the EU agrees to an oil price cap of $65/$70/bbl this week, we see downside risks to our oil price forecast of $95/bbl this quarter," said Vivek Dhar, a commodities analyst at Commonwealth Bank.

Last week, the Energy Information Administration (EIA) reported that U.S. gasoline and distillate inventories have swollen significantly, weighing further on crude oil prices and the trading of futures contracts. However, crude inventories are down by 3.7 million barrels at 431.7 million barrels in the week to Nov. 18, substantially wider than the consensus estimates of a 1.1 million-barrel decline.

In the meantime, oil giant Chevron (NYSE: CVX ) could potentially obtain approval from U.S. regulators to expand operations in Venezuela and continue trading its oil once the Venezuelan government and its opposition restart negotiations.

U.S. representatives and Venezuelan parties want to resume talks in Mexico City this weekend. The move would mark a significant step forward and the first discussion in over a year that could alleviate U.S. oil sanctions on Venezuela.

Mounting Concerns Over China Demand

Another factor that contributed to the latest oil prices drop is expanding coronavirus restrictions in China amid a higher number of infections, making investors more concerned about the economy and fueling the demand. Additionally, global stocks also fell on the reports.

The most populous district in Beijing asked residents to stay at home on Monday as the number of coronavirus cases rose once again. Similarly, at least one district in Guangzhou is under a 5-day lockdown.

"It looked like zero COVID was moving in the right direction and everyone was excited but the Chinese government is taking some strong action and in the short term there's going to be fits and starts," said Thomas Hayes, chairman of Great Hill Capital in New York.

While China’s stringent zero-COVID policy and new lockdowns bode well for demand recovery, rising coronavirus cases remain one of the key risks.

"While this raises hopes for a demand recovery, surging case numbers continue to be a key downside risk. Another round of lockdowns cannot be ruled out if cases keep rising," Daniely Hynes, a commodity strategist at Australia and New Zealand Banking Group (ANZ).

China also recently announced it will reduce the quarantine period for tourists and drop some of the restriction measures for international flights.

Elsewhere, the Organization of Petroleum Exporting Countries (OPEC) trimmed the global oil demand outlook for 2022 and 2023 by 0.1 million barrels per day (bpd), further weighing on crude prices.

The U.S. dollar also rose against a basket of currencies earlier this week, as investors turned to the safe-haven greenback due to the faltering global economic outlook following the latest COVID restrictions in China.

The greenback took another beating this week after the latest Fed minutes suggested that the U.S. central bank is more likely to slow the pace of interest rate hikes in December. The greenback fell over 1% on the Fed minutes data but capped further losses Thursday.

Summary

Crude oil remains a popular alternative investment but is trading under continued pressure after G7 member states proposed a high price cap on Russian oil. Moreover, the market has growing concerns over demand from China given continued lockdowns to curb new COVID infections. This week’s low of $75.30 in crude oil prices marks the lowest level seen since January this year.

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