Dr Carole Nakhle
Oil prices have confounded expectations in the first quarter of 2023. Brent – a major global benchmark – hit a low of US$72 (£58) a barrel on March 17, while the world’s other main benchmark, WTI, dropped to less than US$66 a barrel. This is a far cry from the nearly US$114 and US$103 a barrel, respectively, reached on the same day a year before following the invasion of Ukraine by Russia, a major oil producer.
These unexpectedly low prices remain even as the war in Ukraine continues with no clear end in sight. Other developments have also failed to boost prices as expected. China, the world’s largest importer of crude oil, abandoned its zero-COVID policy in December 2022, creating expectations that Chinese oil demand would quickly return with a vengeance, propelling prices higher. A couple of months before this, OPEC+ (the cartel of certain oil-producing nations) had announced a production cut of 2 million barrels a day (mb/d) – roughly 2% of world supply and the largest cut since 2020.
A surprise announcement of 1.1 mb/d of cuts by OPEC+ on April 2 did boost prices. On top of a 0.5 mb/d decrease announced by Russia in February, this has brought the group’s cuts to 1.6 mb/d. And by mid-April Brent reached US$86 and WTI US$83 per barrel.
But oil has now started to retreat again, an unexpected development during a war involving a major oil exporter, and at a time when a giant consumer like China is reopening after three years of economic isolation.
This shows that oil price forecasts continue to be unreliable. The economic outlook and Chinese consumption growth are key to demand expectations, while Russia is the wild card in terms of supply. Until uncertainty around these three factors dissipates, global oil markets will not have a clear direction.
Oil Price Movements
Data Sources: EIA, Bloomberg (until 24 April 2023)
Oil demand is closely linked to economic growth because a slowing economy shrinks income, leading people to curtail expenditure and travel less, and slowing down manufacturing that uses oil. Various economic forecasts have recently highlighted the major challenges facing the global economy, but widely prevailing uncertainty seems to top the list.
In its April 2023 World Economic Outlook, the International Monetary Fund (IMF) emphasised a high level of uncertainty “amid financial sector turmoil, high inflation, ongoing effects of Russia’s invasion of Ukraine, and three years of COVID”.
The World Bank has also warned that “a lost decade could be in the making for the global economy” as “nearly all the economic forces that powered progress and prosperity over the last three decades are fading”.
April’s OPEC+ Monthly Oil Market Report kept its forecast for economic growth and oil demand largely unchanged from previous reports, but said: “The global economy will continue to navigate through challenges including high inflation, higher interest rates particularly in the Eurozone and the US, and high debt levels in many regions.” It stated that “these uncertainties surrounding current oil market dynamics” were behind its decision to cut production.
The China Factor
China is the world’s second-largest oil consumer and the second-largest economy after the US. So all eyes have been on its oil demand since the country ended the nearly three-year zero-COVID policy that severely restricted its peoples’ mobility and economic activity.
Today, it is the main bullish factor in many global economic forecasts. The IMF’s managing director recently said:
“China this year is going to contribute about one-third of global [economic] growth. We calculated that 1% more growth in China translates into 0.3% more growth for the economies that are connected to China.”
The IEA believes China will account for half of the global increase in oil demand this year. Goldman Sachs expects China’s oil demand growth to boost Brent by roughly US$15 per barrel.
However, such enthusiasm is not universally shared. A Citibank report says China’s post-COVID recovery seems slower than expected. Being an export-driven economy, the Asian powerhouse is exposed to the health of the rest of the world. A weakening global economy will reduce demand for Chinese exports, with negative repercussions on its economy and therefore oil demand.
Similarly, China’s National Bureau of Statistics said “the external environment is even more complex, inadequate demand remains prominent and the foundation for economic recovery is not solid yet”. Or, as the Saudi energy minister reportedly said when asked about an oil demand rebound recently: “I’ll believe it when I see it.”
Russia: Not Done Yet
As a major oil producer and exporter, Russia also has a massive influence on global oil markets. Despite sanctions since the beginning of the war in Ukraine (and following the annexation of Crimea in 2014), Russia continues to be the world’s third-largest oil producer after the US and Saudi Arabia.
When Russia invaded Ukraine, oil prices spiked due to fears of a loss of Russian supply. The IEA warned the resulting 3 mb/d loss (around one-third of Russia’s total and almost 3% of world production) could produce “the biggest supply crisis in decades”. Analysts from investment bank JP Morgan said Russia could cut up to 5 mb/d of production driving global oil prices to a “stratospheric” US$380 per barrel.
Such gloomy scenarios did not materialise. Russian oil continued to flow but changed direction from Europe to Asia, helping to ease price pressure for consumers everywhere. And Russia’s cuts in retaliation for sanctions have so far been smaller than expected. Of course, it could cut more, especially if this would put more economic pressure on the west and affect support for Ukraine.
This cocktail of uncertainties should encourage a more cautious stance when it comes to predicting oil prices, this year at least. Some analysts have already reduced their 2023 price forecasts, with estimates varying between US$81 and US$100 a barrel.
Expect more revisions. As one study that tracked the evolution of oil prices over four decades said: “all price expectations are subject to error”.
“Increasing pressure on Russia’s oil industry“, Dr Carole Nakhle, Apr 2023
“Russia’s oil is in long-term decline – and the war has only added to the problem“, Dr Carole Nakhle, Jul 2022
“After conflicting expectations about oil prices, how do experts read the market prospects in 2023?“, Dr Carole Nakhle, Apr 2023
“OPEC+ announces surprise oil cuts“, Dr Carole Nakhle, Apr 2023