Oil Takes a Dive

Oil prices have caught our attention, primarily because we still heavily rely on petrol and diesel cars. Oil prices impact our electricity and heating bills, whether directly or indirectly. November 2023 seems to mark a trend reversal – oil prices have been steadily declining for three consecutive weeks. What lies ahead for fuel station prices and heating bills?

The situation surrounding oil prices is crucial not just because they significantly affect our daily expenses. Oil serves as an accurate indicator of the overall economic situation – whether stocks, salaries, loan rates, returns on various personal investments, or even property prices will rise.

When oil prices rise, it signals that other commodities like milk, meat, and morning croissants will also become more expensive. This has been evident over the past eighteen months during the crisis triggered by Russia's invasion of Ukraine. At times, Brent crude, which Europe follows, soared above $120 per barrel, as it did in the summer of 2022. However, it has now dropped below $83 per barrel.

The world is tightly interconnected with oil. Oil dollars enable the Russian government to finance the most destructive war since World War II. Oil revenues allow some countries to fund fundamentalist movements, while others, thanks to oil dollars, finance the "green transition" and the reduction of carbon emissions.

Score: 1:4

The second week of November appears to be a significant milestone. This week concluded with a 4% drop in oil prices, although on November 10th, there was an attempt to rebound after a deep decline earlier in the week. This is happening against the backdrop of five major factors currently influencing oil prices.

Only two of these factors – the OPEC+ agreement to reduce production and the crisis in the Middle East – have the potential to drive prices up. The other three factors – the U.S. Federal Reserve's policy, sanctions against Russia, and the slowdown of the Chinese economy – are all depressing oil prices.

Force #1: OPEC+

At the end of November, leaders representing OPEC+ countries will meet (more on OPEC+ below). On November 10th, it was announced that Iraq expressed support for oil production cuts proposed by OPEC+ in response to the global decline in oil demand. Since 2016, when the consultation mechanism within OPEC+ was established, this organization has been quite effective in keeping oil prices unreasonably high. The only exception was the extraordinary events of 2020 when markets collapsed due to the COVID-19 pandemic.

The significance of OPEC+ is colossal. It includes 13 members of the Organization of the Petroleum Exporting Countries (OPEC) and 11 other countries that are not part of OPEC but coordinate their actions with it. OPEC countries control 80.4% of the world's proven oil reserves, and the group of 11 cooperating countries controls 9.7% of proven oil reserves. In total, these countries own 90% of the world's proven crude oil reserves.

Of the top 15 oil-exporting countries in 2022, 8 were members of OPEC, and 3 countries (Russia, Mexico, Kazakhstan) cooperate with OPEC under the OPEC+ group. So, a total of 11 OPEC+ countries accounted for approximately 76.7% of exports from the top 15 exporters in 2022. This also includes a key non-OPEC member of this alliance, Russia with its sanctioned oil. Access to this top 15 club of oil exporters requires exporting at least 900 thousand barrels per day.

Essentially, the production level in these 15 countries determines the dynamics of oil prices. The top 15 also includes three developed countries (the United States, Canada, and Norway) and independently standing Brazil.

But, of course, the appetites of importing countries also significantly impact oil prices.

PHOTO: Major oil exporters - Saudi Arabia (OPEC), Russia (OPEC+), Iraq (OPEC), the USA, Canada, the United Arab Emirates (OPEC), Kuwait (OPEC), Norway, Nigeria (OPEC), Brazil, Kazakhstan (OPEC+), Mexico (OPEC+), Angola (OPEC), Libya (OPEC), Iran (OPEC). This list almost coincides with the list of the largest oil producers shown in the infographic. Source: visualcapitalist.com

Force #2: Federal Reserve System and American Drillers

The policies of the Federal Reserve System (FRS, US) and the strength of the dollar are also driving down oil prices. The current battle of the FRS against inflation compels it to keep key interest rates high, which depressingly affects oil prices. Expensive credits threaten economic activity, and consequently, prices are on the decline.

Costly credits complicate the operations of oil service companies in the United States. They are gradually reducing the number of wells currently being drilled. However, skilled American oil producers are introducing new technologies, allowing them to increase production to record levels even with a reduction in drilling new wells. Crude oil production in the U.S.(third world oil exporter) is expected to grow from 11.9 million barrels per day in 2022 to 12.9 million barrels per day in 2023 and 13.2 million barrels per day in 2024. For comparison, the previous record of 12.3 million barrels per day was reached in 2019, but, as we can see, it has already been surpassed.

Force #3: China

Forecasts regarding oil demand from China suggest that the largest fuel importer will need less. This news puts downward pressure on prices. The situation in the Chinese economy, at least for now, doesn't look too optimistic. The trade war with the U.S. and the real estate market crisis are slowing down the Chinese economy and impeding oil imports. Consequently, prices are turning downward. At least twice in the last 5 weeks, PRC government authorities have announced a reduction in retail prices for oil products.

Force #4: Sanctions Against Russia

Sanctions against one of the largest oil exporters, Russia, have a significant impact on prices. Another, the 12th package of EU sanctions against Russia, is being prepared for mid-November. The UK has imposed special sanctions against companies that helped Russian oil exporters bypass imposed restrictions.

The idea behind oil sanctions against Russia is to leave Russian oil on the global market but make it impossible to derive high profits from its sale. The limited price for Russian oil is set at no higher than $60 per barrel. But in months when the market showed higher quotes, companies from India, Greece, the UAE, and other countries found ways to help Russia circumvent the maximum price restriction. This situation is really dangerous and extremely irritating to the G7, so the design of sanctions against Russian oil and oil products will be altered for greater effectiveness.

Force #5: Gaza Strip

It seems that the escalation of tension in the Middle East, which began on October 7th due to a terrorist attack by Hamas on Israeli settlements near the Gaza Strip, has ceased to influence oil right now. News that foreigners are being successfully evacuated from the Gaza Strip, coupled with clear position of Israel gradually gaining control, has somewhat reassured the markets. Although a month ago, the situation looked quite threatening. If the destabilization scenario had succeeded, prices would have risen.

My Favourite Predictor

Arguably, the best forecasters regarding oil and fossil fuels, in general, reside in the U.S. Department of Energy and the U.S. Energy Information Administration (EIA). In its forecast published on November 7th, the EIA predicts that global liquid fuel production will increase by 1.0 million barrels per day in 2024 compared to 2023. Experts are confident that the ongoing reduction in OPEC+ production will be compensated by an increase in production in countries not part of OPEC (and OPEC+, obviously). This will help maintain a relatively balanced global oil market in 2024.

The EIA believes that the conflict between Israel and Hamas is still capable of pushing up crude oil prices in the coming months. Although such pressure is not currently observed. The EIA predicts that the price of Brent crude oil will increase on average from $90 per barrel in the fourth quarter of 2023 to an average of $93 per barrel in 2024. And this is despite the fact that at the time of publishing this article, the price of Brent crude oil was already less than $83 per barrel, and at the time of the forecast publication, it was $85 per barrel.