Which direction is the oil market heading?

Prices in the oil market remain volatile. At the start of this week, oil prices managed to win back last week’s losses, returning to a range of $100-110 a barrel, with Brent crude trading at $104.06 a barrel, and WTI at $101.34 a barrel. Besides technical factors, traders took solace from statements from the Chinese central bank on its willingness to provide sufficient liquidity in the financial markets, which dampened concern about the state of the Chinese economy.

For now, market participants are assessing the geopolitical risks of war in Eastern Europe, monitoring the outbreak of COVID-19 in China and the US dollar exchange rate. The market also awaits the outcome of the next OPEC+ meeting, scheduled later this week.

On the geopolitical side, the situation with energy supplies in Russia remains significant for the market. On April 27, Russian energy giant Gazprom halted supplies to Poland and Bulgaria, both heavy consumers of its gas. The move comes after both countries refused Moscow’s demand to pay for supplies in rubles,

At the same time, the German Economy and Climate Minister Robert Habeck said that Berlin has reduced its dependence on Russian oil and can afford to impose sanctions on supplies from Russia. He added, Russia’s share in the total volume of oil imported by Germany has fallen from 35 percent to 12 percent since the beginning of the Ukrainian crisis in February.

According to the International Energy Agency, the total demand for oil in Europe is about 13 million barrels per day, of which Russian oil accounts for a third — around 4.5 million barrels per day. It is very difficult to replace such large quantities at once. Also, European refineries are focused on processing heavy Russian oil.

Banning imports of Russian oil is still being discussed in Europe, but since February, supplies from Russia to Europe have been practically paralyzed. Banks refuse to open letters of credit, and shipowners refuse to send tankers to Russia’s Baltic ports. The UK and the US have already banned Russian oil. True, the share of Russian oil imports to the UK is only about 8 percent, while in the US it does not top 3 percent.

The key risk for oil demand has unexpectedly turned out to be China, the world’s largest importer of oil, where the fight against a new outbreak of the pandemic continues.

China’s financial capital, Shanghai, has been quarantined since March 28. China strictly adheres to a zero tolerance strategy for the infection, so the city of 25 million has been isolated from the outside world. Citizens can leave their homes only for urgent needs, most businesses, markets and shops have closed. Work at seaports has also stopped. The quarantine led to a fall in business activity, which has led to a fall in energy consumption.

According to Bloomberg, the demand for fuel in China may drop by 20 percent this year. This is equivalent to 1.2 million barrels per day of lost consumption, which would be the most significant decline in more than two years.

However, there are positive signals coming from China, as Shanghai authorities have hinted at the possibility of easing quarantine measures as new COVID-19 cases fall, to a minimum in three weeks. In Beijing, infections have also stabilized.

Nevertheless, according to data body Rystad Energy, global oil demand will slip by 1.4 million barrels per day this year to 99.6 million barrels per day. This is 0.6 percent below pre-pandemic consumption levels. Analysts expect that demand will not recover before next year.

The Organization of the Petroleum Exporting Countries and the IEA also lowered their demand forecasts. OPEC, lowered its forecast for the growth of world oil demand in 2022 by 500,000 barrels per day to 100.5 million. The IEA lowered its forecast for global oil demand this year by 950,000 barrels per day — to 99.7 million barrels per day. As the increase in commodity prices and the sanctions imposed on Russia, significantly impacts world growth.

In addition to this slowdown, additional pressure on demand is being exerted by tightening US monetary policy. The Federal Reserve’s rate hikes have led to a stronger dollar against other major world currencies, such as the yen, and the euro. Last week, the American dollar hit a two-year high. A strong dollar makes oil more expensive for holders of other currencies.

The next OPEC+ meeting takes place this week on May 5, at which the group will decide on production volumes for the coming months. According to Reuters, OPEC+ is likely to stick to its existing plan and agree to increase oil production by 432,000 barrels per day in June. However, many members of the group have consistently failed to deliver the agreed production increases for various reasons, chief among them oil infrastructure underinvestment and political tensions. There are only two members of OPEC+ that could potentially fill the gap: Saudi Arabia and the UAE. Both, however, have not responded to calls from large importers to boost production by more than their OPEC+ quotas.

In the near future, the global energy market will remain scarce, even though IEA countries will begin a plan to sell oil from their strategic reserves from May. The release of oil from IEA strategic reserves will have a short-term effect on the market, since OPEC countries will need to increase production in the long term. But there are chronic problems with this plan of action, and the upcoming OPEC+ meeting should once again confirm this.

In the coming months, the balance in the oil market will be determined by the decisions of key players regarding oil imports from Russia. The possibility of compensating for the fall in Russian output from the US, OPEC countries — including Iran and Venezuela, in the event of sanctions being lifted against them — is limited. In the face of continued sanctions pressure, the balance in the market will depend on whether it will be possible to reorient world trade channels by increasing Russian exports to Asia.

Therefore, in the coming weeks, apparently, oil prices may consolidate in the range of $95 to $110 a barrel. However, the prospects for concluding a peace treaty on Ukraine, or, on the contrary, new tough sanctions against Russian oil can push prices out of this range.

• 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.