OPEC keeps output steady into new year

Oil markets have endured several days of heightened risks at the start of December with the EU deciding on an oil price cap days before implementation and OPEC+ meeting to decide its stance on output. In the end, the events came out as neutral as both tried to maintain the status quo.

The EU approved a price cap level on Russian oil of USD 60/b in line with the G7 plan to limit revenues to Russia’s government but not overly disrupt oil market balances. Under the scheme, third-party importers would be able to make use of EU-domiciled services—shipping and insurance for example—when buying Russian crude oil so long as it was purchased at or below the price cap level. Russia’s main export grades have been trading on either side of the USD 60/b level in recent days: Urals, the main grade exported from western terminals in Russia, has traded below USD 60/b recently, while ESPO, which is delivered on the Pacific coast has been trading nearer to USD 80/b.

The price cap notionally will keep Russian oil flowing to key import markets like China or India and prevent a scramble for the few spare cargoes that are available in the market. Russia’s oil production may decline as a result of the price cap but may not drop off precipitously. Some buyers may try to make use of EU and G7 services and push Russia for prices at USD 60/b or below but officials from the country have said they will not participate in the scheme. That could leave some importers squeezed out of the market while others will continue buying without any EU/G7 services. The price cap probably doesn’t mean an enormous downside risk for Russian oil output but it certainly won’t encourage more production or exports and the impact is still to keep a positive tone to prices. In parallel to the price cap, EU sanctions on imports of seaborne Russian crude oil come into effect on December 5th, adding another market that will be closed off to Russian exporters.

OPEC+ holds steady

OPEC+ made its latest decision on oil output levels on December 4th amidst the uncertainty of the price cap plan. At its last meeting in early October, the producers’ alliance chose to cut output by 2m b/d from their target, though the impact of the cuts was countered by many members already failing to hit their targets. At this meeting, given the uncertainty around the level and implementation of the price cap on Russia, which remains part of OPEC+, the group decided to keep production targets unchanged.

While it did not announce any further cuts at the December meeting, OPEC+ did maintain an interventionist tone toward oil markets, saying in its statement after the meeting that it was ready to “meet at any time and take immediate action to address market developments.” Should market worries over a global recession help to push oil prices lower in the near term, the OPEC+ stance would mean more cuts while any news that China is easing its restrictive stance on Covid-19 could mean a hike in output. However, in both directions freedom of action is limited to only a few producers—such as Saudi Arabia, the UAE, Kuwait, Iraq—as most members are running up against capacity constraints. While OPEC+ didn’t shock the market with another cut, the outlook for OPEC+ supply into 2023 looks flat.

Focus turns to China

The critical variable for the near term in oil markets is how China progresses in its easing of its Covid-zero policies. News that several large cities in China are easing some restrictions has helped to give a boost to prices. While the moves are limited, and unlikely to translate into any material change in oil demand, they appear to be the first steps towards more opening of China’s economy and a greater pick-up in oil consumption. While recession worries in the US and EU, among other major economies, will keep the 2023 outlook cloudy, a Chinese economy converging on pre-pandemic levels of activity would represent a substantial tightening of oil market balances given the flat supply trajectory headed into next year.

Our expectation is that oil prices in 2023 will be roughly similar to where they end up for 2022. For Brent we maintain our expectation of an average of USD 105/b vs roughly USD 100/b this year and for WTI we expect an average of USD 95/b, nearly flat on 2022.