Oil prices recover from 11-month lows; EU price cap discussions flounder

Crude oil prices rebounded today from 11-month lows, with WTI and Brent trading at $78.6 and $84.8, respectively, at the time of writing, both up about 2% in the session.

Yesterday’s decline came on the back of reports of heavy protests in parts of China as the state continued with its harsh zero-covid measures, leaving investors jittery and Asian equities lower.

Are you looking for fast-news, hot-tips and market analysis? Sign-up for the Invezz newsletter, today.

Demand, especially in Asia, has taken a hit with the sharp rise in covid cases in China, the world’s largest crude importer, while the obstacles to public services sparked outrage on social media.

With Chinese societal attitudes being highly-sensitive to inflation, a CPI of 2% this month (although moderating) may only be adding fuel to the fire.

Witnessing the turmoil, the United Arab Emirates, a key OPEC member, elected to reduce its target supplies of crude oil to Asian customers by 5% in the coming month.

The planned cut in deliveries comes hot on the heels of a slide in the oil market for three consecutive weeks.

Russian price cap woes

The EU and G7 are looking to implement the highly politicized price caps on Russian oil on December 5.

With less than a week to go, the most crucial details of the plan are still far from settled as negotiations resumed yesterday.

Simply put, different countries have different priorities, and working together to establish a single price cap amid the Ukraine invasion, is yet to bear fruit.

The US and other G7 partners (three of which are also part of the EU) are awaiting the EU’s final proposal on a common price cap, before rolling out the fresh mechanism.

Under the agreement, insurance companies and shipping providers will not enter into contracts with any organizations that are purchasing Russian oil for a price that exceeds the established cap.

The rationale is that a tight framework would stifle Russian economy’s war machine and force Putin to pull out of Ukraine.

The Kremlin has hit back, warning that it would stop supplying countries that are party to the agreement, making it highly unlikely that the biggest importers such as China and India would participate in the exercise.

Early reports suggested that the EU has been discussing the possibility of a price cap between $65 – $70, although, some officials reported in the Wall Street Journal believe that this may be cut to as low as $62.

Vivek Dhar, Director of Mining and Energy Commodities Research at Commonwealth Bank of Australia, noted that the Urals, the Russian benchmark for oil, trades in the $50-$55 vicinity.

He believes,

(At such levels) Oil price (capping) is just going to be a non-effective part of the policy.

However, studies suggest that a cap of under $60 may be effective in preventing Russia from balancing its national budget.

Competing interests

Countries in Europe that have strong maritime capabilities such as Cyprus, Malta and Greece, argued that a price cap below $70 is too low, as it would adversely affect their own revenue base.

Cyprus, for instance, has argued that it would expect adequate compensation in such a scenario, further complicating negotiations.

On the other hand, member states such as Poland, Lithuania and Estonia with the support of Ukraine, believe the cap needs to be much lower and operate in the range of $20 to $30, pointing out that this is much closer to the cost-level for Russia and would squeeze revenues.

These countries border Ukraine or Russia, and their primary objective would be to end the hostilities at their doorstep as soon as possible.

Moreover, a lack of transparency in the Urals market as well as falling prices in recent days has made this task that much harder for European policymakers.

For its part, the United States is trying to direct a verdict that is near or at Russia’s selling price, to both appear tough on the Putin regime and avoid further tightening in the global oil market.

Bob McNally of Rapidan Energy Group states that there is an inherent contradiction in the targets of price cap setters,

…there are two objectives here and they are contrasting and competing. One is to keep Russian oil flowing. For that reason, you’d want a higher price cap like $65 or $70. But the others want to restrict the revenues that Putin is earning to fund the war. For that, you want … a $30 cap. The risk there is that you won’t get any Russian supply and you get a price spike.

Outlook

Given the diverging aims, there is a possibility that a price cap won’t materialize at all.

However, Amrita Sen, founder of Energy Aspects, believes that the oil price cap discussions will be superseded by the fresh EU embargo on Russia that also takes effect on December 5.

She pointed out,

So, the EU will still stop importing Russian oil regardless of the price cap.

Having said that, Russia is likely to be able to continue shipments even post the December 5 deadline, especially to China.

Indian oil companies however are hesitant to purchase oil post the expected rollout date and are in wait-and-watch mode.

In February 2023, the EU’s plan to sanction Russian oil products may create greater supply disruptions than what may occur today, especially as diesel products and heating oil dry up in the bloc.