The price of Brent crude ended the week at $109.10 after closing the previous week at $113.12. The price of WTI ended the week at $107.62 after closing the previous week $109.16.
In last week’s note, we highlighted that while prices have been declining, the price movement remained on the upward trend that started in December of last year. We also stated that if the trend breaks, we are expecting to see the price of Brent crude oil dropping towards $100.00. At the end of last week, the price of Brent crude did break below the upward trend line, but not decisively. As such, we are still waiting for confirmation.
There are signs that the global economy is slowing down, including the economies of Europe and the US. Last week, the IMF lowered its forecast for US GDP in 2022 to 2.9% from 3.7%, and to 1.7% from 2.3% in 2023 and to 0.8% in 2024. Additionally, the Federal Reserve Bank of Atlanta is indicating that the US economy is growing at zero percent in 2Q of this year – after contracting by 1.5% in 1Q. The economic slowdown and the high price for oil and oil products are softening demand. US demand is running below pre-COVID levels with gasoline demand for the last month lagging 2019 level by 6.7%, diesel demand lagging by 6.2% and jet fuel demand lagging by nearly 14%. The strong US dollar is also putting additional pressure on those countries which have seen their currency weaken against the US dollar. While the US dollar weakened slightly last week, as indicated by the US Dollar Index decreasing to 104.19 from 104.65 of the previous week, the US dollar remains the strongest since December of 2002.
In addition to the tepid oil demand, we have been putting forth the view that the supply situation will be stabilizing, in part, because the announced EU ban on imports of Russia oil, will be the last major announcement which will negatively affect sentiment pertaining to future oil supply. Now, there is noise coming out of the ongoing G-7 meeting with members considering the possibility of placing price caps on Russian oil and pipeline gas. The price cap on natural gas would entail European countries not paying above some fixed price for natural gas. The price gap on crude oil would place the burden on the International Group of Protection and Indemnity Clubs, which are responsible for insuring oil tankers, and would be sanctioned if the oil is sold above a fixed price. There are risks associated with the implementation of these price caps. The most obvious is that Russia will reduce sales of natural gas and crude oil to Europe, which will have a major negative impact on the economies of Europe. The price cap on natural gas has a better chance of working because Russia has less flexibility in moving natural gas to other regions because of logistical constraints. The cap on crude oil has a reduced chance of being effective because Russia can move increased volumes to other regions, including Asia. As such, for price cap on crude oil to work it will require the cooperation of India and China, which seems unlikely, given that these countries are already buying Russian crude at a discount. Plus, these countries have other reasons for wanting to maintain good relationships with Russia. Additionally, such a price cap is unlikely to be embraced by the other members of OPEC+, which are being asked to increase supply.
While we are less concerned about the talk of price caps, we are increasing concerned about the risk of further escalation of the Russia-Ukraine because of several developments:
- The military of Belarus is carrying out mobilization exercises, and Russia is moving military equipment to Belarus, including missiles. Additionally, Putin has indicated that nuclear-capable missiles will be moved to Belarus in the next few months.
- Tensions are rising between Russia and Poland, which is a NATO member. On Saturday, Russia claimed it had killed 80 Polish fighters in eastern Ukraine and destroyed 20 armor combat vehicles and eight rocket launchers in eastern Ukraine.
- Lithuania is preventing Russia from moving material to Kaliningrad through Lithuania with Lithuania claiming that the ban is required because of EU sanctions. Kaliningrad is about 1300 (800 miles) from Moscow and is located along the Baltic Coast between Lithuania and Poland and has a population of around 1.0 million Russians. Additionally, Russia has a significant military presence in Kaliningrad, including naval and air forces. Russia is viewing the ban as a “blockade”, which is a military action.
The longer the conflict goes on, the greater the risk of escalation – and the greater the damage to western economies – and to developing economies, which are getting hit hard by elevated energy and food prices, while facing the possibility of physical shortages.