Russian oil shock is wearing out as prices settle as pre-war levels

The energy crisis created by Russia’s invasion of Ukraine and the associated jumps in oil and gas prices are all calming down to normal even as the oil transaction currency, the dollar, is also shedding influence as the market heals.

According to reports by agency sources, energy prices have fallen back to pre-war levels, driven lower by fears of a global recession and weak oil demand in China due to Covid outbreaks.

Analysts remain divided regarding oil prices in 2023 however, with some analysts believing the return of China and the lack of Russian energy will send prices soaring.

Russia’s invasion of Ukraine back in February triggered a major market crisis. Oil and gas prices soared to multi-decade highs; coal prices grew by nearly 70%, global wheat prices increased by over 60% while prices of metals exported by Russia, such as nickel, palladium, and aluminum all increased significantly.

Meanwhile, the euro fell below parity with the dollar for the first time in over two decades on fears that the war would trigger a global economic crisis.         

Now, however, there are growing signs that the disruption could be coming to an end, with crude oil, natural gas, and food prices having all fallen back to prewar levels while the euro has staged a 7% rally against the dollar over the past three months to $1.06.

Benchmark oil prices soared to just under $130 a barrel in March just weeks after Russia invaded Ukraine. Russia was the second largest exporter of crude, and sanctions against the country squeezed supply and drove prices up. But oil prices have been on a steady decline since July and are currently trading around their pre-war level of $80 per barrel.

“In large part, oil prices have declined in recent months due to recessionary fears and increasing interest rates in many developed economies. A worsening of the situation in Ukraine could also provide bearish signals to the market as a result of the global economic slowdown,” Jorge Leon, a senior oil markets research strategist at Rystad Energy, told Yahoo News.

There are fears that oil prices could fall further due to surging Covid cases in China. Chinese manufacturing activity dropped for a third consecutive month in December, increasing the probability that oil demand could weaken in the early months of the new year.

‘‘China has slowed down dramatically in 2022 because of this tight zero COVID policy. For the first time in 40 years China’s growth in 2022 is likely to be at or below global growth. That has never happened before. And looking in to next year for three, four, five, six months the relaxation of COVID restrictions will mean bush fire COVID cases throughout China,” Kristalina Georgieva, managing director of the International Monetary Fund (IMF), has told the CBS program.

The selloff is not yet over, according to a warning by Credit Suisse.

“The market remains well below its 55-Day Moving Average and 200 DMA at 89.01 and 100.67, and with medium-term momentum declining and global growth concerns looming, we think further weakness is likely to follow. Brent is likely in due course to see further downside towards the 61.8% retracement at 63.02, where we would have higher confidence of a more stable floor and for a consolidation phase to emerge.”

Another bearish signal: crude futures markets have gone into backwardation. Contango and backwardation are terms commonly used in commodity futures markets. A contango market is one where futures contracts trade at a premium to the spot price. For example, if the price of a WTI crude oil contract today is $60 per barrel but the delivery price in six months is $65, then the market is in contango.

In the reverse scenario, suppose the price of a WTI crude oil contract today is $60 per barrel but the delivery price six months down the line is $55, then the market is said to be in backwardation.

A simple way to think of contango and backwardation is: Contango is a situation where the market believes the future price is set to be more expensive than the current spot price, whereas backwardation is said to occur when the market anticipates the future price to be less expensive than the current spot price.

The current situation, therefore, means that oil traders believe that Brent prices will continue falling.

In this market, however, there are just as many bulls as bears, and the handle on the future is slippery, at best.

Some predict that global oil demand could soar as much as 4% in the coming year if the world manages to fully emerge from Covid restrictions. 

Hedge fund trader Pierre Andurand has told Bloomberg that oil demand may increase by 3 million to 4 million barrels a day in 2023 helped by a switch to oil from gas.

Likewise, some analysts believe that many of the headwinds that have cut short the oil price rally this year, including China’s zero-Covid policy and the coordinated SPR releases by several governments, will no longer be there in 2023. Coupled with sanctions on Russia’s oil and gas, this should elevate oil prices. He has also predicted that the energy sector will continue to outperform other market sectors due to the high demand for oil and gas stocks.