The conflict was initially gas-induced but in an increasingly globalized energy market, crisis in one type of energy has immense potential to spread to a wide spectrum of mineral resources and onward. Oil prices jumped to $130 per barrel right after conflict. However, it did not stay that high for a long time. Chinese Zero-COVID policy came to the rescue. Chinese economic slowdown led to a lower oil demand and international benchmark Brent leaned back to a double digit range and hovered around $80 per barrel as we are writing this piece late December 2022.

What to Expect for 2023

To be frank, I tend to believe that 2023 is already with us. I can’t foresee a much different prospects for the world oil market for the first quarter of 2023. However, several factors may influence our expectations on both demand and supply side. Let’s begin with the demand side. Chinese Zero-COVID policies was perplexing once it entered into the second year. A country with 1.45 Billion population and the second largest economy in the world cannot afford to shut down entirely for such a long period of time. An economy that experienced double digit growth only ten years ago to fall in the vicinity of one percent growth meant so much for the world economy. Growth engine of global oil demand is switched off.

However, early December 2022, China declared a swift shift from its Zero-COVID policy and reopened parts of the economy. OPEC+ hailed the news and markets celebrated with a 12 percent oil price rise that stabilized the oil market well above $80 per barrel. Markets will keep up $80 plus range into the winter of 2023. As for the second quarter beginning April 2023, markets should wait for the strength of demand side not only from China but from India, too.

Indian economy is poised for a major show of year on year growth in 2022-2023. A rate of growth of around 6 percent for Indian economy means an average of 5.1 mb/d of crude imports for 2023 some 0.46 mb/d above 2022. As such Indian crude imports will exceed that of China by 0.46 mb/d. In fact, major oil producers are already negotiating long term oil exports contracts with India. However, both China and India are major crude oil refiners. They refine and export oil products to other major consuming countries in Europe, Africa and Latin America.

We aren’t certain on how President Xi Jinping envisages to continue his third term in office as far as the economic texture of China is concerned. China has virtually acted as the factory of the world for some three decades. There are signs that China wouldn’t want to keep manufacturing for the rest of the world anymore. This means much for the world economy and the international oil markets. In case China decided to move towards an inward looking economy for the current decade and probably next decade, oil consumption will not be in commiserate with growth. Global oil market scenario will have to undergo change of direction. As such oil producers will have to gradually shift focus towards new destinations.

A shift in economic outlook from export-led growth to domestic-oriented growth doesn’t necessarily mean a decline in energy consumption, but as China moves towards a service economy and reliance on its own population for most of its production, types and patterns of energy use changes from oil to gas and most notably new sources of energy like hydrogen. In the meantime, reliance on other sources of minerals such as lithium will also increase at a higher rate. Though, this is the case for other industrial countries such as Europe, too. Nevertheless, oil and energy traders cautiously watch China’s next Zero-COVID move in order to evaluate and see signs of the direction of the economy and level of oil that would be required to maintain the pace in 2023 and possibly beyond.

Nevertheless, I still cautiously expect to see how the world oil markets will react to Russian oil price cap policy that will go into effect at 12 Midnight of January 2023. It is interesting to note that the $60 per barrel oil cap is already high for Ural trading at $57.73 per barrel in late December 2022.

Gas Factor

Gas markets have historically followed oil. Most gas pricing formulas are oil-related. This has often been the case for LNG, as well. The year 2022 was the year of gas. Europe imported over half of its gas requirements from Russia via pipelines; and with the commencement of conflict between Russia and the Western countries and consequent disruptions of Russian gas supply to European Union, gas demonstrated its powerful appearance in the international energy scene. Gas price is now oil-indexed. In fact, in certain cases, oil market is gas-related and not the reverse. Having said that since gas has always been regarded as a regional energy phenomenon, it hasn’t been seen to require logistics that have been in place for oil and oil products.

OECD countries have SPR (Strategic Petroleum Reserves) for oil. This is a compulsory emergency logistics that was designed since early 1970’s after Arab oil embargo on US and three other countries. International Energy Agency (IEA) required OECD members to store equivalent of 60 to 90 days of oil consumption in their reservoirs. There has never been Strategic Gas Reserves. Nobody ever heard or talked of it. Companies do have commercial gas storages but not for emergency disruptions.

After Ukraine conflict and imposition of sanctions by the United States that was followed by two major explosions in Nord Stream 1 and Europe realized that two major blunders have been committed on gas fronts namely; full reliance on one giant supplier and; then being too timid towards the US.

Building costly gas storage facilities and procurement of gas carriers have been considered important events in the history of gas that affected price of gas, as well. This should surely need to be sped up during 2023 and onwards. A new phenomenal texture of international gas markets. Developments on the gas front doesn’t end up here. Europe is still importing close to 10 percent of its gas requirements from Russia through various routes. Europe has to rely on the US for purchase of LNG. This costs Europe four times the price of natural gas imported via pipelines from Russia prior to sanctions. Costs on LNG carriers have been raised, too. LNG cargo ships charge more than twice what they charged before and are in short supply, too. I call this the golden moment of gas. The revenge of gas. Gas will pose to be a dominant player in the energy market in 2023.

Not yet done with gas-driven oil prices, we’re also confronting with the issue of product-driven international crude oil prices. Europe has virtually abandoned investments on building new refineries. Europe has preferred to move away from the dirty and environmental harming refineries to importing refined products from other sources in Asia or South America. For Europe, refining is something of the past. However, countries such as China, India and Middle Eastern NOC’s preferred to buy crude oil, refine and export to Europe. Once crude oil is affected by geopolitical risks or any other disruptions that signals supply security threats, refineries raise product prices of crudes that were imported long before prices went up.

Markets Sentiments vs Market Fundamentals

Rising oil prices as 2022 draws to a close signal, a return to bull market conditions in 2023 with oil expected to go on a rally within the top and bottom range of around $50 per barrel or more. In fact, the dimension and gap between the high and lower price range has never been as wide as that of 2022. There’s no evidence to believe that violent price fluctuations will not continue in 2023.

Persistent concerns about the potential health of the world economy is going to be even stronger in 2023. As such oil market remain volatile but weak demand seems to be the least of its worries. It’s hard to suggest that crude oil prices dropping below $80 per barrel for average of 2023. However, there are too many factors pointing to a sizable breakout in oil prices.

Now that we’re moving towards demand variable, there would be no way out but to start with China. Easing Zero-COVID policy may prove to be tricky. Still in December and with limited easing of Pandemic restrictions, new cases of COVID-19 and surge in hospitalizations and even death rates is reported. As such while COVID policy easing means more factory hours and production and more importantly much more traveling and movements, it may also mean a subsequent spread of pandemic and delayed lockdowns. There’s no hard evidence to believe that the current easing of COVID policies that began in mid-December may necessarily stay in place well into 2023.

However, another major factor beyond oil market fundamentals is health of the world economy. The United States of America is the most indebted country in the world. US dollar is the backbone of the country’s economy. Once Russia underwent sanctions by America, Southern block economies began to consolidate. From Beijing to Riyadh and Dubai began talk tough on Washington, and openly discussed non-dollar international transactions. Global economy is about to reinvent itself after the series of powerful disruptions. First, with the pandemic and the war in Ukraine and the sanctions imposed by the US. Most economists and energy market observers believe that given economic and market behaviors of the US Federal Reserves in non-stop interest rates hikes, the era of cheap money supply might have reached its limits and as such the possibility of inflationary recession in 2023 cannot be ruled out. This will have a severe impact on the world economy but oil is going to be a prime target of a recession.

A full-fledged recession may be distant but even the fear or sentiment of emergence of recession will slow down oil demand. Here comes the issue of non-dollar transaction of oil markets that has been talked about time and again. In 2021, some 83 percent of traded crude oil was priced in US dollar. After the imposition of sanctions against Russian crude oil, Moscow demanded Ruble for its oil trade. This was again discussed in full length when Chinese president visited the Middle East November 2022. The issue had been taken up between Iran and China in previous negotiations, too. Once a recessionary trend begins to roll out in the US and the Western economies, the notion of non-US dollar oil transactions will emerge as a real possibility as early as 2023.

As for the US Federal Reserve and Congress, printing money is the best and possibly the only solution to tackle most economic problems. The US Federal Reserve has printed over $7.2 trillion during the last five years and 65 percent during President Biden’s term in office. This amount of money is lavishly used to finance wars and together with it inflation around the world. The US economy experienced 7.4 percent inflation during the last quarter of 2022. An inflation rate that was experienced during 2007-2008 recession. Most European countries are also experiencing inflation rates not seen in years.

International oil market is sensitive towards inflation or even a burst of stagflation. That’s one reason why major oil companies prefer not to invest their windfall profits from higher oil prices in oil industry. Emergence of stagflation means that oil prices will lose a hefty part of its 2022 record price to lowered economic growth.

SPR Factor

Strategic Petroleum Reserves (SPR) was designed early 1970’s in the wake of Arab oil embargo. It was the idea put forward by Henry Kissinger. Later OECD members created IEA that regulated SPR by member states. To this end the US erected SPR that could support the country’s needs of 90 days of consumption. However, SPR was only used twice for strategic and security purposes. Over recent years, US presidents have concluded that SPR has virtually lost its relevance for security and militarized objectives. US is currently drawing from SPR for commercial reasons and oil trade policies.

As such SPR has posed as a challenge and rival for OPEC and oil producers. During 2022 American government drew up to 1.7 mb/d of SPR in order to battle OPEC + in cutting oil prices and more importantly contribute to ease gasoline prices at the pumps. This was particularly evident in run off to US November mid-term election.

US government drew from SPR at $65 per barrel. However, reserves must be filled and replaced by new oil. SPR exists because it is filled up from time to time. Level of US SPR was registered at 245 Million barrels, the lowest since SPR was first built. Current oil prices is at $81 per barrel. Government is tempted to draw even more so that it can benefit. Biden administration intends to keep filling reservoirs when oil price is at 65 to $70 per barrel. The problem is that in case all other OECD members decided to withdraw from their SPR, market may face a sudden risk of oversupply and then once they decide to refill reservoirs, an unwarranted push for demand. The perception by the major consuming countries that SPR is no more relevant and required or that oil is available in abundance is indicative that oil might be on the wrong side of history.

Nevertheless, this is another risk factor for the international oil market and an added complexity that needs to be addressed by OPEC +. Commercialization of SPR is one of the factors that leads to market fragmentation. SPR release and sale in the open market is considered toxic barrels. Countries are certainly free to keep and stockpile as much as commercial crude or products but SPR commercialization is new phenomenon for the global oil market.

2023 Onward

What we shall experience in the global oil market in 2023 may have a more lasting impact that will possibly be experienced through the middle of the current decade.

To narrow down my concept, I would like to refer you to COP27 Climate Summit in October 2022 in Egypt and compare it with the earlier summit in Glasgow. COP27 was a retreat from most of those sweet talks on climate and zero-emissions policies that have negative impact on oil and gas consumption.

COP27 was overshadowed by the war in Ukraine and US sanctions on Russian energy supply. There weren’t any shouting against oil and gas and even coal. COP27 showed that today heating for G7 is much more relevant to saving the planet some hundreds of years later.

COP28 will be hosted by OPEC member UAE that’s an aspiring producer within the Organization. I believe that UAE climate summit is going to be important in that it is going to bridge the gap between oil and gas producing and consuming countries. As such COP28 will have an important impact on issues related to carbon emissions and clean energy enthusiasts.

As we bid farewell to 2022 we may have to prepare for an even harder and more volatile 2023.

 Fereydoun Barkeshli,

Energy Market Analys

Courtesy of Iran Petroleum