Turmoil in Oil:

Global oil markets are showing increased volatility. Market fundamentals remain strong, but a possible worldwide recession is on the horizon. At the same time, Asian giants China and India are displaying mixed signals: Beijing continues to struggle with the impact of COVID, while India is deploying its own energy strategies. Europe’s energy markets are facing an extreme hit, with some short-term relief due to the availability of high-priced LNG imports, but 2023 is forecast to be a troublemaker, as energy demand could be much higher than the global market is willing to reroute to the Old Continent. US oil and gas production is still not hitting the levels that some analysts have forecast. 2023 could be a watershed moment for European governments, as their current energy strategies are not going to bring much real relief. As long as the Russian invasion of Ukraine continues, Europe’s energy sector is staring into the abyss, and the worst is yet to come.

OPEC+ Market Stabilization

While the media and markets are focused on natural gas, LNG, and even coal sector developments, the oil market seems to be partly forgotten. The current oil price decline is seen as a sign that demand is being met and supply is sufficient to counter potential fallout of the EU-US sanctions on Russia. The first results of the EU sanctions package on Russian oil will be seen in February-March 2023. The EU oil price cap, set at $60 per barrel, is also not having a real impact; most Russian crude affected by the cap is currently being traded below the cap price, opening up even more markets to Russia than before.

At present, oil is trading at levels not seen for some time. OPEC+, the unforeseen strong alliance between OPEC, led by its kingpin Saudi Arabia and UAE, and non-OPEC producers, mainly Russia, remains oil’s sole market maker, and the Saudi-Russian bromance continues, even after Russia’s invasion of Ukraine. Saudi Arabia’s official standpoint is that OPEC(+) is not a geopolitically motivated alliance of the willing, but only seeks to stabilize the oil market based on fundamentals, not political considerations. For Russia, OPEC+ is one of the few remaining levers to any real power in the energy markets, and Russia is still profiting from the arrangement. Moscow also uses its energy exports to gain leverage over several Asian countries.

Beijing and New Delhi have shown to be multipolar focused, not openly supporting Moscow’s onslaught on Ukraine, but also not openly criticizing it. For China, all recent developments seem to be positive, as Russia’s loss of its European energy clients has pushed Moscow into the fold of Beijing. Militarily and economically, the Ukraine war also has another positive outcome for China, as its main Asian military rival and historical opponent Russia is severely weakened.

India has been another quiet beneficiary of the Russia situation. Lower energy prices (in comparison to global markets) have led to large volumes of Russian crude and natural gas being stored or used in India’s refineries, that in turn make bumper profits when selling them on the global market (even to Europe). A weakened Russia also works to India’s advantage as its negotiating position has been bolstered by Moscow’s need for new clients and friends.

In the coming months, all eyes will be on the discussion within and around OPEC+. In 2022 the role of OPEC+ has come under scrutiny internationally, as the fallout of the Ukraine war, and subsequently international sanctions on Russia, have shifted not only major power dynamics but also destabilized oil markets in a way that few had foreseen.

Market Volatility

In the coming years, no real new energy cooperation between Europe (including UK) and Russia is possible, as the geopolitical and geo-economics of this formerly strong relationship has been undermined or even destroyed. As Europe is seeking to find alternatives, Brussels and its compatriots have been focused on securing natural gas and crude oil contracts for the coming years.

With the extreme emphasis still on short-term or spot-market solutions, volatility in the European energy markets is expected to continue, perhaps even spiraling into a new energy crisis in 2023. Consequently, EU members are reconsidering their current and future relationships with conventional energy exporters outside the Russian orbit. Germany, Italy, and France are seeking to rekindle their existing, but sometimes fragile, economic, and diplomatic relationships with Arab OPEC members, especially Saudi Arabia, UAE, Algeria and even Libya. At the same time, former OPEC members, such as Qatar and Egypt, have increased in importance, as they are potentially major natural gas exporters for Europe.

OPEC is evaluating the situation through its "market management" lens, with a focus on maintaining supply and price stability. The latter is being pushed forward by OPEC+, but statements here are a more diffuse to say the least. While Saudi Arabia and the UAE (Abu Dhabi) are clearly leading the efforts inside of OPEC to stabilize markets and remove existing volatility, the growing links with OPEC+, aka Russia, are taking a toll. Since 2016 the new alliance, officially dubbed OPEC+, has been successful to some extent. By cutting production, OPEC has been able not only to remove additional volatility but also bring back stability in prices. At least until the COVID-19 pandemic and Ukraine war roiled the markets. Over the last two years, OPEC has been struggling to maintain its decisive market role.

Market Alliance in Doubt

China-COVID and Ukraine have put OPEC back in the limelight. During the first part of 2022 OPEC was called upon to counter a perceived loss of Russian crude, estimated to be in the range of 4.4 million bpd for Europe alone. However, Russian exports were much more robust than expected by Europeans, as they have targeted Asia, to the advantage of China, India, Turkey, and even some Arab oil producers.

For OPEC, 2022 has been a major struggle. In the second half of 2022 growing concerns about a potential global economic recession, combined with a struggling China, have backed OPEC into a corner. Lower global economic growth, high inflation, partly caused by higher oil and gas prices (including LNG), and shortages in petroleum products such as gasoline or diesel, have increased international pressure to be more flexible in its market management.

The continuing calls by Western leaders, especially US president Biden, on Saudi Arabia and others to increase production, or at least not cut export volumes, has not been answered to date. Last month’s new production cut agreement to remove 2 million bpd extra from the market has been met by international criticism and concerns. Still, when looking at fundamentals, from the OPEC angle, struggling demand and declining oil prices, are normally a reason to cut production levels. Criticism by OPEC leaders, such as Saudi Arabia and the UAE, that the USA should be also putting their money where their mouth is, are also partly correct.

The situation outlined above, however, omits one other key issue, OPEC’s cooperation with Russia. Since the Russian invasion of Ukraine, which has resulted in a major military confrontation and possible defeat of Moscow’s military in the coming months, OPEC+ is being seen as not only an oil market alliance but increasingly as a geopolitical powerhouse. OPEC’s decision to cut oil production and exports in the last two months has been linked directly to a struggling Russian economy and its faltering power. By trying to stabilize oil markets and keep prices up, OPEC is in a confrontation not only with European and American governments but also partly mitigates Western sanctions on Russia in due course. In the West, the narrative described above currently predominates, regardless of what OPEC kingpin Saudi Arabia or Abu Dhabi manage to inject into the news cycle.

Reality, however, is mixed; both sides can make their points, which reflect their respective market positions and geopolitical considerations. For most OPEC members, including Saudi Arabia or the UAE, a stable energy market, with reasonably high price levels, is needed to counter not only growing government demand for revenues to invest, but also to control the overall effects of the scale up of renewables strategies in the rest of the world.

There is doubtless an ongoing discussion within Saudi Arabia, UAE, Kuwait, and other members on whether or not to cooperate with Russia inside of OPEC+ in 2023. Pressure will be building on the alliance in coming months to reassess its future with Russia. Looking at the ongoing market developments and shifts in oil flows from the different countries, OPEC kingpin Saudi Arabia, UAE and Russia could be heading for a potential market clash. The discount currently given by Russia on its main crude qualities, such as a $30+ discount on Urals, is battling with the normal flows of Saudi and Abu Dhabi crude to China, India and other clients. At the same time, Saudi Arabia is slowly but steadily taking over former Russian markets in the Baltics, Poland and potentially northwest Europe. Another market clash is coming.

It is still too early to foresee a real break between Russia and OPEC, or an end to OPEC+, but the first signs are there to support a thesis that the alliance has outlived its purpose. The former might of Russia, geopolitically, militarily, and economically, has been diminished. Moscow’s status as a rogue player is even understood by China, that is increasing its independence from Moscow’s hardline anti-Western positions. As shown in the last weeks during the visit of Chinese president Xi to Saudi Arabia where he met with all GCC leaders, Beijing is taking a more pro-Arab attitude, even pushing back on its former strong support of Iran in the region.

As part of this effort, Beijing is also in talks to price energy deals in Chinese Yuan. For OPEC Arab leaders the latter is significant too, not only based on their growing dependence on Asian oil and gas demand, but also in light of the possible new Iran crisis on the horizon in 2023. Growing Russian-Iranian military cooperation is a major worry for Arab Gulf states at present. Any further pro-Iranian moves by Russia could be seen as another nail in the coffin of OPEC+.

Instability Looms

As long as markets are volatile and global economic growth is fleeting, the market will need a main force at play. Without OPEC+, current oil prices would have realized much higher volatility, with prices possibly hitting rock bottom. One unanswered question on the OPEC+ alliance is how much OPEC could be producing without Russia in the market. Looking at the current official production figures presented by OPEC, overall production is several million barrels below its own agreement. As long as this market dynamic continues, most observers believe that lower production is caused by a lack of capacity in several member countries, and that cooperation within OPEC+ will stay strong.

If stability in the market only depends on the two main players of Saudi Arabia and Abu Dhabi, the market could be in for a shock. Abu Dhabi is currently pushing for much higher capacity, which is already partly materializing. Saudi Arabia officially maintains 2-3 million bpd of spare capacity, so in theory a gap caused by a total blockade of Russian crude is able to be filled. The worrying part is the questions around capabilities of the other producers, most of whom are struggling. A combination of a blockade of Russian exports and an Iran crisis in 2023 is not unthinkable, and would be a shock that the market is not currently prepared for.

2023 will be volatile, as fundamentals are being stretched, and the stability provided by OPEC+ is not to be taken for granted. Geopolitical risks are also increasing, as the failure of the JCPOA is now putting Iran on track to potential nuclear capacity on a very short time horizon. Asian markets are also worried, not only because of China’s COVID policies but also Taiwan, North Korea or even the potential for China-India border clashes. When OPEC leaders claim that they are only looking at market fundamentals, the story becomes a bit disputable, as geopolitics are now ruling all. OPEC+ is at present a volcano, bubbling and boiling inside, but seismic analysis doesn’t yet show an eruption.