(Cover photo source: CNBC)
Since the outbreak of the Russia-Ukraine war in February, the price of crude oil in the international market has fluctuated after a dozen consecutive days of gains. Oil is the blood of the industry. The price of crude oil not only tugs at the heartstrings of countless investors but also decides the cost of production and transportation, thus further influencing the world market. So, in the fluctuant background of the crude oil market, what is the inner logic of the changing price? Is it possible to predict the future trend?
WTI Crude Price on June 2 (source: CNBC)
The price of crude is influenced by many factors and is in a dynamic equilibrium. The influence factors can be mainly divided into three parts: supply and demand, financial policies, and international politics.
Supply and Demand
Supply and demand are the determinants of price. The influence of supply and demand is stable and determines the central tendency of the price.
On the supply side, the United States and NATO are imposing sanctions on Russia. On March 3rd, the United States, European Union, Britain, and Canada banned Russia’s central banks from using the SWIFT international settlement system, which impedes the export of Russian oil. On March 8th, President Biden spoke about banning oil imports from Russia. Recently, the EU is agreeing to stop importing oil from Russia or charging high tariffs. Simultaneously, to address energy shortages caused by sanctions against Russia, the United States renewed oil imports from Venezuela and planned to restart Iran’s nuclear deal. Meanwhile, OPEC is slightly increasing oil production. Overall, the impact of sanctions has not been fully compensated, and the supply stays low.
On the demand side, the Omicron outbreak affects manufacturing and tourism. The world economy is developing slowly, with less energy demand. The high price of oil is urging many factories to decrease production. Besides, new energies are gradually occupying the market. Many factories are seeking new substations of oil and demand is also relatively low. But overall, the change in supply is more significant; thus, demand exceeds supply in the world market.
The essence of the Russia-Ukraine war is ideological opposition. The strategic expansion of Europe and the United States on Eurasia significantly compressed Russia’s strategic security space, resulting in Russia being forced to fight back in a war of aggression. By imposing sanctions against Russia, the United States intends to cut or undermine the economic relationship between Russia and the EU, thus influencing Europe’s energy supply structure.
However, not everything is going within expectations. According to recent news, the 27 EU countries struggle to agree on a Russian energy embargo, and the domestic right-wing political power impedes this progress. In some EU countries, more than 50% of their energy comes from Russia and it is hard to change this reliance. Meanwhile, to maintain domestic economic stabilization, Russia is selling oil to Asian countries like China and India at a price that is 30% lower than the international price. As a result, the sanctions promoted the transformation of the world energy supply structure.
Geopolitical instability brings a high risk premium. As a safe asset, the oil price always increases a lot at the beginning of a war, no matter the Gulf, Afghanistan, or Iraq. When realizing a crisis, people tend to transform their currency into something with solid value to keep their wealth. Many companies and countries are worried about the future oil shortage and have begun to store oil. At the early stages of the war, the oil price soared due to the conflict. Any political decision could worsen the regional instability and lead to an increase in the price. Later, the situation gradually stabilized as the negotiations progressed, and the risk premium decreased.
The price of oil is often directly linked to the state of the world economy. The United States and Europe’s sanctions against Russia have weighed on the European economy, causing fuel and food prices to soar while increasing pressure on the Central banks to tighten monetary policy. Under the combined stresses of the pandemic and the economy, the world economy is sluggish, and the inflation rate of the United States stays high. Financial pressure on oil remains high. The Federal Reserve has raised interest rates several times since March, which is a tight monetary policy to curb oil prices. Low global growth expectations and the risk of recession have spurred crude oil selling.
Local wars near oil-producing areas can often cause violent fluctuations in the world oil market. With many influence factors, the oil price is in a dynamic equilibrium. Excess demand and high risk premiums make up the high oil price. In the short run, Europe and the United States continue to push for sanctions but with limited impact. An unstable war situation maintains the risk premium. In the long run, the economy enters a contracting cycle, and the war ends. Future economic recession expectations will rise gradually, and financial pressure will increase progressively. The oil price is also going to face considerable downward pressure.