Oil & Energy
Oil Price Cap Continues To Baffle Traders
Last week saw the start of a price cap mechanism conceived of by the U.S. and embraced by the G7 and the European Union, aimed at keeping Russian oil flowing into international markets but reducing Russia’s revenue from that oil.
The price cap came into effect in the company of an almost complete embargo on Russian oil imports into the European Union, giving traders in Europe at least a theoretical opportunity to buy and sell Russian crude. But the authors of the cap did not think about oil traders.
To begin with, about half of the G7, including the U.S., Canada, and the UK, already have a ban on Russian oil imports, so the cap will make no difference to their supply of foreign oil.
Japan, although backing the cap, has been exempted because it is entirely dependent on imported hydrocarbons.
Then comes the bigger problem, and that problem is that crude oil is just not traded under fixed prices, which is already causing headaches in the sector.
In fact, oil is traded in such a way that it could often be impossible to comply with the cap, even assuming Russia would sell to cap backers.
Bloomberg cited traders last week as saying that a lot of them risked getting stuck with Russian crude cargos that cost more than the $60-per-barrel cap, unable to access Western insurance and tankers because of that fact. And that, in turn, would threaten the supply side of the global oil equation.
“Physical traders rarely trade on a fixed price,” John Driscoll, chief strategist at JTD Energy Services, told Bloomberg.
“It’s a much more complex space where they trade on formulas and spot differentials to a benchmark crude for the trading of actual cargoes as well as for hedging that follows.”
The report went on to explain that the top three Russian oil blends — Urals, Sokol, and ESPO — are priced under forward or floating contracts, which means that the final price of a cargo is only determined several weeks after the purchase of the cargo.
Bloomberg gives an example of these pricing models with a recent Chinese purchase of a cargo of Russian ESPO. The price for the cargo, per the contract, is a discount to the average of the front-month Brent crude futures and this average will only be calculated at the end of this month.
This creates all sorts of complications for traders that want to comply with the price cap—there is simply no way of knowing if the price of a cargo will remain below the cap by the time it needs to be paid, again, assuming Russia does not make good on its promise to stop selling oil to parties that enforce the cap.
How this can create problems in the physical oil market – the market that matters the most – is obvious. Cargos could get delayed or never reach their destination because the deal gets canceled because it had violated the cap. And there is already a disruption in the physical market, thanks to Turkey.
Following the introduction of the price cap, Turkey started asking for proof of insurance for all tankers passing through the Bosphorus and the Dardanelles.
Because insurers have so far refused to provide the documents claiming they have never needed to do so before, there are more than 20 tankers stuck in the Turkish straits with more than 20 million barrels of crude.
All but one of the tankers carry Kazakh crude, which gets via pipeline to Russian ports and from there goes on to international markets. The one tanker carrying Russian crude was allowed to pass the straits earlier this week.
“These cargoes would not be subject to the price cap under any scenario, and there should be no change in the status of their insurance from Kazakh shipments in previous weeks or months,” one U.S. government official who CNBC called “a price cap official,” said.
Yet Turkey appears insistent on seeing proof of insurance, and the club of big insurers, the International Group of P&I Clubs, insists it cannot provide a guarantee of insurance coverage in case it so happens that a vessel with such coverage violates the price cap and drags its insurer down with it.
Western officials have been quick to slam Turkey for its additional insurance proof demands, with that same unnamed price cap official from above telling the FT that “The price cap policy does not require ships to seek unique insurance guarantees for each individual voyage, as required under Turkey’s rule. These disruptions are the result of Turkey’s rule, not the price cap policy.”
If those tankers remain stuck for another week, the absence of these 20 million barrels will begin to be felt, according to analysts. And if the pricing confusion on physical markets persists—and there is no reason for it not to—more cargos might get stuck and undelivered. And this will be happening in a market that, despite the recent price developments, remains undersupplied, as Canadian fund manager Eric Nuttall reminded everyone earlier this week.
By: Irina Slav
Slav reports for Oilprice.com
The Federal Government has expressed optimism in attracting more investments by International Oil Companies (IOCs) into Nigeria to foster growth and sustainability in the energy sector.
This is as some IOCs, particularly Shell and TotalEnergies, had announced plans to divest some of their assets from the country.
Recall that Shell in January, 2024 had said it would sell the Shell Petroleum Development Company of Nigeria Limited (SPDC) to Renaissance.
According to the Minister of State for Petroleum Resources (Oil), Heineken Lokpobiri, increasing investments by IOCs as well as boosting crude production to enhancing Nigeria’s position as a leading player in the global energy market, are the key objectives of the Government.
Lokpobiri emphasized the Ministry’s willingness to collaborate with State Governments, particularly Bayelsa State, in advancing energy sector transformation efforts.
The Minister, who stressed the importance of cooperation in achieving shared goals said, “we are open to partnerships with Bayelsa State Government for mutual progress”.
In response to Governor Douye Diri’s appeal for Ministry intervention in restoring the Atala Oil Field belonging to Bayelsa State, the Minister assured prompt attention to the matter.
He said, “We will look into the issue promptly and ensure fairness and equity in addressing state concerns”.
Lokpobiri explained that the Bayelsa State Governor, Douyi Diri’s visit reaffirmed the commitment of both the Federal and State Government’s readiness to work together towards a sustainable, inclusive, and prosperous energy future for Nigeria.
While speaking, Governor Diri commended the Minister for his remarkable performance in revitalisng the nation’s energy sector.
The Federal Government has assured investors in the nation’s gas sector of the security and safety of their investments.
Minister of State for Petroleum Resources (Gas), Ekperikpe Ekpo, gave the assurance while hosting top officials of Shanghai Huayi Energy Chemical Company Group of China (HUAYI) and China Road and Bridge Corporation, who are strategic investors in Brass Methanol and Gas Hub Project in Bayelsa State.
The Minister in a statement stressed that Nigeria was open for investments and investors, insisting that present and prospective foreign investors have no need to entertain fear on the safety of their investment.
Describing the Brass project as one critical project of the President Bola Tinubu-led administration, Ekpo said.
“The Federal Government is committed to developing Nigeria’s gas reserves through projects such as the Brass Methanol project, which presents an opportunity for the diversification of Nigeria’s economy.
“It is for this and other reasons that the project has been accorded the significant concessions (or support) that it enjoys from the government.
“Let me, therefore, assure you of the strong commitment of our government to the security and safety of yours and other investments as we have continually done for similar Chinese investments in Nigeria through the years”, he added.
Ekpo further tasked investors and contractors working on the project to double their efforts, saying, “I want to see this project running for the good of Nigeria and its investors”.
Earlier in his speech, Leader of the Chinese delegation, Mr Zheng Bi Jun, said the visit to the country was to carry out feasibility studies for investments in methanol projects.
On his part, the Managing Director of Brass Fertiliser and Petrochemical Ltd, Mr Ben Okoye, expressed optimism in partnering with genuine investors on the project.
Crude oil prices recently logged their second monthly gain in a row as OPEC+ extended their supply curb deal until the end of Q2 2024.
The gains have been considerable, with WTI adding about $7 per barrel over the month of February.
Yet a lot of analysts remain bearish about the commodity’s prospects. In fact, they believe that there is enough oil supply globally to keep Brent around $81 this year and WTI at some $76.50, according to a Reuters poll.
Yet, like last year in U.S. shale showed, there is always the possibility of a major surprise.
According to the respondents in that poll, what’s keeping prices tame is, first, the fact that the Red Sea crisis has not yet affected oil shipments in the region, thanks to alternative routes.
The second reason cited by the analysts is OPEC+ spare capacity, which has increased, thanks to the cuts.
“Spare capacity has reached a multi-year high, which will keep overall market sentiment under pressure over the coming months”, senior analyst, Florian Grunberger, told Reuters.
The perception of ample spare capacity is definitely one factor keeping traders and analysts bearish as they assume this capacity would be put into operation as soon as the market needs it. This may well be an incorrect assumption.
Saudi Arabia and OPEC have given multiple signs that they would only release more production if prices are to their liking, and if cuts are getting extended, then current prices are not to OPEC’s liking yet.
There is more, too. The Saudis, which are cutting the most and have the greatest spare capacity at around 3 million barrels daily right now, are acutely aware that the moment they release additional supply, prices will plunge.
Therefore, the chance of Saudi cuts being reversed anytime soon is pretty slim.
Then there is the U.S. oil production factor. Last year, analysts expected modest output additions from the shale patch because the rig count remained consistently lower than what it was during the strongest shale boom years.
That assumption proved wrong as drillers made substantial gains in well productivity that pushed total production to yet another record.
Perhaps a bit oddly, analysts are once again making a bold assumption for this year: that the productivity gains will continue at the same rate this year as well.
The Energy Information Administration disagrees. In its latest Short-Term Energy Outlook, the authority estimated that U.S. oil output had reached a record high of 13.3 million barrels daily that in January fell to 12.6 million bpd due to harsh winter weather.
For the rest of the year, however, the EIA has forecast a production level remaining around the December record, which will only be broken in February 2025.
Oil demand, meanwhile, will be growing. Wood Mackenzie recently predicted 2024 demand growth at 1.9 million barrels daily.
OPEC sees this year’s demand growth at 2.25 million barrels daily. The IEA is, as usual, the most modest in its expectations, seeing 2024 demand for oil grow by 1.2 million bpd.
With OPEC+ keeping a lid on production and U.S. production remaining largely flat on 2023, if the EIA is correct, a tightening of the supply situation is only a matter of time. Indeed, some are predicting that already.
Natural resource-focused investors Goehring and Rozencwajg recently released their latest market outlook, in which they warned that the oil market may already be in a structural deficit, to manifest later this year.
They also noted a change in the methodology that the EIA uses to estimate oil production, which may well have led to a serious overestimation of production growth.
The discrepancy between actual and reported production, Goehring and Rozencwajg said, could be so significant that the EIA may be estimating growth where there’s a production decline.
So, on the one hand, some pretty important assumptions are being made about demand, namely, that it will grow more slowly this year than it did last year.
This assumption is based on another one, by the way, and this is the assumption that EV sales will rise as strongly as they did last year, when they failed to make a dent in oil demand growth, and kill some oil demand.
On the other hand, there is the assumption that U.S. drillers will keep drilling like they did last year. What would motivate such a development is unclear, besides the expectation that Europe will take in even more U.S. crude this year than it already is.
This is a much safer assumption than the one about demand, by the way. And yet, there are indications from the U.S. oil industry that there will be no pumping at will this year. There will be more production discipline.
Predicting oil prices accurately, even over the shortest of periods, is as safe as flipping a coin. With the number of variables at play at any moment, accurate predictions are usually little more than a fluke, especially when perceptions play such an outsized role in price movements.
One thing is for sure, though. There may be surprises this year in oil.
lrina Slav
Slav writes for Oilprice.com.
