Crude oil prices continue to be relatively range-bound. Brent traded largely in a 65 to 70 \$/b range in August and September before switching to a mainly 60 to 65 \$/b range since then. It has been a different story for diesel prices which have rallied sharply. Meanwhile, the International Energy Agency (IEA), amongst other forecasters, continues to predict a large surplus in the market which does not seem to be making itself felt in Brent, still less in diesel prices. What is going on here? The explanation seems to be sanctions on Russia and the impact of Ukrainian strikes on its refinery capacity.
On 22nd October, the US announced sanctions targeting oil companies Lukoil and Rosneft Trump’s frustration with President over his failure to make progress on ending the war in Ukraine: "Given President Putin’s refusal to end this senseless war, Treasury is sanctioning Russia’s two largest oil companies that fund the Kremlin’s war machine" Treasury Secretary Scott Bessent said in a statement. The sanctions were effective immediately, but with a "wind-down" period stretching to 21nd November, which enables certain transactions. This period is intended to be used to unwind contracts with sanctioned entities and subsidiaries, not to be used as a window for refineries in, for example, Inda and China, to continue buying crude from Lukoil and Rosneft. In practice, however, it appears that is happening to some extent. Never-the-less, these refineries that have relied heavily on cheap sanctioned Russian crude in the past, are now looking elsewhere. The difficulty of using sanctioned crude increased after Trump put pressure on India to reduce its use of Russian crude and these latest measures have raised that pressure still further. All of this has contributed to an increase in crude oil in floating storage in Asia.
According to Vortexa data, crude in floating storage more than doubled from 31m barrels at the end of August to 67m barrels by the middle of this month. This equates to nearly 500 kb/d or around 0.5% of world supply) being absorbed into storage. This increase is likely to be attributable to a build-up of sanctioned barrels that refineries are avoiding using. On top of this, it is well known that China has been adding to its strategic petroleum reserves and sanctioned crude provides a cheap means of doing so. Estimates range from 500 kb/d to 1 mb/d going into China’s reserves over the course of this year. Meanwhile, other sources of crude have been in demand as alternatives to Russian crude and so benchmark future such as Brent, do not obviously reflect an oversupply. Indeed, the forward curve for Brent is downward sloping for deliveries across the next few months, pointing to tightness in the market as consumers need to pay a premium for immediate delivery. In an oversupplied market the forward curve would need to be upward sloping to pay for storage. Consequently, the overall surplus in oil markets is not manifesting itself in benchmark prices.
For middle distillates such as jet fuel and diesel, there are additional issues. Ukraine’s efforts to limit the availability of fuel for Russia’s war machine has focused on attacking refinery infrastructure with drones. This has led to reduced Russian refinery activity, domestic fuel shortages and reduced availability of product for export. As well as impacting the availably of jet and diesel directly, there has also been an indirect impact of reduced Russian refinery activity from lower exports of fuel oil and vacuum gasoil which are further processed into jet and diesel in refineries in Asia. Add to this the problems of using cheap Russian crude and we have an environment in which jet fuel and diesel prices have increased significantly.
It is unclear for how much longer floating storage and Chinese inventory builds can absorb supply and prevent a surplus becoming more obvious in international prices. On the other hand, if sanctions become more effective and demand for non-Russian barrels increases, prices may escalate from here. However, the lesson of the past few years has been that ways are found to circumvent sanctions and their impact on the availability of oil tends to wane over time – it’s more a question of how much of a discount the Russians have to accept to sell their barrels, which has really been the main aim of sanctions all along. The US is currently engaging in another effort to find a solution to end the war, it remains to be seen whether the chance of success is better than last time. Oil is also influenced by developments in asset markets. US equity markets are becoming more wary of the AI related rally that has sent the S&P 500 index to fresh highs. The much anticipated quarterly earnings numbers from Nvidia last night, surprised on the upside and may have helped to assuage concerns for now, but might only delay a deeper correction that we have seen thus far, presenting a risk for oil.
No representation or warranty, express or implied, is or will be made and no responsibility or liability is or will be accepted by Investec or its Affiliates in relation to the accuracy, reliability, suitability or completeness of any information contained in this document and any such liability is expressly disclaimed. This document does not purport to be all inclusive or to contain all the information that you may need. Investec gives no undertaking to provide the recipient with access to any additional information or to update this document or any additional information, or to correct any inaccuracies in it which may become apparent.
This document does not take into account the specific investment objectives, financial circumstances or particular needs of any recipient and it should not be regarded as a substitute for the exercise of the recipient’s own judgement and due diligence. Investec does not offer investment advice or make any investment recommendations. Recipients of this document should seek independent financial advice regarding the appropriateness or otherwise of investing in any investment strategies discussed or recommended in this document and should understand that past performance is not a guide to future performance, and the value of any investments may fall as well as rise.
Investec expressly reserves the right, without giving reasons therefore, at any time and in any respect, to amend or terminate discussions with the recipient of this document without prior notice and hereby expressly disclaims any liability for any losses, costs or expenses incurred by such recipient.
