As the G7’s new price cap on Russian oil kicks in, attention now shifts to the potential impact on energy markets. Anthony Okolie speaks with Bart Melek, Head of Commodity Strategy at TD Securities, about the latest developments and the outlook for oil prices going forward.
The price of oil is trading around $76 a barrel, as traders weigh what a cap on Russian oil prices mean for the market. But amid tight global supply, is the price set to remain lower for longer, or does it have room to run-- to run higher, either? Joining us now to discuss is Bart Melek, Head of Commodity Strategy at TD Securities. Bart, thank you very much for joining us.
Oh. It's my pleasure. It's always very nice to be here. Thank you very much for inviting me.
Well, to your answer, to your question, I think oil does better. I think, probably, the big factor behind oil's weakness is it was the uncertainty, and now the acknowledgment by OPEC that they will not reduce supply going forward. And part of the reason is, as you've mentioned, is the price cap on Russian oil.
It's still quite uncertain how impacted the supply side will be. There are various schools of thought, something that could be quite a robust decrease because of that particular cap. And some think that much of the impact will be circumvented by Russia's clandestine fleet of 100 tankers or so, and other, perhaps, of methods of circumventing these particular sanctions, this form of sanctions.
And do you think that there's risks that the Russians could cut off the oil exports because of the embargo?
I think the risk is small. Of course, Russians are threatening that that could very well be the case, but my suspicion is they are in a conflict with Ukraine. They are positioned against, of course, the United States and NATO nations who are supporting Ukraine.
They are going to need that revenue stream, and I suspect this is a lot of hyperbole on their part. Perhaps, threatening language that they're hoping may convince the allies to not take this action. But in the end, I think it's probably in self interest of the Russians to continue to do what they're doing, even if they get less revenue. I guess, less revenue is better than no revenue.
OK. Let's talk about the other big announcement. Of course, OPEC plus its allies agree to keep production at current levels. Any surprise in that decision for you?
This is what we thought was going to happen. OPEC tends to be very guarded in how they change policy, typically, and I think this has been true for a while, as they try to balance supply with demand and, at the same time, make sure that their national budgets are adequate. So I'm not particularly surprised, given the uncertainty of this price cap and the impact it will have on supply. We thought that they were going to continue with their two million barrel per day quota cut from the last meeting, which resulted-- which ideally targets about 1.1 million barrels of supply. And I think they're going to wait and see how demand evolves, how China's reopening impacts these markets, and how the macro economies in the West are doing.
So they're going to be more strategic, going forward, in terms of how they manage their production.
Absolutely. I think they have continued to be strategic for quite a while, and the reason they're able to do that, there aren't really significant competitors in the wings. In essence, if OPEC cuts another half a million barrels, after cutting the two million barrels worth of quotas last time around, it's not like there is excess shale production that can fit that void and reintroduce new supply. OPEC is pretty free to do as they will, at least for now.
OK. Now, what are some of the geopolitical risks for all, going forward? We've heard that the US is seeking to halt tapping its oil reserves to refill their stockpiles. You've mentioned lack of demand from China. What are some of the risks that you see, going forward, for oil?
Well, the big risk, of course, is surrounding natural gas, and it might be a little strange for me to talk about natural gas, when we're trying to answer our question about oil. But we are still at the start of the winter, and the winter could still get very cold, perhaps a lot colder than we expect. We simply don't know. Weather forecasting is hard, particularly future weather, as opposed to back casting.
But so far, the inventories have been ample, but there remains a risk that natural gas stockpiles will be reduced quite significantly. And that could very well mean that we will be tapping distillate supply a lot more than we have. And as we all know, these supplies are quite low by historic levels, and so is oil. So there is some excess capacity on refining in China, and if we do find that distillate demand is much higher than we thought, because of winter conditions, we could see these oil markets go into a much tighter configuration than we think now.
OK. So given all these risks in the market, what's your outlook on the price of oil, heading into 2023?
Well, we're quite positive on oil. I think at this point, everybody knows our logic, but of course, I'm going to restate it here again. We do think that OPEC will continue to behave quite strategically, and although we do expect demand growth to deteriorate next year-- because, certainly Western world recession, we would expect a recession in many parts of the world-- Europe probably not doing great. US most likely sliding into a contraction at some point. But we're still expecting demand to be positive, well over a million barrels per day.
And at the same time, we're seeing a crisis in the natural gas market, where, as I just said, we could get much higher demand for product. And I think OPEC continues to behave quite strategically, and they will right-size their production to make sure that there isn't an oversupply, and that likely will drive prices higher. And I think the other big risk here is that, once we see a pivot in Federal Reserve policy-- we don't expect that until well into the middle of the year. That's when the markets we think are going to start pricing it.
We could see speculative money drive it up. So fundamentals should remain tight, and the moment, I think, we start thinking that this contraction demand growth is being reversed or goes the other way, I think oil does a lot better. Perhaps, not as quickly as we've hoped. We've written this outlook a few weeks ago, and as I said--
Things change and forecasting of the future in particular is quite hard. But I think the general theme remains.
And I know that, prior to this, you had a roundtable on your outlook for commodities. Were there any key themes that you think investors should be aware of going forward?
Yes. I think one of the key themes here is that the supply side is quite constrained. And, although we do expect a cyclical type of downturn, we don't expect it to be anywhere near as deep as it has been historically. Because historically, we've seen 40, maybe even up to 70%, some cycles, some commodities like oil or copper.
We don't see these type of corrections coming up, and that's mainly because-- for base metals, for example-- we're seeing constraints on the mine site. We're seeing constraints with smelters because of energy problems around the world. And we are seeing a less significant drop in demand than you normally would expect during a contractionary period. And for a metal like copper, we're seeing first signs that electric vehicles-- and that's Chinese data is showing that copper is being supported on the demand side by EVs. And taking that logic forward, where you're using a lot more metal per vehicle, as this whole decarbonization initiative around the world matures, we're going to see a lot more of that copper demand for ESG purposes.