Oil nosedives, with Brent breaking below $90 on China COVID news

© Reuters.

By Barani Krishnan

Investing.com -- OPEC+ might be holding the reins to global oil supply, but it’s the bears in the market who seem to be prevailing in setting crude prices lately — no thanks to China’s Covid situation.

London-traded Brent, the global benchmark for oil, broke below $90 per barrel for the first time since October while New York traded West Texas Intermediate crude was less than $2 above the key support of $80 per barrel amid little regard for the sharp production cuts enforced from this month by the Organization of the Petroleum Exporting Countries and its allies.

OPEC+, led by Saudi Arabia with help from Russia, said the 23 nations in its coalition would impose a 2 million barrels per day production cut from this month — its most in two years since oil prices began recovering from the worst effects of the coronavirus pandemic.

OPEC+’s motive was to offset constant worries about oil demand that had crept up in recent months as global economies sent off recession signals from runaway inflation in the aftermath of the pandemic. Crude prices hit 14-year highs in March, with Brent just shy of $140 and WTI tipping just over $130. By September though, Brent had fallen to around $82 and WTI to around $76.

The OPEC+-ordered production cuts helped Brent to recover to within cents of $100 a barrel two weeks ago, while WTI reached above $93.

But Covid headlines out of China zapped the rebound, driving both benchmarks forcefully lower over the past fortnight.

St. Louis Federal Reserve President James Bullard -- one of the central bank's biggest policy hawks -- added to the bearish pressure on oil by saying that U.S. inflation remained “unacceptably high” for the Fed to ditch jumbo-sized rate hikes in favor of only smaller increases,

In Thursday’s session,  WTI for delivery in December settled down $3.95, or 4.6%, at $81.64 per barrel. The U.S. crude benchmark was down 8.3% week-to-date, extending last week’s 4% decline.

Brent settled down $3.08, or 3.3%, at $89.78, settling below $90 the first time since Oct. 18. For the week, the global crude benchmark fell 6.5%, after last week’s tumble of 2.6%.

Technical charts indicated more weakness ahead for WTI and Brent, said Sunil Kumar Dixit, chief strategist at SKCharting.com.

“WTI’s sharp drop from $85.42 to $81.64 has left it oversold on a daily time frame,” said Dixit. “Nonetheless, there is potential for further drop, which is limited to the 100-week Simple Moving Average (SMA) of $81.05 which is likely to act as support even if temporary. In the event of extended sell off, the weekly lower Bollinger Band $77 may be in focus.”

Dixit said Brent had somewhat similar oversold conditions on daily stochastics as in WTI, with room for a  little more drop.

“A sustained break below $90 may extend Brent’s correction to the monthly Middle Bollinger Band of $87.97,” he said, adding that a break below the previous month's low $86.35 will open an extended drop to the 100-week SMA of $84.80.

“Oil prices are getting punished as crude demand concerns show no signs of easing,” said Ed Moya, analyst at online trading platform OANDA. “The world’s two largest economies are struggling here as China battles Covid and the US is seeing a significant drop with manufacturing activity.”

China’s new case total rose above 23,000, which is the highest level since April and is approaching their record high.  Fears are growing that the spread won’t ease soon as cases have spread across the populous Chinese regions of Guangzhou and Chongqing.  

In the United States, a gauge of manufacturing activity in the U.S. mid-Atlantic region fell unexpectedly this month to its lowest level since 2011 as firms reported continued softness in new orders and a weak outlook.

“Some of the geopolitical risk that sent oil higher earlier this week is coming off the table,” Moya added. “With no immediate escalation in the war in Ukraine, we could see energy traders fixate on the Russian crude price cap that takes hold early next month.”

Poland and NATO concluded on Wednesday that a missile which crashed inside Poland was probably a stray fired by Ukraine's air defenses and not a Russian strike, easing fears that the conflict between Russia and Ukraine was spilling across the border.

Some analysts said that the EU’s ban on seaborne imports of Russian oil, along with the G7’s plan to cap prices of oil from Russia early next month might not result in a lasting rally for crude.

“In isolation, the sanctions on Russia should be bullish for prices,” Matt Smith, lead oil analystm for Americas at Kpler, said in a special focus report carried by MarketWatch. “However, they may have a limited effect, as Russian barrels get “rerouted and not taken off the market,” while a price cap still has so much uncertainty surrounding it that its impact may be “muted due to workarounds or may simply be ineffective.”

Prices may see a rise in the few weeks following the Dec. 5 implementation of the ban and price cap, Vikas Dwivedi, global oil and gas strategist at Macquarie Group (OTC:MQBKY), said. 

However, following an adjustment period that may last three to six weeks to find new sources of shipping, capital, and insurance, oil may give back premiums that it accrued from the implementation date, he says.

The International Energy Agency estimated that 1.1 million barrels a day of Russia oil exports would be halted by the EU oil ban.

There will “not be a penalty from a price cap perspective on barrels that are loaded before Dec. 5 but discharged afterward,” says Kpler’s Smith, who notes that the “ultimate deadline” for delivery is Jan. 19.

With just over a couple of weeks to go, the price cap hasn’t been set yet. It may be in the $65-a-barrel range, says Smith—which would represent a bigger discount than there is currently for Urals, the most common export grade of oil from Russia, versus the global crude benchmark.

The G-7’s rationale is to have a fixed number for the price cap, which will “tame the oil market” and limit the amount of profit that Russian President Vladimir Putin can feed to his war machine, says Samir Madani, co-founder of U.S.-based vessel-tracking research firm TankerTrackers.com.

What’s likely to happen, however, is the market will find in the days and weeks thereafter that India and Turkey have rapidly slowed imports of Middle East oil in favor of more Russian oil, Madani says, noting that Turkey has already quadrupled imports from Russia year on year, based on the August-through-October average.

Madani says that Russia’s non-G-7 clients are likely to “import cheap Russian crude, refine it, and sell it at a large profit margin to the G-7.” That probably won’t get much pushback, given that the situation still means Putin won’t receive his profit, and allows refined products to enter the market, he says.

All in all, Madani expects that in the initial chaos of the ban and price cap on Russian oil, prices for the commodity will end up in the “three-digit range” by the end of the year.

Then, once the non-G-7 countries have “sorted out their logistics,” oil is likely to see a fallback in prices, Madani added.