• In 2023, the price cap has reduced Russian revenues by an estimated £29.5 billion.
• US oil supplies and exports are at record highs.
• OPEC+ market share fell to its lowest level since its creation in 2016.

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Following the turmoil of 2022, oil markets have stabilized in some regards over the previous 12 months.

Having said that, there has been plenty of volatility, brought on particularly by tightening monetary policy, geopolitical upheaval, and transitional supply-demand dynamics.

Fossil fuel prices are now well below 2022 peaks and have surprisingly assumed a bearish turn, even as upside risks remain and market watchers continue to be cautious.

Moreover, it is becoming increasingly clear that the Russian-Ukraine war will continue to have economic effects in the medium to long term.  

This piece shall also explore the structure of sanctions imposed; some of the effects on national economies; changes in global trade flows as a result of Russia’s invasion; as well as the potential oil outlook for 2024.

 

An overview of oil movements in 2023

With the outbreak of the global health crisis in 2020, demand for oil and energy products fell sharply, with both WTI and Brent benchmarks trading in the $60 (~£47.1; $1 = £0.78) range.

Source: FRED Database

Over the next year or two, the demand outlook remained uncertain, particularly as China was often subject to strict health restrictions, as crude oil cautiously moved towards the $80 mark.

However, the onset of the Ukraine-Russia war in February 2022 sent shockwaves through global energy markets.

Within two weeks, crude oil prices surged over 25%, and as per Statista data, the average price of the Brent benchmark eventually increased 42.4% over the course of the full year.

Policymakers and market watchers were alarmed that renewed fighting in Ukraine could kickstart a stagflationary trajectory with escalating food and energy prices, and injured logistical supply chains.

On March 7, 2022, the WTI futures peaked at an intra-day high of $133.4 per barrel, while Brent futures reached $139.1 per barrel, marking the highest level since July 2008.

A knock-on effect was also felt during the US vacation-camping season, when producer prices for gasoline increased by 85% by June 2022.

The sharp increase in prices was not only due to immediate disruptions of the war, but the subsequent flurry of sanctions that the United States, European Union, and other allies imposed on Russia, which exacerbated the already present concerns of underinvestment in refineries.

Source: St. Louis FRED

Amid the surge in oil prices, the consumer price index (CPI) peaked in the same month at 9.1% YoY.

 

2023

Moving into 2023, oil market prices hovered around $80 per barrel.

Over the past 12 months, WTI has traded between $63-$95 per barrel while Brent has moved between $70-$95 per barrel – a tighter range compared to 2022.

Despite the fighting in Ukraine, as well as the imposition of widespread sanctions by multiple countries and weakened economic growth, global demand and supply during the year have both behaved stronger than was initially anticipated.

High expectations of a US recession in 2023, as well as developments during the regional banking crisis, added expectations of severe disruptions in broader markets.

Other sources of potentially far-reaching disruptions included the outbreak of the Israel-Palestine war in October 2023, which fuelled considerable speculation that Iran, a crucial OPEC player may be drawn into the war.

Yet, markets have eased over the past three months, retreating from their near $100 high.

Late in 2023, the high-interest rate environment coupled with geopolitical disruptions and logistical issues has given way to a bearish environment, with WTI and Brent down 11.4% and 10.4%, respectively, for the year.

The key driver of this has been the excess production emerging from several countries, notably the United States, but also Iran and Guyana, which have overwhelmed planned production cuts from Saudi Arabia.

Additionally, the International Energy Agency (IEA) points to improved efficiencies and the shift towards electric vehicles as factoring into slowing demand for oil.

For their part, Russian Urals found a market that was willing to downplay the price cap of $60 per barrel for much of this year, although prices have dipped below this level in December owing to an expected soft landing and slower growth prospects.

However, Middle Eastern continue to fester even as financial markets have seemingly sidelined these concerns.

In the Red Sea, the US’s Operation Prosperity Guardian to protect shipping lines from Houthi forces has garnered checkered support, with major allies such as Italy and Spain seeming non-committal.  

Other countries such as the UAE and Saudi Arabia have also shown no interest, and this reluctance may be an unwillingness to appear seemingly pro-Israel, while also wanting to guard against possible Houthi attacks on their own soil or interests.

Looking to 2024, the focus of markets appears to have largely shifted from geopolitical challenges and the absence of Russia in the European fuel market, but instead toward the brewing weakness in demand.

Earlier this month, EY analysts noted that they anticipate four rate cuts in 2024, a hint that markets believe that the Fed may have overtightened, or that the inflation picture is uncertain. 

Expectations for weaker demand henceforth were supported by last week’s data showing that oil inventories had increased to their highest level since August 2023, which marked gains for eleven weeks in a row.

 

Key supply and demand trends

The primary concern for oil markets has shifted from ever-tightening Fed policy, geopolitical conflicts, and earlier fears of chronic underinvestment in refineries to now being squarely focused on excess supply.

The key driver is immense production in the United States, with Clifford Krauss, the national energy correspondent for The New York Times, noting that,

 

…is producing about 13.5 million barrels a day, and we’re heading towards 14 million barrels a day. That is more oil than any country in the world.

Consequently, Brent is lower by 16.3% while WTI has declined by 21.4% in trading, despite a hostile geopolitical environment and expectations of rate cuts.

Krauss argues that while large producers in the United States have deliberately tried to maintain lower production levels, there are plenty of privately-backed small producers who have ramped up production at the onset of the Ukraine war to capitalize on higher prices.

This quantum of supply is far overshadowing the roughly six million barrels per day (~ 6% of global supply) of cuts which OPEC+ has operationalized.

Record-breaking supply from Brazil and Guyana, as well as higher Iranian oil production, also contributed to the recent fall in prices, while the IEA projects total output flows to rise to 101.9 million barrels per day in 2023.

Crucially, the United States is accounting for two-thirds of all non-OPEC+ output growth, which has resulted in the market share of OPEC+ falling to 51% for 2023, the lowest level since its formation in 2016.

 

Demand

The slowdown in Europe, generally weaker industrial activity numbers and the uptick in EV rollouts also contributed to falling oil demand over the past three months.

As a result, the IEA notes that annualized growth in oil demand is forecast to moderate from 2.8 million barrels per day in Q3 2023 to 1.9 million barrels per day, a reduction of nearly 400,000 barrels per day compared to the previous forecast.

For the full year, demand is projected to increase to 101.7 million barrels per day.

Source: IEA

Further, the IEA notes that 78% of new growth in oil demand during 2023 is concentrated in China.

In relation to China, the Peterson Institute of International Economics points to concerns of sharp deflation, a lack of private sector confidence, the “recent collapse” in FDI, and the property crisis as major challenges for the coming year.

This could prove to be a source of concern for markets ahead.

 

Sanctions structure

The US and its allies imposed sanctions on Russia in relation to Ukraine as early as 2014.

In response, Vladimir Putin has been following a policy of building a “macroeconomic Fortress Russia,” to put the country on track for strategic independence.

In accordance with these aims, Russian policymakers set about lowering debt levels, maintaining strong currency reserves, and operationalizing a robust sovereign wealth fund.

Partly as a result, pre-2022 sanctions did not make significant inroads.

However, in the case of the 2022 invasion, a whole new toolset of sanctions was brought in to target Russian energy revenues; and as per the European Commission covers 90% of Russia’s inbound oil supplies.

These measures were specifically designed to weaken Russia’s economic base, and access to essential markets to raise the Kremlin’s costs of engaging in war.

Following Russia’s entry into Ukraine, the EU rolled out a crude oil ban which included refined products and along with the US and other allies, denied access to over $300 billion in foreign-exchange reserves which were held overseas.

Sanctions also included the suspension of transactions via the SWIFT network, the extension of the EU’s embargo, and the setting of a price cap at the $60 mark in December 2022, which further dented Russia’s export earnings.

In addition, “premium-to-crude” products including diesel and gasoline were capped at US$100 per barrel, while “discount-to-crude” products were set at US$45 per barrel.

In June 2023, additional measures were taken which prevented the transfer of dual-use items such as computer chips.

 

12th round and asset confiscation

On December 18th, 2023, Europe rolled out the twelfth package of sanctions against Russia which included bans on diamond imports, aluminum and other metal goods, and machinery.

In relation to the price cap, tanker monitoring has been stepped up.

Earlier this week, unprecedented measures were proposed to confiscate $300 billion in Russian assets which were earlier frozen by Western governments.

The majority of frozen assets are held in central bank vaults overseas, over 60% of which are priced in euros, and 12% are in dollars.

This has prompted Russia to state that if this occurs, they shall respond in kind.

 

Effectiveness of sanctions and economic impacts on Russia

Assessing the effectiveness of these sanctions is critical due to the wide-ranging impacts these actions have had on the global economy.

As noted earlier, these measures were developed keeping in mind the strengthened monetary and macroeconomic strategies of Russian government officials and were said to be aimed at making the war financially unviable for Russia.

In March 2022, World Bank officials had forecast that without access to export markets for fossil fuels, Russia’s GDP would contract by 11% by year-end, and inflation would gallop to 22%.

Although there was widespread panic across energy markets, an exodus of leading foreign companies from Russia, and a sharp decline in FDI, the eventual impact was more muted than initially expected.

Source: Russian Central Bank

Supported by elevated oil prices during 2022, GDP contracted by 1.2%, while inflation was at 11.9% YoY in December 2022.

In a recent report, the US Treasury noted Russian exports fell 14% YoY while imports were down by 11% YoY, while sanctions had forced chronic underinvestment, poor productivity, and a dwindling labor force.

It estimates that since the onset of the war, as of December 2023, the Russian economy has contracted over 5% while the rouble has depreciated by 20%, making it much more expensive to import hi-tech equipment to advance the war front.

 

Fiscal situation

As expected, the significant discount on Russian crude oil led to a compression in fiscal headroom, and a 40% fall in energy export revenues from January – October 2023 compared to the corresponding period in the previous year.

In terms of its overall budget, Q1 2023 witnessed a deficit of 2,400 billion roubles, which was over 50% of what was slated for the whole year.

However, economist Sergei Guriev noted that Russian defense spending has reached an estimated 6% of GDP, thrice the budget outlay of the NATO members, with armament suppliers available in Iran and North Korea.

Despite the increasing financial burden, the war budget has expanded to focus on manufacturing armaments and other associated materials, such as metals, textiles, and medical goods.

While oil demand scaled new highs in August and September 2023 since there was a strong resurgence in summer air travel, improved sentiments, and a rebounding Chinese petrochemical complex, which allowed the budget deficit to reduce substantially.

Even though sanctions have been continuing in one form or another since at least 2014, the improved budgetary position, contrary to what NATO-aligned policymakers may have expected, Russia is likely still a distance from a macroeconomic collapse.

Overall, the Russian economy has been able to perform better than anticipated, and on the back of high public spending, a Reuters poll suggested that it is expected to grow by 3.1% YoY during 2023.

 

Oil revenues

As mentioned, measures by the USA, EU, and G7 have meant a consistent decline in oil revenues for Russia, and Guriev noted that oil and gas revenues reduced by half in H12023 on an annualized basis.

Source: Centre for Research on Energy and Clean Air (CREA)

For all energy exports combined, daily revenues have declined from a high of €1,250 million (~£1084.7 million; €1 = £0.87) in March 2022 to under €750 million.

A paper written in April 2023 by a team of authors led by Tania Babina, Assistant Professor of Business at the Columbia Business School, noted that Russia was forced to accept heavy discounts to maintain its export volumes, which likely cost the economy upwards of $3 billion per month even before the roll-out of the price cap in December 2022.

Despite this, in a recent report, Centre for Research on Energy and Clean Air (CREA) experts estimate that the delay in implementing the price cap enabled Russia to secure a trade surplus of $230 billion in the 10 months to December 2022.

However, between December 2022 (the start of the price cap) and November 2023, CREA analysts believe that Russian revenues have been reduced by €34 billion, which amounts to approximately 2 months of earnings.

Yet, the impact of these sanctions has been limited due to the use of “shadow tankers” as well as market players’ appetite for above price cap rates.

As can be seen in the graph below, the price of Russian Urals has stayed well above the price cap for extended periods.

Source: CREA

However, Urals dipped below the price cap in December 2023 following lower demand and excess supply.

November data confirmed that crude revenues dropped $2.4 billion since the previous month, but this is likely more a reflection of waning demand and a surge in supply rather than sanctions efficiency.

In addition, CREA analysts discussed the possibility of implementing a $30 price cap, which would still be twice the production costs but would have lowered Russian export revenues by an estimated €56 bn if implemented in December 2022.

 

Impact of the war on global economies

As per Eurostat, pre-war, the European Union imported 28% of its extra-EU petroleum oil shipments from Russia.

As of Q3 2023, this figure has crashed to 3%.

A paper released in September 2023 by researchers of the Swiss National Bank studied the impact of oil price shocks and noted that European growth had been severely curtailed following the war in Ukraine.

They argue that these macroeconomic effects would likely not have played out in the absence of Russia’s invasion.

In addition, inflation was “considerably” higher than it likely would have been owing to the disrupted supply conditions, possibly in the range of 0.2% to 0.4% across various countries.

Source: Swiss National Bank (Note: Does not necessarily reflect views of the SNB)

Rather than just in the immediate term, the authors’ concerns extend into the medium and long term where they expect the real economy to be negatively impacted by as much as twice the above estimates.

 

Russian oil imports 

As per CREA, data from their Russia Fossil Tracker for 2023, shows that energy trade flows from Russia have shifted away from the EU and primarily towards China, India, and Turkey.

In monetary terms, China assumed the top spot purchasing €EUR 59,072 million, followed by India and Turkey at €EUR 39,622 million, and €20,700 million, respectively.

In 2023, the European Union continues to be a significant buyer of Russian oil (and the single largest buyer of Russian gas, as well) at €14,596 million.

It should be noted that since the beginning of the war, the EU has been the single largest importer of Russian fossil fuels (including coal, gas, and oil) having a combined expenditure of €183,316 million.

Strictly for oil flows, the bloc is now in the second position behind China, with €102,197 million as against €109,297, respectively, with the Netherlands and Germany being the most significant buyers.

This is a reflection of the heavy imports of Russian fossil fuels the European Union executed in 2022 in a bid to top up reserves ahead of the winter season.

During 2023, other European nations such as Hungary, Slovakia, and Bulgaria continued to depend on Russian oil and imported flows to the tune of €1,800 million, €2,144 million, and €2,366 million, respectively. 

 

Cost of war on stock markets

The Centre for Economic Performance at the London School of Economics and Political Science published a study in September 2023 to gauge the impact of a company’s trade dependence on Russia on its cumulative stock returns.

The paper also analyzed the stock market impact of having a Russian affiliate.

Within the constructed database of 19,774 firms listed from 29 countries, the average pre-war dependence on Russia was 0.25%, particularly through the import of commodities channel.

High dependence was concentrated in manufacturing and other energy-intensive sectors.

In the first 14 days of the conflict, the impact for these companies was sharp, with the average cumulative stock returns falling 4.5% but being subject to a wide standard deviation of 13.39%.

Eventually, the impact on stock market performance due to trade dependence on Russia was found to be an average of 0.8% on the aggregate stock market with a median of 0.47%.

In the case of the existence of an ‘affiliate presence’, the average was 0.73% while the mean was higher at 0.52%.

Source: LSE

As a result, due to the dependence on Russia, the impact on stock market performance for Luxembourg, Estonia, and Latvia, was found to be most significant; Luxembourg, Switzerland, and Italy were the most impacted by affiliate presence.

 

Shifts in global oil trade

 

Red Sea

Through 2023 and following severe embargoes on Russia, oil flows have expanded significantly through the Red Sea and Suez Canal.

This increase along with additional volumes in the SUMED pipeline which runs through Egypt was estimated to be 60% higher as compared to 2020.

However, the recent Houthi attacks, as well as the uncertainty around the maritime protection in the region has convinced leading shippers to avoid the route in favor of going around the tip of South Africa.

Unfortunately, this will result in oil shipments taking anywhere from approximately 20 to 40 days compared to the earlier time of under 20 days.

This in turn could have inflationary impacts, particularly as monetary policy eases.

 

United States and OPEC

The study from the Centre of Economic Performance showed that the United States faced little impact on its stock market from any direct trade relationship with Russia or affiliate presence, coming in at 0% and 0.81%, respectively.  

However, an incidental benefit of the war that has accrued to the US has come from the surge in energy exports.

In 2023, oil is on track to be the US’s leading export for the first time, and has accounted for more than 40% of all oil trade (exports as a share of imports and exports).

The US Energy Information Agency (USEIA) noted that oil exports for 2023 are at 12.93 million barrels per day, marking the highest in history.

In addition, the USEIA reported that exports in H1 2023 averaged 20.4 billion cubic feet per day, a 4% increase over the corresponding period in the previous year. 

With the surge in US energy production and the lessening impact of OPEC in the global markets, the US is likely to try to significantly expand its foothold in the coming years, while draining market share from Saudi Arabia and other OPEC members.

 

Europe

Major European economies such as Germany have greatly reduced dependence on Russian energy imports, and do not even feature among the leading buyers in 2023.

This is in sharp contrast to the purchases since February 2022, which reflect heavy buying in the previous year.

As discussed in a previous piece from August 2023, Italy has substantially reduced its dependence on Russian energy, particularly through LNG deliveries from Qatar and the United States, as well as by inking agreements with the Trans-Adriatic Pipeline (TAP); while beginning construction on two of their own LNG terminals.

In addition, the CREA data for oil imports was in line with the above-mentioned article where we noted,

 

Each of these countries is acutely aware that lasting dependence on Russian energy could prove dangerous, either in terms of economic security or in drawing the ire of Western governments. Yet, they are not able to switch overnight and current import levels may act as a proxy for their willingness to extend Russian economic integration with Europe. For instance, Hungary and Slovakia, both negotiated exceptions to the EU-Russia oil embargo. Further, a recent RFERL report noted that Bulgaria became the third-largest buyer of Russian oil in the world in 2023. All three of these countries have generally called for a less strict approach towards anti-Russian sanctions…

Hungary, Slovakia, and Bulgaria have continued to purchase energy from Russia and will likely do so at least until they can secure alternate durable arrangements.

In the case of the Czech Republic, the country will likely continue its Russian energy imports until 2025 when its connection to the Transalpine Pipeline alongside Italy, Germany, and Austria is completed.

 

China

In terms of its Russia relationship, China intends to continue buying energy from Russia, with an estimated increase of 25% in purchases during 2023 alone.

In a recent discussion, Igor Sechin, CEO of Rosneft confirmed that Chinese deliveries will continue to be transported safely through the Eastern Siberia-Pacific Ocean pipeline despite geopolitical tensions elsewhere.

India

As noted above, India also stepped up energy purchases from Russia in 2023.

Earlier this year in a discussion in London, External Affairs Minister of India, Dr. S. Jaishankar was asked about India’s ongoing policy of buying Russian oil and gas, where he argued,

 

Just imagine for a moment if we hadn’t bought oil from Russia, I think global oil prices would have gone high. We would have gone into the same market and same suppliers that Europe would’ve done, and frankly, we discovered…many supplies that were traditionally coming to Asia got diverted to Europe. At least India was a big enough country to command some respect in the markets, but there were much smaller countries that didn’t even get responses to their tender inquiries because the LNG suppliers were no longer interested in dealing with them. They had bigger fish to fry. So, we’ve actually softened the oil markets and gas markets through our purchase policies. We have, as a consequence, managed global inflation, so frankly…I am waiting for the thank you.

 

Rounding up

In conclusion, leading European economies such as Germany, Italy, and the Netherlands have diversified away from Russian energy supplies.

CREA data shows that this follows intensive buying in 2022 by these economies.

Other European countries such as Bulgaria, Hungary, Slovakia, and the Czech Republic will continue their Russian energy purchases for the foreseeable future.

For countries such as China, India, and Turkey, Russian oil flows became increasingly important given that traditional sources were being redirected towards Europe.

Lastly, the United States, has become a major player on the global energy stage.

It is to be seen if the US will continue to generate such high levels of output if energy prices continue their bearish trend.

 

Outlook

Looking ahead to 2024, energy prices are now in the hold of a bearish trend and are likely to continue to ease as the US and countries such as Brazil, Guyana, and Iran produce higher outputs.

The USEIA forecasts that the US will supply 13.11 million barrels per day of oil in 2024, a new record.

Moderating GDP in advanced economies will also likely cap prices, while the IEA estimates that non-OPEC countries shall contribute an additional 1.2 million barrels per day of crude oil in the following year.

At the same time, consumer demand is expected to weaken by 1.1 million barrels per day.

Upward risks to oil prices (and inflation) could materialize from intensifying geopolitical conflicts and depend on the trajectory of rate cuts the Federal Reserve decides to execute.

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