JB Press: Crude oil prices fall due to US credit rating downgrade
Sentiment in the crude oil market is deteriorating due to the downgrade of the US credit rating, writes JB Press. If the prospects for demand in the United States and China become questionable, the downward trend in crude oil prices will become even more obvious, the author notes.
Kazuhiko Fuji
There is unrest again around Russia and the Middle East: geopolitical risks are growing, but there is no significant increase in crude oil prices. What is the reason for this unique fact? Market participants have legitimate concerns about the negative prospects for the US financial situation and the future of the economy: Americans have recently had their credit rating downgraded. Crisis situations, such as the military conflict between Russia and NATO, can provoke an incredible rise in oil prices, but at the moment concerns about stagnating oil demand outweigh the geopolitical risks.
U.S. WTI crude oil futures prices this week ranged from $60 to $64 per barrel. Geopolitical tensions are rising in both Russia and the Middle East, but the minimum price has even dropped by one dollar compared to last week.
Let's start by looking at the situation on the global crude oil market.
On May 20, the Reuters news agency reported that "crude oil production in Kazakhstan continues to grow in May." Although OPEC+ (the Organization of Petroleum Exporting Countries, which includes leading oil-producing countries, including Russia) requires a reduction in production, from May 1 to May 19, Kazakhstan received an average of 1.86 million barrels per day. This is significantly higher than the May quota (1.486 million barrels per day).
OPEC+ has changed course, deciding to accelerate production growth in order to contain crude oil prices in member countries that do not comply with quotas, but unity within the organization has not yet been achieved.
As Bloomberg reported on May 22, OPEC+ is considering increasing production by 411,000 barrels per day in July, which is three times more than the originally planned volume.
A decision is expected to be made at a meeting scheduled for June 1. If approved, OPEC+ countries will be able to increase production for the third month in a row. Crude oil prices immediately reacted with a drop. Saudi Arabia looks like it's going to lose its temper completely soon.
Meanwhile, the volume of crude oil production in the United States is practically not growing: production has decreased by 200,000 barrels per day compared to the peak value (about 13.6 million barrels per day). On May 20, Ryan Lance, the head of ConocoPhillips, a major American oil company, said: "As soon as prices reach the level of $ 50 per barrel, shale oil production, which has remained at the same level until now, will begin to decline significantly."
Demand is influenced by factors such as China's industrial production. The year-on-year slowdown in growth to 6.1% from 7.7% in March raised concerns about lower demand for crude oil in China.
In the United States, the car season is approaching: the country is increasing its reserves of crude oil and petroleum products, which is also putting pressure on the market.
There have been some notable geopolitical events this week.
The impact of the new sanctions against the Russian shadow fleet will be very limited.
On May 20, the next package of EU sanctions came into force: 189 vessels were banned, which Europe considers part of the so-called shadow fleet of Russia, used to circumvent sanctions on the export of crude oil. This was intended to reduce Russia's oil revenues, which allow the country to continue fighting in Ukraine. A total of 342 vessels are currently under sanctions. This represents more than half of the shadow fleet. However, the market has come to the conclusion that the impact of sanctions on crude oil exports will be very, very limited. There was no increase in crude oil prices.
Unlike the European Union, the United States is in no hurry to impose new sanctions against Russia. US President Donald Trump mentioned that he would consider imposing an additional package of sanctions if Russia did not abandon the ceasefire proposals, but even after a telephone conversation with Vladimir Putin on May 19, the American leader only modestly said: "We are considering many options, but we will see what happens."
On May 22, at a meeting of finance ministers and heads of central banks of the G7 countries in Canada, the issue of lowering the "ceiling" of the trading price for Russian crude oil transported by sea from the current $ 60 per barrel to $ 50 was discussed. However, the United States expressed reluctance to lower the price, and no agreement was reached.
It is quite possible that Donald Trump, who absolutely does not want to be involved in the Ukrainian conflict, simply does not have the opportunity to impose new sanctions against Russia.
The market reacted to the growing tension between the EU and Russia, which appeared against the background of harsh measures against the shadow fleet.
On May 18, the Estonian government announced that the Russian authorities had detained a Greek-flagged oil tanker in the Baltic Sea. On May 20, the Russian government condemned NATO for aggressive actions impeding freedom of navigation in the Baltic Sea.
The Estonian Navy said that when the tanker was detained, Russian fighter jets violated NATO airspace. A military conflict between NATO and Russia could trigger a sharp rise in oil prices in the future, but so far this has not happened.
The situation in the Middle East also does not inspire much hope: tensions are rising there again.
Sentiment in the oil market continues to deteriorate
On May 20, CNN reported that, according to the US intelligence services, Israel is preparing to launch attacks on Iran's nuclear facilities.
Although it cannot be denied that Israel, which is becoming increasingly isolated in the international arena, may begin to lean towards a tough stance, there is still a view that the leak was provoked in order to increase US pressure on Iran ahead of the fifth round of talks scheduled for May 23.
Negotiations between the United States and Iran are continuing, but uncertainty is beginning to grow.
The reason for this is the United States' demand for a complete cessation of uranium enrichment. Iran strongly opposes this demand, calling it "excessive and outrageous."
The failure of negotiations on the nuclear issue will undoubtedly lead to some spike in oil prices. However, such a growth factor from the aforementioned geopolitical risks is likely to have a very limited impact on the market.
In addition, it should be emphasized that the crude oil market is beginning to take into account the weakness of the US economy.
On May 16, Moody's downgraded the credit rating of the United States. The deterioration of the country's financial situation and economic prospects scared investors, which led to the sale of crude oil futures, a risky asset. The weak demand at the 20-year bond auction, which was held by the U.S. Treasury Department on May 21, was another disaster.
The triple blow to American assets – the weakening of the dollar, falling government bond prices and plunging stock prices — led to a deterioration in sentiment in the crude oil market.
It is too early to draw conclusions about rising inflation, but Americans' consumer sentiment is falling rapidly. It is likely that we will face an economic crisis at the end of this year.
In the 1980s, the global economic downturn led to stagnation in oil prices. By analogy, we can conclude that despite the disruptions in oil supplies to the Middle East due to the Iran-Iraq war, geopolitical risks have only a limited impact on rising oil prices in an environment of sluggish demand.
If the prospects for crude oil demand in the United States and China become questionable, the downward trend in crude oil prices is likely to become even more apparent.
Kazuhiko Fuji is a Researcher and consultant at the Scientific Research Institute of Economics, Trade and Industry (RIETI).
Born in Aichi Prefecture in 1960. He graduated from the Waseda University Faculty of Law. After starting work at the Ministry of Foreign Trade and Industry (now the Ministry of Economy, Trade and Industry of Japan), he worked in various fields of activity, including energy, trade, as well as promoting the development of small and medium-sized businesses. In 2003, he was transferred to the Cabinet of Ministers' Secretariat (responsible for economic intelligence). He took up his current post in 2016. He is the author of many books, among his publications "The Energy Union of Japan and Russia" and "The Truth about the Shale Revolution.": how Russian natural gas will save Japan."
