The Game of Chess Continues – OPEC, China and the Oil Market

Michalis Efthymiou, Market Analyst at NAGA

Over the past decade, the US has been complaining about the amount of power which the BRIC group, and specifically China, has on the global economy. BRIC stands for Brazil, Russia, India and China; these were the world’s fastest growing economies. Only in the past 10 months, the US has turned their attention toward OPEC due to the prices of fuel. Nevertheless, China seems to have a strong influence even over the price of crude oil.

Over the past 2-weeks, crude oil prices have declined by 12.8% and this week to an 11-month low. So why has the price significantly declined after strong price increases in October?

China’s Supreme Reign over Oil Demand

One of oil’s main price influences is, without doubt, China. It is the largest economy in the world and the largest purchaser of crude oil alongside the US. China actually consumes 14% of the world’s oil – this is 5 times more than Germany and 8 times more than the UK. For this reason, if news develops in China, it can rock the entire oil market.

In addition to this, China is also one of the largest exporters of raw materials. Therefore an economic decline in the Chinese economy, or worse a lockdown, can have a very strong impact on the global economy and supply chains. A potential decline in the price of crude oil is yet another consequence.

The amount of COVID-19 cases in the region is the main concern at the moment. Such numbers have previously resulted in the government placing full lockdowns. COVID-19 cases in China have reached over 55,000 per day and recorded their first deaths since September.

These developments have resulted in most market participants believing that the level of demand is likely to decline. In fact, a decline has already been seen due to the increased level of restrictions placed by the Chinese government. However, the demand will definitely drop sharply if cities fall into full lockdowns.

In addition to the above, the price of crude oil has also been pressured by the decline in economic activity. For the first time this year, the PMI figures for the UK, EU and US have all dropped into the contraction zone. The same can be said of the GDP figures which have declined for all economies. Consumer demand has remained high according to many reports such as Retail Sales figures. However, in spite of that, if economic activity continues to decline it can lead to further pressure on oil prices.

Nonetheless, traders should note that the decline cannot be certain. Traders should be cautious of opposing factors. For example, a weakening US Dollar is known to support the prices of crude oil.  This is because it becomes cheaper for foreign buyers due to the altered exchange rate. Although such a situation could support prices, we have not witnessed it this time around. Oil prices have fallen despite the US Dollar Index having declined by almost 6.5%.

Another issue for the price of crude oil is a potential oil price cap being placed on Russian oil. The European Union and G7 members are currently in the middle of these negotiations. The issue with the planned restrictions on Russian oil is that, of course, Russia will not agree to it. In fact, the country has advised that it will halt all supply. This is an issue as Russia is the second largest global supplier of crude oil. However, the effect on the market will depend on how low the price cap will be.

Will OPEC Intervene Again?

OPEC have not been shy in making their opinion on pricing known. On many occasions, the group has repeatedly stated that they aim for an $80 per barrel price. This is slightly higher than the current price. But the question that traders are now asking is, “what will OPEC decide at their next meeting?”

OPEC is due to meet in the first week of December. If they announce a production change, as they did in October, it can create high levels of volatility. Back in October, the organization had announced that they would decrease their production targets by over 1 million barrels per day, prompting a 6 week upward trend. This was in response to the price declining to $76.

In conclusion, we can see that the price of crude oil is understandably under pressure from certain elements such as global economic contraction, as well as lower demand from China. However, it’s vital that traders remain cautious because other factors, such as supply and OPEC, can create a change in the trend and volatility levels.

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