Trading the Recent Crash in Oil Prices
Despite the ongoing war in Eastern Europe, crude oil prices recently slumped to fresh lows—a sign of declining confidence in the global economy
Crude oil has been on a wild ride in 2022, and based on recent developments, that ride is far from over.
Last week, crude oil prices briefly dropped to nearly $70/barrel—representing a year-to-date low in the world’s best-known commodity. Oil started 2022 trading around $75/barrel, and then spiked above $120/barrel in both March and June due to global shortages associated with the war in Eastern Europe.
For many, the recent correction in oil prices has likely been an astounding development. But bearish sentiment in the market appears to stem from slowing global economic conditions, as opposed to an easing of tensions in Ukraine.
Along those lines, the International Monetary Fund (IMF) announced back in October that worldwide economic output is expected to slow from +3.2 percent in 2022 to +2.7 percent in 2023. Current and expected levels of economic growth heavily influence global oil demand and oil prices, which helps explain why prices may have dipped in recent weeks.
However, another factor affecting global energy markets is the recent push by the United States and Europe to cap the price at which Russia can sell its oil on the international market.
Russia is one of the world’s top producers of crude oil, with the capacity to pump out roughly 12 million barrels per day. However, due to sanctions from the West, current estimates suggest that Russia is only producing about 10 million barrels per day.
Based on recent developments, Russia may have to drop production further, unless it wants to sell the bulk of its daily inventory at a significant discount to current market prices. That’s because leaders in the U.S. and Europe recently agreed to cap the price at which they will buy Russian crude—at $60/barrel. And to ensure the cap is upheld, the new sanctions include a framework for punishing maritime vessels that carry cargos of Russian crude that have been sold above the $60-threshold.
Under the new framework, transoceanic shippers will have their insurance revoked if they are caught freighting Russian oil that’s been sold for more than $60/barrel. Considering that such shipments are often worth tens of millions of dollars, it’s unlikely that most transoceanic shippers would be willing to carry such loads without the backdrop of a reliable insurance policy.
Russia has already announced it won’t abide by the new $60 price cap. However, it may not have much choice in the matter, because Russia doesn’t control enough maritime vessels to circumvent the new rules.
Importantly, however, the new sanctions are only limited to seaborne oil. That means oil shipped through pipelines can continue to flow out of Russia at market prices. But in Europe, only about 10% of the supply from Russia is delivered via pipeline. And, as illustrated in the chart below, about two-thirds of Russia’s total oil exports are shipped via the ocean.
Russia is already selling oil at a discount to countries such as China and India. Both countries significantly increased their purchases since Russia expanded its war with Ukraine in spring.
Undoubtedly, China and India will use the new $60 price cap to their advantage when negotiating new contracts with Russia.
The goal of the price cap is to reduce Russia’s incoming cash flow from energy exports, which would serve to further impair the Russian economy. The price cap went into effect on Dec. 5, and may have weighed on the price of oil last week—pushing crude to fresh 2022 lows.
Going forward, it will be interesting to see if the framework is successfully implemented, and how the cap impacts prices in 2023. But investors and traders shouldn’t lose focus, because ongoing demand for oil will still be a critical factor heading into the new year.
If, for example, China scraps its “zero-COVID” policy, that decision could have far-reaching consequences in the global energy markets. Over the last couple years, growth in the Chinese economy has been stunted as a result of strict COVID-19 measures. So if China were to abandon those measures, and resume “normal” operations, then China’s demand for oil would likely expand significantly.
Under that scenario, oil prices would almost certainly rebound—at least to some degree.
Of course, some companies in the energy sector have seen their stocks pullback alongside the recent slide in oil prices. Listed below are 15 stocks that have experienced some of the sharpest declines in the industry over the last five trading days:
- Opal Fuels (OPAL), -26%
- VAALCO Energy (EGY), -23%
- NRG Energy (NRG), -22%
- Ramaco Resources (METC), -22%
- Snow Lake Resources (LITM), -20%
- Earthstone Energy (ESTE), -20%
- Independence Drilling (ICD), -19%
- Energy Vault Holdings (NRGV), -19%
- TPI Composites (TPIC), -18%
- Ranger Oil (ROCC), -18%
- Laredo Petroleum (LPI), -18%
- Amplify Energy (AMPY), -18%
- Borr Drilling (BORR), -18%
- Core Labs (CLB), -18%
- Riley Exploration (REPX), -18%
To follow everything moving the markets during the remainder of 2022 and beyond, monitor tastylive, weekdays from 7 a.m. to 4 p.m. CDT.
Sage Anderson is a pseudonym. He’s an experienced trader of equity derivatives and has managed volatility-based portfolios as a former prop trading firm employee. He’s not an employee of Luckbox, tastylive or any affiliated companies. Readers can direct questions about this blog or other trading-related subjects, to email@example.com.