‘Unexpected Changes In Demand And Supply': Oil Analyst Vandana Hari On Factors Impacting Oil Prices

Oil prices rose to $85 a barrel two weeks ago, and are expected to rise further, raising fear of an inflationary spike in the coming months in some regions. While this may not have immediate repercussions, the International Energy Agency (IEA) said last week that global oil demand is poised to peak again in August, after oil demand hit a record 103 million barrels a day in June.

The agency said that the demand for 2023 as a whole is expected to reach 102.2 million barrels a day. China is responsible for more than 70% of this growth, the IEA said, adding that the demand was “stronger than expected” and reached new highs “despite persistent concerns over the health of the economy.” Furthermore, the IEA said Russia’s oil exports breached the price cap put in place by the Group of Seven (G7) nations.

Last month, prices surged to an average of $64.41 per barrel, surpassing the G7’s cap of $60 per barrel. The flow of oil and exports from Russia, a major producer, too has shifted away from Europe and towards Asia. India's share of Russia's total crude and refined oil exports has risen to almost 25%, exceeding 60 million barrels per month. The IEA said crude exports to India and China accounted for 80% of Russia’s shipments.

To understand what fundamentally changed in recent months and what that tells us about the near future on oil prices, The Core’s Govindraj Ethiraj spoke to oil analyst Vandana Hari of Vanda Insights.

“If you look at OPEC+ output, it has sunk to two year lows. Now, while two years may not sound that drastic, you have to keep in mind that two years ago, we were in the throes of COVID. The pandemic had destroyed substantial global demand. So that's where we are. So OPEC is, or OPEC+, rather is tightening supply,” Hari said on the Organization of the Petroleum Exporting Countries’ (OPEC) move to cut supplies. OPEC, responsible for producing approximately 40% of the world's crude oil, has been reducing its oil production since November last year.

Here are the edited excerpts from the interview:  

What has led to the skyrocketing oil prices and what do they tell us about the future trends?

I think a couple of things, I would say have been a little bit unexpected. One is on the supply side, and one is on the demand side. So on the supply side, OPEC+ and mind you, not all members of the organisation, but eight members of that alliance stepped up and said we are going to cut production because it seems that there is oversupply in the markets. And basically, what they didn't say, which is probably more important, is that they did not like prices threatening to slip down. That had been a feature of the markets pretty much since the banking crisis of March. It was widely believed and rightly so in the market, that $70 per barrel for Brent was the sort of threshold, a pain point, for the OPEC+ alliance. In order to protect that they proceeded with cuts, output cuts that wasn't all then Saudi Arabia came in with a second round. Saudi Arabia, obviously being even more hawkish to support prices at a higher level, said that on top of the cuts that had been announced by the eight members, including Saudi Arabia, they said they will now cut an additional 1 million barrels per day, which is substantial, right? It's 1% of the global consumption, and they also wanted to keep the market in suspense. So they said we will do it a month at a time. So far, they have rolled it over for three months. So it started in July, is continuing in August, and they have already rolled it over to September. 

So what has happened is, all of these cuts put together, have taken away about 3.2 million barrels per day of supply from the market as of August compared with what they were pumping in February. Now that kind of a cut just to put this in context, is the biggest OPEC+ cut since May 2020. Mind you, which was at the height of the demand crash caused by COVID. If you look at OPEC+ output, it has sunk to two year lows. Now, while two years may not sound that drastic, you have to keep in mind that two years ago, we were in the throes of COVID. The pandemic had destroyed substantial global demand. So that's where we are. OPEC is, or OPEC+, rather is tightening supply. 

The other is on the demand side. So what has actually changed on the demand side, it's very hard to say. What has really changed is the sentiment, when you look at the broader financial markets, which by and large across the globe are led by what is the mood amongst the investment community and the financial markets in the US. A dramatic change that unfolded on that scene, I would say since the end of June, but very distinctly since early July, was the so-called soft landing narrative. So basically, it is a picture that has now come together with a lot of conviction in the investment community that US inflation is cooling down substantially exactly what the Fed wanted. Whereas at the same time, the US economy is proving quite resilient, spending is proving quite resilient. Consumer sentiment is proving quite resilient in the face of the unprecedented tightening of monetary policy that we've seen from the Fed. So all of this put together has injected a lot of cheer, a lot of optimism in the financial markets, which has flown through as a proxy for demand for oil. So these are the two main factors that have quite visibly changed the outlook. 

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From the India context, we buy a lot of Russian oil, and prices have been going down there. You've been saying that this is not the smoothest of trades, what's happening then?

Yes, so when India first started buying, there was a little bit of concern, and rightly so that how would the western allies and especially the US, which is known to sanction trades. We know, producers like Iran and Venezuela, have been living under US sanctions. India, for instance, used to buy Iranian oil but doesn't buy any more simply because of the sanction by the US. So there was concern, even though the US had said that, what we want is that we, the NATO allies, will not buy Russian oil, but we want Russian oil to continue flowing into the market. So they had said that but it was cold comfort for countries, especially in Asia that have seen the effect that US sanctions can have, both direct and even indirect. You see lots of refiners just wanting to avoid taking that risk. A lot of financial institutions, a lot of banks wanting to avoid taking a risk and not touching trade where they fear there might be the chance of US sanctions so that however subsided gradually. But off late, there's been a little bit of concern again, because Russian crude prices have gone above the $60 per barrel price cap that the west has decreed. 

Now, just to be clear, that price cap is only applicable if the buying parties, refiners in Asia are actually using western services such as shipping or insurance or other trade financing services. Now, we know that the Russian oil flowing to India is not using those by and large, but we can't see that 100% of it that is the case. So there has been a little bit of concern. And of course, I think let us not forget that India and you know, the foreign minister being a case in point has had to constantly defend India's position on the international stage, because the other blame that gets put at India's doorstep routinely, is that indirectly the country is helping fund the war in in Russia. So, at least that I think India has managed very elegantly, very firmly. I'm basically quite proud of how it has been handled, that question in the international arena.