The cusp of a new oil era

While for the past few years the world has been living in the throes of uncertainty, as reflected by the fear index (VIX) in Fig. 1, it is now also going through massive change on nearly every level. Events that were regarded as shocking just a while ago nowadays go unnoticed, and economic ties that once seemed perfectly reliable are now falling apart, replaced with new ones.

Market mechanisms are giving way to intergovernmental regulation. One of the examples is a price cap of $60 per barrel introduced this week by the G7 for Russian crude oil (for comparison, a barrel of Urals and ESPO traded at $66.5 and $83.2 last month, respectively). In retaliation, Russia is planning to ban sales to countries applying this restriction. The exact measures are yet to be determined. Russia may either ban crude oil sales to countries and intermediaries which have joined the price cap, or prohibit exports under contracts that include the price ceiling condition, regardless of which country is the recipient.[1] As an alternative, the government is also considering setting a price floor (i.e., a maximum discount for its flagship Urals crude to the benchmark Brent) for outbound sales allowed from Russia. Since the turn of December, Urals has been trading at an average discount of 27% (see Fig. 2), which is anticipated to rise to 35% next year, while ESPO has been selling for 8% less than Brent.

Despite these tectonic shifts, Brent prices are now trending down, from $92.1/bbl this autumn to an average of $81.3/bbl in December (see Fig. 3), amid uncertainty around the COVID-19 pandemic and mounting geopolitical tensions globally.

It’s hard to predict how the situation will unfold, as even some of the most common correlations now look different: the correlation between the Brent price and the US dollar (DXY), though remaining negative, has changed from 0.83 in 2009-19 to 0.14 in 2022 (reverse dependence), while the coefficient of determination (R2) has dropped from с. 68% to 36% for Urals and 2% for Brent. The traditional global landscape that has been in place for decades seems to be breaking up in the gales, and no one knows how the puzzle will look once completed.