Oil Softens as Traders Assess Plan to Cap Russian Exports

Liubov Georges
By  Liubov Georges , DTN Energy Reporter

WASHINGTON, D.C. (DTN) -- While the New York Mercantile Exchange West Texas Intermediate October contract settled flat Tuesday, the nearest to delivery products contracts and Brent crude traded on the Intercontinental Exchange registered losses in afternoon trading as investors navigated a myriad of conflicting reports, including a G7 agreement to cap the price of Russian oil exports that should, in theory, result in more supplies available on the global market, and an unexpected production cut from the OPEC+.

To add to the uncertainty, Russian state-owned energy company Gazprom announced on Friday the permanent closure of its largest natural gas pipeline to Europe, citing the debilitating effects of Western sanctions on its ability to operate the pipeline. The Nord Stream 1 pipeline has the capacity to deliver 55 billion cubic meters per year of the blue fuel to the German port of Greifswald, which would then be redistributed across regional European gas markets.

In both 2020 and 2021, Russia supplied roughly 40% of Europe's gas market, followed by Norway and Algeria with 21% and 12% shares, respectively. The shutdown threatens additional closures of Europe's heavy industry such as steel and fertilizer production that heavily rely on natural gas, as well as hiking energy bills for households ahead of the heating season.

"This has the ingredients for a kind of a Lehman Brothers of energy industry," Finnish Economic Minister Mika Lintila said on Sunday, referring to the investment house that imploded in September 2008.

Fitch Ratings forecasts a full shutoff of Nord Stream 1 would reduce Eurozone gross domestic product in 2023 by 1.5% to 2%, effectively plunging the economic bloc into prolonged recession.

The government response to the deepening energy crisis appears to mirror the pandemic crisis, with politicians across the European Union pledging billions in support for the industry, utilities, and households.

United Kingdom's new Prime Minister, Liz Truss, announced a £130 billion plan to subsidize household energy bills over the next 18 months. Similarly, Finland and Sweden have announced plans to offer liquidity guarantees to power companies in their countries after Nordic utilities were pushed to the brink of default following the Nord Stream closure.

The shutdown came hours after G7 countries agreed on Friday to impose a price cap on Russian oil exports in an attempt to stem the flow of funds to Vladimir Putin's regime for its invasion of Ukraine. The initiative will hinge on an incentive system where importers of Russian oil seeking insurance and shipping from companies located in G7 countries, which constitute roughly 80% of the global market, would need to observe the price ceiling. The level of the price cap along with an enforcement mechanism will be decided in further talks with all interested participants outside of the G7, notably China and India.

"We will be seeking input from all interest parties," said German finance minister Robert Habeck.

It's unclear where India and China stand on the price cap agreement. Both countries markedly increased purchases of Russian oil this year despite Western sanctions and reputational risks associated with such transactions. For its part, the Kremlin issued a statement that it would refuse to sell oil to any country that participates in the price cap agreement.

Currently, the price cap is designed to take effect simultaneously with an EU embargo on Russian oil imports on Dec. 5, which could deliver a massive supply shock for markets should Moscow choose to curtail oil exports and shut down fields.

Many questions remain over the viability of the agreement and enforcement mechanism. For instance, shipping insurers have expressed concern that insurance coverage is being used as an enforcement mechanism for the cap, given that underwriters do not typically track the trading price of the cargo. The situation remains fluid.

Against this backdrop, OPEC+ on Monday agreed to cut oil production for the first time in over a year, lowering the collective target by 100,000 bpd for the month of October. The small cut would reverse the 100,000 bpd that OPEC+ said it would add to the market last month, meaning the group's production targets will remain virtually unchanged at the August level. The decision to reverse the small production increase designed for September is more symbolic than fundamentally significant but it sends a clear signal that the alliance stands ready to defend the market should prices continue to fall.

At settlement, NYMEX October WTI futures posted a $0.01 gain from Friday's close at $86.88 bbl, while Brent for November delivery declined to $92.83 bbl, down $2.91 in Tuesday's trading. NYMEX October RBOB futures plummeted 4.77 cents to $2.4159 gallon, and NYMEX October ULSD futures eased 0.42 cents to a $3.5738 gallon settlement.

Liubov Georges can be reached at liubov.georges@dtn.com

Liubov Georges