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Russia’s invasion of Ukraine has resulted in condemnation by Western leaders.
The war, taken together with inflationary pressures and the threat of rising interest rates, has seen market volatility rise. On 7 March 2022, the S&P 500 Index saw its most drastic one-day drop since May 20201, commodity prices are climbing, and inflation is poised to hit a 32-year high. It appears the uncertainty will continue for some time, and market volatility will be with us for a while.
In response to the invasion, the Western world is slowly banishing any form of trade with Russia in protest. From a world trade perspective, the international coordination of sanctions across the European Union (EU), the U.S, the U.K, Canada, Switzerland, Japan, Australia, and Taiwan on Russia has caused significant disruption to Russia’s exports of agricultural commodities, gas and oil.
Having said that, history tells us that with uncertainty comes opportunity. While not for the faint-hearted, are investors currently presented with an opportunity to benefit from rising oil prices?
What are the key influences on the oil price today?
As is the case with most commodities, oil’s price is driven by supply and demand, with an overlay of geopolitical influence.
This was evident back in May 2020 as demand for oil dried up due to the global pandemic, sending oil prices into negative territory for the first time in history. This was happening whilst Russia and Saudi Arabia were experiencing a price war.
Fast forward to March 2022, and the situation is very different. As we emerge from the pandemic, we have seen a rise in oil prices due to higher than expected demand met by sluggish supply, and now international sanctions against Russia are adding to the pressures driving prices up.
According to the International Energy Agency (IEA), Russia is the world’s third largest oil producer and the world’s largest oil exporter2. Russia supplies about 10% of the world’s crude oil, and with the sanctions taking place, this has resulted in a skyrocketing oil price.
Source: Bloomberg, data for 2020
The sanctions affecting oil prices include:
- On 9 March 2022 President Joe Biden announced a complete ban on Russian energy products including all oil, gas and coal imports.
- The U.K. has announced it will phase out Russian oil and oil products by the end of 2022.
- ‘Self-Sanctioning’ – Oil buyers and bidders are showing reluctance to take on Russian oil to protest the Ukraine invasion.
The oil price has surged to its highest level since 2008, and about 70% of Russian oil is struggling to find buyers3. With this short-term supply shock, JPMorgan Chase is predicting the price of crude oil will climb to $185 a barrel by the end of 20224.
Russia typically exports about 7.3 million barrels a day of seaborne crude oil and petroleum products. Sanctions mean that this source of supply to global markets is effectively shut down. While 31 member countries of the IEA recently announced that they will be releasing 60 million barrels of emergency oil reserves, this represents only a third of a one-month disruption to Russian seaborne oil.
The only other potential short term supply response available would need to come from OPEC, for example in the form of increased production from Saudi Arabia and the United Arab Emirates. However, this could come at the expense of a depletion of the global oil market’s spare capacity, potentially pushing prices even higher5.
Source: investing.com. Past performance is not indicative of future performance.
Even though the purchase of Russian oil is not entirely banned, many potential buyers are pulling back, worried about running afoul of existing Western sanctions, concerned about possible future sanctions, or simply wary of the reputational risk of potentially being seen as supporting Putin. Russia’s highest-quality oil recently was selling at a discount of $20 a barrel6 – and even at that price, had few buyers.
Exiting the Russian market will continue to be a complex challenge, sanctions are likely to continue for the foreseeable future, and oil will likely continue to experience a short-term supply shock which should add to upwards pressure on oil prices.
How can investors gain exposure?
Given the volatility of energy markets, exposure to oil should be considered only by those investors willing to accept the risks involved, and only as a small part of a diversified portfolio.
Investors can gain exposure to the price of crude oil futures through the BetaShares Crude Oil Index ETF – Currency Hedged (Synthetic) (ASX: OOO). It’s important to understand that the price of oil futures contracts is not the same as the spot price of oil, and as such, OOO does not aim to, and should not be expected to, provide the same return as the performance of the spot price. This is because the process of ‘rolling’ from one futures contract to the next to maintain investment exposure can result in either a cost or benefit to the Fund, affecting returns. The performance of an ETF that is linked to oil futures may be materially different to the performance of the spot price of oil itself. For more information, please see Understanding the performance of OOO.
There are risks associated with investment in OOO, including market risk, commodity volatility risk, commodity roll risk and derivatives risk. For more information on the risks and other features of the Fund, please see the Product Disclosure Statement available at www.betashares.com.au. The index which OOO aims to track is based on the price of WTI crude oil futures contracts. Investing in commodity futures is not the same as investing in the “spot price” of a given commodity. As such, OOO does not aim to, and should not be expected to, provide the same return as the performance of the spot price of oil. The performance of ETFs that are linked to commodity futures may be materially different to the spot price for the commodity.
1. Davis, William, and Stanley Reed. “Business News for March 7, 2022.” The New York Times, 8 Mar. 2022.
2. “Oil Market and Russian Supply.” International Energy Agency, www.iea.org/reports/russian-supplies-to-global-energy-markets/oil-market-and-russian-supply-2. Accessed 10 Mar. 2022.
3. Hume, Neil Harry Dempsey. “Russian Tankers at Sea despite ‘Big Unknown’ over Buyers.” Australian Financial Review, 8 Mar. 2022, www.afr.com/companies/energy/russian-tankers-at-sea-despite-big-unknown-over-who-will-buy-oil-20220308-p5a2qq.
5. Goldman Sachs, Commodity Views: Demand destruction the likely only buffer left, February 2022.
6. Krauss, Clifford. “Russian Oil Not Worth the Trouble, Some Traders Conclude.” The New York Times, 2 Mar. 2022, www.nytimes.com/2022/03/01/business/energy-environment/russia-oil-price.html.