Russia, China increase pressure on global inflation

The reduction in production by Russia amid the recovery of Chinese demand will further strangle the oil market, thereby pulling up inflation.

The Kremlin announced on February 10 that it would reduce oil production by 5% due to Western sanctions. Their allies in the Organization of the Petroleum Exporting Countries and their allies (OPEC+) show no sign of wanting to fill this void.

At the same time, China's fuel consumption is increasing after dropping the Zero Covid policy. China is currently the world's largest oil importer. The country's oil giant Unipec has bought millions of barrels of oil from the Middle East, causing the price of this commodity in the region to skyrocket.

"News that Russia cuts production and China reopens can both push prices up. Supply will tighten in the second half of the year. We will see very low inventories," said Gary Ross - an expert Oil consultant at Black Gold Investors said.

Tighter supply and rising demand are supporting the oil market. Earlier this year, a spike in oil inventories prompted Wall Street analysts to debate whether prices could return to triple digits. Currently, each barrel of Brent costs $86.

Rising oil prices can drag inflation up, complicating the efforts of central banks. They are having to both stimulate growth and contain the cost of living crisis that is affecting millions of people around the world.
Inflation in the US last year was 8%. Economists forecast this number to increase in the first quarter. In the European Union (EU), inflation in 2022 is 8.9%, mainly due to the energy crisis after the Russia-Ukraine conflict.

Russia announced yesterday to cut production by 500,000 barrels a day next month. This is equivalent to 0.5% of the world's oil demand. The move comes after they repeatedly said they would retaliate against the sanctions on crude oil. The price of Brent oil therefore increased by nearly 3% in the trading session on February 10.

This week, the EU's embargo on Russian oil products also took effect. Buyers can only use EU shipping and insurance services if they buy Russian oil below the ceiling price.

If policymakers expect OPEC+ to fill the production gap from Russia, they will be disappointed. Saudi Arabia and other OPEC members have no intention of increasing production, representatives of the countries in the organization said yesterday. They will keep output steady this year, as demand is still too fragile.

"We don't think they need to increase production this year. They are trying to hold back," Bob McNally said on Bloomberg.

Saudi Energy Minister Abdulaziz bin Salman last week asserted that the possibility of their intervention was very low. "I believe I know when to act," he said.

Meanwhile, Chinese demand is showing signs of accelerating rapidly. Domestic flights increased by 80% during the Lunar New Year after the decision to abandon most of the epidemic prevention policy. Traffic in major cities has tripled since the holiday, according to BloombergNEF.

All of these factors make UBS think that "the outlook for oil prices is very positive". "Russia's production cuts and China's reopening will tighten the oil market further in the next few quarters," said Giovanni Staunovo, an analyst at UBS. However, this move has not caused organizations to simultaneously raise their price forecasts. 
Yesterday's increase was also quite modest compared to the volatility of oil over the past few months. 
The reduction in Russian production has also been predicted since President Vladimir Putin launched a military campaign in Ukraine a year ago. 

Yesterday's announcement could therefore indicate that the country is having difficulty redirecting oil sales from Europe to Asia. 
Many analysts believe that the real reduction in Russian production could exceed 500,000 barrels a day. The International Energy Agency (IEA) forecasts Russian production to fall by 1.6 million barrels per day by the end of the quarter. 

The fact that the market hasn't reacted too strongly to Moscow's announcement shows that at least there is a surplus of supply. "In the short term, supply is still plentiful. But the next few weeks could be very different. Supply will go down as China accelerates consumption," said Ryan Fitzmaurice, commodities trader at Marex North America. A rebound in demand and OPEC+'s refusal to increase production will provide a bullish base for crude, said Amrita Sen, an analyst at consultancy Energy Aspects. "We will return to the $100 a barrel mark in the second half of this year," he forecast.

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