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Figure 2: The front-month price of WTI crude in USD per barrel.
The analysis of these graphs is both interesting and useful. We start with the run-up to January 10 and look at the reasons for the price of crude oil. There are three reasons. First, and certainly most importantly, the thoroughness (or harshness, as some put it) of this batch of sanctions was substantial. They named specific people, specific companies and specific ships. This was going to make it much harder for Russia and its two main partners in sanction-evasion (China and India) to operate. Second, the price of crude oil was increasing quite strongly from the beginning of January to January 10. That doesn’t mean that there weren’t still bearish sentiments around. Even the icon Bloomberg published an apology for bearish articles. But there is no question that the upward momentum of prices boosted the strength of the spike. The third reason is less obvious, buried in technical analysis. The oil price had been consolidating (moving in a narrow sideways channel) since the middle of October 2024. This is an unusually long time. And technical analysis says that the longer the consolidation, the more aggressive the price movement is once it breaks out. Consolidation is like winding up a spring and is stored up energy for when the breakout happens. And that breakout occurred early January, providing more energy to the January 10 spike.
Now, let’s look at the price action after the spike. The price continued its rapid rise as the magnitude of the sanctions became clearer. Then there was a sharp correction, which looks like a major entity, such as a hedge fund, decided to take profits, but when that large order was filled, the price shot up again. The reactions of China and India, two countries mentioned earlier that have paid little attention to US sanctions, had a large effect. Although neither country is named explicitly, they both seemed to be taking the sanctions seriously, and that kept the crude oil prices going up. Different loopholes that Russia had been using were tightened or closed altogether.
What is the expected effect on specific prices on crude oil? The obvious immediate effect is that the price of crude oil will increase, as we have seen, due to the decrease in the total supply of crude oil. But then extended effects kick in. OPEC+ wants to control the price of oil, so they are likely to allow increases in production to bring the price back down, but also to take advantage of the current higher prices. Most non-OPEC countries will continue pumping oil again to take advantage of the higher prices. All of this extra production will provide plenty of crude oil for the newly oil-deprived countries of China and India, but not at the discounted prices they were able to get from Russia. This will be a hit that China’s economy will find painful. And, of course, it will eliminate a major source of income for Russia, which is the purpose of the sanctions.
How then should these conditions be traded? The price of crude oil will peak sometime soon (if it hasn’t already), so trying to pick the top is not recommended. More useful will be the gradual decline in oil prices that will follow. The remedy for high prices is high prices, so there will be an incentive to pump more oil. Drilling new wells is not likely to change the price of crude oil very rapidly due to the lead time (roughly four months at a minimum) to get a new well to production status. On the other hand, high enough prices will cause crude oil in storage to emerge. Remember that there is a natural restorative force that pushes prices back toward previous values, in the long run.
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