Crude Oil Retreats as Trump Waives Russian Sanctions, but Middle East Tensions Keep Risk Premium High

What happened

Crude oil prices started the week with a drop after President Trump announced the waiver of several sanctions and tariffs on Russia. The measure aims to ease fuel shortages and contain prices without making concessions to Iran. However, the prospect of price relief was mitigated by a drone attack in Ukraine, targeting energy infrastructure near St. Petersburg, including an oil export terminal, undermining expectations for a proposed energy ceasefire.

Simultaneously, the US-Iran conflict remains the main bullish driver for oil, with negotiations for the reopening of the Strait of Hormuz stalled. Attacks on commercial shipping continue, and Gulf crude exports fell sharply last week, according to Kpler data cited by Reuters. Additionally, the conflict between Saudi Arabia and the Houthis continues with attacks on key infrastructure and oil supply disruptions.

Why it matters

Trump's decision to waive Russian sanctions, while specific, represents an attempt to inject more supply into the global oil market and ease inflationary pressure on fuel prices. This could, in theory, have a deflationary effect. However, the effectiveness of this measure is questioned given the escalation of geopolitical tensions. The attacks in Ukraine and the persistence of conflicts in the Middle East, especially the situation in the Strait of Hormuz and attacks in Saudi Arabia, create a scenario of uncertainty about future oil supply. These events maintain a significant risk premium in prices, outweighing the impact of the Russian sanctions waiver and indicating that, without de-escalation in the region, oil prices are likely to remain supported.

Market impact

• Interest Rates and Bonds: The initial, albeit limited, drop in oil prices could marginally ease inflationary expectations, which, in a longer-term scenario, would tend to reduce pressure on government bond yields, such as Treasuries. However, the persistence of a high risk premium in oil may limit this effect, keeping inflation expectations and, consequently, yields at higher levels.
• Dollar and Exchange Rates: Higher oil prices, driven by geopolitical tensions, tend to strengthen the US dollar, which is seen as a safe-haven asset during times of global uncertainty. Emerging market currencies, such as the Brazilian real, may depreciate against the dollar, especially if Brazil is perceived as more vulnerable to supply shocks or an increase in energy import costs.
• Equities: The energy sector, particularly oil and gas companies, tends to benefit from higher oil prices, which can boost their stocks. Conversely, companies in other sectors that rely on lower energy costs may see their margins compressed, negatively impacting global and local stock indices, such as the Ibovespa, due to increased production and transportation costs.
• Commodities: Crude oil is the most directly affected commodity, with an upward trend sustained by geopolitical factors despite occasional drops. Other energy commodities may follow this trend. Agricultural commodities and industrial metals may experience mixed impacts, depending on the sensitivity of their production and transportation costs to energy prices.
• Brazil: Brazil, as an oil producer and exporter, may see a benefit in its trade balance and revenues for companies like Petrobras with elevated prices. However, rising domestic fuel costs could pressure inflation and require a more cautious stance from the Central Bank (Copom) regarding the Selic rate. The appreciation of the dollar can also impact external debt and import costs.

What to watch

The primary focus will remain on developments in the Middle East, including any progress or setbacks in US-Iran negotiations, the evolution of attacks on commercial shipping and oil infrastructure, and the situation between Saudi Arabia and the Houthis. Additionally, on Thursday, the latest US Jobless Claims figures will be released, and on Friday, the Flash US PMIs, which may offer insights into the health of the American economy and its impact on global oil demand.

Scenarios

Base Case: Middle East tensions persist, maintaining a high risk premium on oil. Trump's waiver of Russian sanctions has a limited and temporary impact, and oil prices remain supported above current levels. Risk Scenario: A significant escalation of conflicts in the Middle East, especially in the Strait of Hormuz, could lead to a substantial supply disruption, pushing oil prices much higher. Conversely, an unexpected and rapid de-escalation in the region, coupled with an effective increase in Russian supply, could lead to a sharper drop in prices.

Original source: ForexLive (InvestingLive). For information only, not investment advice.