Russia's central bank dealt a severe blow to the oil market as it released its most pessimistic forecast for oil prices for 2016. Russia, being a major exporter of oil, is heavily dependent on higher prices to sustain its economy. Expectedly, the Russian economy is in shambles.
In a latest report, Bank of Russia lowered the forecast for oil price to $25 a barrel in worst-case scenario, and to $35 a barrel in base-case scenario. This is in line with my bearish call on oil trading close to $25 in 2016. For 2017-2018, the risk-case scenario puts the oil price at $35 a barrel while the base-case scenario has been kept at $45 a barrel.
Bank's first deputy governor, Dmitry Tulin said,
"The degree of uncertainty is high. We're aware that such volatility and unpredictability in world oil price dynamics creates uncertainty for us on how probable it would be to achieve our inflation targets within a specific time frame."
In its recent publication, Bank of Russia expected inflation to tone down to 8.3-8.7% in February year-on-year. Inflation dropped from 12.9% in December 2015 to 9.8% in January. The central bank has been struggling to bring down the inflation to 4% as it battles dual blows from falling oil and depreciating ruble. The Russian government has been surviving the massive crash in oil by dipping into its forex reserves but that cannot be a long-term solution.
Another factor working against Russia is the non-cooperation between OPEC and non-OPEC members regarding a production cut to stem the falling prices. Recently, International Energy Association dismissed talks of a coordinated production cut as mere speculation.
Each of the producing nations are refusing to pump less oil in order to protect their market share. Iraq pumped record oil in January and Saudi Arabia is making no attempts to stabilize the volatile markets. Sanctions on Iran have been lifted which is adding to chaos. A decelerating Chinese economy, which has been the global growth driver for more than a decade, is posing structural problems world over. Investors have been shunning Chinese equities, pushing Hang Seng to a fresh three-year low of 18545.80 points.
Several nations such as Japan and US are aiming to achieve higher inflation levels but lower oil prices are leading to cheaper imports. The nations fear entering into a vicious deflationary spiral and higher energy prices will help their cause. The US Fed Chair Janet Yellen, in her recent testimony, flinched from giving any clear indications regarding future interest rate hikes, significantly reducing the probability for further tightening in 2016. A higher dollar will put further downward pressure on crude oil and derail the economic recovery of the United States.
A downward revision of this magnitude from a central bank may lead to more downward revisions from other central banks as well. While it is hard to estimate, consensus will be closer to $35 per barrel for 2016. So yes, the world should be prepared for cheaper oil for a longer term. And that is good news, but only for the importing nations!
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