End-of-year turbulence overshadows COP28 success

Red Sea tensions add to shipping costs but energy flows unaffected
End-of-year turbulence overshadows COP28 success
The U.N. hailed the COP28 UAE Consensus agreement as the “beginning of the end” of the fossil fuel era

In 2023, the Middle East once again took center stage in the global energy landscape for various reasons, both positive and negative. On the positive side, the COP28 climate summit in Dubai concluded with unanimous agreement from nearly 200 countries to begin transitioning away from fossil fuels. While not quite a pledge to phase out oil, gas and coal, the outcome represented a compromise that accommodated the diverse opinions and interests of the participating nations.

It took an all-night session of bargaining and drafting to come up with wording that was acceptable to holdouts like Saudi Arabia, Russia and Iraq, three of the world’s biggest oil producers.

Voluntary oil cuts

On the eve of COP28 on November 30, the OPEC+ alliance of 23 oil producers led by Saudi Arabia and Russia met virtually to discuss market developments. While that alliance reached no formal decision, Riyadh and several other producers agreed to implement voluntary cuts. The cuts totaled 2.2 million barrels per day starting from January to shore up prices. Hence, oil prices have slumped by $25 per barrel since September.

However, the announced cuts failed to prop up prices as soaring U.S. oil production, which has hit a new record, and softer demand weighed on the market. Oil prices began to edge up in early December amid speculation that the U.S. Federal Reserve would cut interest rates in 2024. They increased further due to threats to Red Sea shipping after Houthi rebels in Yemen targeted more than a dozen ships in the Red Sea.

Benchmark Brent crude oil traded above $80 per barrel in the final week of the year. That is due to fears that the escalation could draw in Iran.

While there is currently enough oil supply to meet global demand, the fallout from the ongoing Gaza conflict, coupled with the Houthis opening a new front, is having a pronounced impact on the global economy.

Trade flows

Several shipping companies, along with energy major BP, have rerouted their ships to circumvent the Bab al-Mandeb strait. This has resulted in increased insurance and security costs for shippers due to higher war premiums.

The knock-on effect on trade flows and global inflation is more difficult to predict. However, higher shipping costs will ultimately affect consumers. This could potentially hinder European governments’ efforts to address persistent inflation.

As more vessels traveling between Europe and Asia opt for the longer route around the Cape, the need for additional ships to maintain current trade volumes may lead to short-term disruptions in the supply chain and higher demand for bunker fuel.

This comes as traffic through the Suez Canal has been hitting record levels in the wake of the Ukraine conflict. For Egypt, revenues from Suez Canal transit fees are a key source of foreign currency. They contributed $8.8 billion to the economy in 2022-2023. Any loss of income would pose a significant challenge for the struggling Egyptian economy.

Oil barrels

Oil trade

The Red Sea is also a key route for oil trade. With Russian oil displaced from Europe, there has been an increase in flows to the Asian market. Approximately 2 million barrels per day of Russian oil destined for India transited the Suez Canal. Europe, meanwhile, has increased its imports of oil and gas from the Middle East through the Suez Canal to replace Russian supplies.

Kpler, a data intelligence firm, predicts that around 6 million bpd of oil will traverse the Bab al-Mandeb strait in 2023. This includes more than 1.5 million bpd of crude shipments from Iraq and Saudi Arabia to Europe and the Americas. Additionally, over 2 million bpd of Russian crude from Baltic and Black Sea ports is expected to head to India and China.

In an effort to safeguard this crucial trade route, the U.S. has announced the launch of Operation Prosperity Guardian, an international coalition based in Bahrain. Houthi leaders have dismissed the U.S. announcement, saying they intend to continue with their attacks.

The Middle East

The situation is more critical as much of the world’s spare oil production capacity is concentrated in the Middle East. It is held mainly by Saudi Arabia, the UAE and partially in Iraq. Because of a series of agreed OPEC+ cuts in 2023 totalling around 5 million bpd, there is more spare production capacity. This typically exerts bearish pressure on prices under normal circumstances.

According to the International Energy Agency’s December Oil Market Report, the output by the 19 OPEC+ producers bound by quotas was 690,000 bpd below the implied target of 36.92 million bpd. That left the group’s spare capacity at 5.3 million bpd, excluding Iran and Russia, with Saudi Arabia accounting for around 60 percent of the cushion.

Read: Saxo Bank: Understanding crude oil dynamics as 2024 gets underway

Geopolitical tensions

As the year drew to a close, tensions escalated between the U.S. and Iran. The White House accused Iran of being “deeply involved” in the attacks on commercial shipping in the Red Sea. The stakes were raised after Tehran vowed to retaliate for the killing of a senior commander of the Islamic Revolutionary Guard Corps in a U.S. air strike on December 25.

Amid all this uncertainty, it is difficult to assess the full impact of these developments on the global economy and energy prices as the new year begins.

These events unfold against the backdrop of an energy transition that will likely accelerate in the wake of the Dubai climate summit. The U.N. hailed the COP28 UAE Consensus agreement as the “beginning of the end” of the fossil fuel era. Hence, it is paving the way for a swift, just and equitable transition underpinned by deep emissions cuts and increased finance.

For an uninterrupted transition, trillions of dollars in green investment, unrestricted goods flow and a stable global economy are essential. The war in Gaza has unleashed a geopolitical storm, reintroducing a risk premium with the possibility of higher oil and gas prices. If oil and gas price volatility persists into the new year, it could negatively impact a fragile global economy, with the specter of recession still looming over the U.S. and the Eurozone.

About Kate Dourian

Kate Dourian is a non-resident fellow at the Arab Gulf States Institute in Washington. She is also a fellow at the Energy Institute. Previously, she was the regional manager for the Middle East and Gulf states at the World Energy Council. Dourian joined the IEA from the Middle East Economic Survey where she was a senior editor. She was also responsible for compiling the monthly OPEC survey for MEES. From 2000-13, Dourian was the editor-in-chief for the Middle East for oil price reporting agency Platts.

Dourian has been a speaker and moderator at international conferences and has made many radio and television appearances, discussing energy and geopolitics on several platforms in English, Arabic, and French.

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