As the new year unfolds, the international oil and natural gas markets have experienced a grim start, marked by significant price declinesThe West Texas Intermediate (WTI) crude oil futures and Brent crude oil futures both suffered a steep loss over the past two trading days, plummeting nearly 10%. Brent crude has now dipped below the $80 mark, recording its deepest decline at the beginning of the year since January 1991. Concurrently, the European benchmark TTF Dutch natural gas futures have hit a near one-year low, reverting to levels observed prior to the onset of conflict in the region.

The driving forces behind these price shifts extend beyond global economic dynamics and geopolitical tensionsShort-term weather patterns have emerged as a key factor impacting energy supply and demand across various regions

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Recent forecasts indicate that Europe is set to experience one of the warmest January months in decadesThis alleviation of temperature-related stress provides a glimmer of hope in addressing the energy crisis that has plagued the continent for several months.

Transient Weather Factors in Play

Remarkably, on January 1st, the capital of Poland, Warsaw, recorded a maximum temperature of 18.9 degrees Celsius, surpassing the previous record for this date by 5 degreesMeanwhile, the small town of Dielmo in Northwestern Switzerland reached a staggering 20.2 degrees Celsius—marking the highest January temperature ever logged in this area, which lies north of the Alps.

According to meteorological firm Maxar Technologies, temperatures in France and Germany are projected to exceed normal levels by 2 to 5 degrees until mid-January, significantly reducing heating demands below the ten-year average

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Stefano Besseghini, President of Italy's Regulatory Authority for Energy, Networks and the Environment (Arera), noted that the effects of the mild weather on natural gas prices have thus far eclipsed those of the ongoing war.

The mild climate during the holiday season has also contributed to a surprising boost in natural gas reserves across EuropeTypically, demand for heating rises during the winter; however, with demand suppressed, European gas inventories have risen rather than fallenCurrently, Europe boasts a gas storage level of 84%, significantly higher than the five-year winter average of 70%.

Despite this, concerns remain in the marketAny unexpected extreme weather events could pose significant risks

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If Europe were to face a prolonged cold snap later this winter, the accumulated natural gas inventories could be depleted rapidly, leading to potential spikes in fuel prices once again.

Valdis Dombrovskis, the EU's Economy Commissioner, recently emphasized that while considerable measures were taken in 2022, these alone would not ensure an adequate energy supply in 2023. There remains a pressing need to secure additional natural gas supplies and develop the necessary infrastructure; otherwise, the next winter could become exceptionally challengingThe previous heavy reliance on Russian gas by Europe has led to a series of complications.

Economic Downturns Impact Demand

Beyond variable weather patterns, the global economic landscape and the actions of multiple central banks, including interest rate hikes, are also instrumental in shaping energy prices

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In the previous year, the U.SFederal Reserve raised interest rates seven times; despite a recent slowdown in their pace, the latest minutes from their meetings indicate that no members support a rate cut in 2023 and have cautioned against the risks associated with premature shifts in policy.

The tightening of monetary policy in 2023 is expected to reveal its delayed adverse effects on the global economyAnalysts consistently downgrade the forecasts for global economic growth, with the prevailing consensus indicating that the growth rate in 2023 will significantly lag behind that of 2022. The International Monetary Fund (IMF) anticipates a 2.7% growth rate for 2023, while the World Bank projects a decline from 2.9% in 2022 to 1.9% in 2023.

Continued concerns regarding an economic downturn may further dampen oil demand

In an interview, Huang Liunan, Senior Energy Researcher at Guotai Junan Futures, remarked that there has not yet been a noticeable recovery in transportation demand across the Asia-Pacific regionWith the ongoing fluctuations of the pandemic, the potential for significant improvement in terminal petroleum demand remains limited, particularly as the strong performance of diesel has weakened recentlyThe latest data from the American Petroleum Institute (API) shows a simultaneous and substantial accumulation of crude oil and gasoline inventories, indicative of a deteriorating supply-demand balance in North America

In fact, API's latest statistics indicate that, for the week ending December 30, crude oil inventories increased by 3.298 million barrels to 419.1 million barrels, while gasoline inventories rose by 117,300 barrels.

Looking ahead to 2023, Huang underscores that a slowdown in global oil demand appears inevitable, although opinions remain divided on the prospect of an economic recession

Amid an unprecedented level of inflationary pressures, the major downside risks facing markets in 2023 are strikingly similar to those of 2022, namely the risks of deflation caused by tightened liquidityOf course, whether this will lead to stagnant growth or deflation remains uncertainHowever, it is likely that as the inflationary narrative reaches its conclusion, the commodity markets will grapple with periods of price declines in the face of deflation risks, leading to an ongoing correction of expectations.

“If the Consumer Price Index (CPI) in the U.Sand Europe decreases rapidly and pushes markets to trade in anticipation of deflation risks, oil prices could face immense downward pressure during the first half of the yearBrent crude and WTI may potentially temporarily dip below $60 per barrel, while SC prices could see drop below 480 RMB per barrel

Should OPEC+ experience fractures internally prompting unexpected production increases, the downward pressure on oil prices could intensify,” cautioned Huang.

The complexities of the post-war dynamics have resulted in increasingly complicated relations between OPEC+ oil-producing nations and Western countriesThis increase in geopolitical tension markedly influences the adjustments in OPEC+ production policies, suggesting that 2023 may see continued political-driven adaptations of oil policies among OPEC+ countriesAdditionally, interactions between Middle Eastern oil producers and the U.Scould significantly shape these production policies.

According to Huang, if the declines in CPI for both the U.S

and Europe occur at a more tempered pace, the negative impacts on oil prices are likely to be moderatedMarket perceptions might pivot back towards supply and demand dynamics, allowing oil prices to stabilize at higher levels during the transition out of inflation yet prior to any deflation scenario.

“In such a scenario, while oil prices may experience temporary declines due to tight supplies and the backdrop of OPEC+ production cuts, the duration of low prices is unlikely to become extremeBrent and WTI may encounter phase dips below $70 per barrel, while SC could briefly drop below 500 RMB per barrelHowever, even in the event of rapid declines, a resurgence in demand across the Asia-Pacific region alongside insufficient output and seasonal advantages could allow Brent and WTI to rebound to above $85 per barrel in the latter half of the year, potentially pushing SC prices back above 570 RMB per barrel,” Huang concludes.