I am invited at the start of each new year to participate in a survey of energy analysts who are asked to forecast the price of benchmark Brent and WTI crude oil prices one year forward.
I have not seen the survey results, so I do not know how my forecast compares with the other participants. But this year it was easy to go bullish—including an expectation for triple-digit crude prices during 2022—because I feel like I have seen this movie before.
Today’s oil market is characterised by sharply rising demand, slower supply growth, low oil inventory levels and thin Opec spare production capacity. To that must be added a series of oil supply disruptions and growing market anticipation of more to come.
The analogue that comes to mind is 2008, when WTI peaked at $147/bl and averaged $98/bl that year.
Fortunately, the string of oil supply concerns seen already during 2022—ranging in geography from Ecuador to Libya and from the UAE to the Iraq-Turkey export pipeline—have been short-lived, with fast restoration of interrupted operations and volumes. But the darkening geopolitical crisis in eastern Europe threatens to overshadow all the other threats facing the world oil market, and it could force Opec’s hand to play its remaining spare capacity card.
The approaching storm highlights the tremendous geopolitical leverage afforded Russia by its role as Europe’s top energy supplier. While its leverage from gas is currently maximised and poised to diminish with the onset of warmer spring temperatures, Russia’s supply of 5-6mn bl/d of crude and refined products is a permanent feature of Europe’s energy landscape.
European countries receive c.4mn bl/d of crude originating in Russia. Data from energy intelligence firm Vortexa estimates c.2.16mn bl/d of Russian crude, mostly Urals grade, plus another 1.09mn bl/d of Kazakh CPC Blend, arrived in Europe on average in January via tanker vessels. Another 750,000bl/d of crude is estimated to reach Europe via the Druzhba pipeline network.
Europe is also heavily dependent on Russia for refined products, including an average 1.2mn bl/d of clean fuels, primarily diesel/gasoil, plus another c.400,000bl/d of heavy fuel oil.
The prospect of a geopolitical conflagration could thus jeopardise as much as 5mn bl/d in lieu of easily accessible substitutes, presenting a complex threat matrix to oil and gas markets worldwide. There are several scenarios that oil traders and policymakers should consider.
- International sanctions
Many of the aforementioned oil flows to Europe could be complicated or even compromised if Russia is excluded from the global interbank messaging system known as Swift. Other sanctions under consideration would limit transactions with Russia’s top banks, its government bonds, and its oil and gas production companies, as well as the controversial Nord Stream 2 gas pipeline.
There are already signs that some European refiners are taking steps to mitigate the risk of Urals crude disruptions; average export volumes from Primorsk, Ust-Luga and Novorossiysk have decreased by almost 30pc during the first nine days of February versus January.
- Russia’s withholding of oil supplies
Should Washington and European governments begin directly confronting a Russian military offensive, Moscow will likely utilise oil ‘as a weapon’ to pressure its adversaries to accept a new status quo—whether a weakened, paralysed or replaced Ukrainian government in Kyiv, and/or occupation of additional sovereign Ukrainian territories.
This would certainly not be the first time that oil has been used by a supplier as a weapon to force a political outcome. The analogue that first comes to mind, the Arab oil embargo of 1973-74, was arguably brandished with less at stake for Arab oil producers—merely retaliating against certain buyer countries’ support for Israel in the October 1973 Arab-Israeli war—than for Russia should the current crisis erupt into the largest military conflagration in Europe since the Second World War.
While sceptics point to Russia’s need to maintain its reputation as a reliable supplier, this prerogative could be outweighed by Russian president Vladimir Putin’s need to win the war. Moreover, it might be done with a modicum of plausible deniability, citing force majeure conditions in affected regions—or even the impact of Western sanctions themselves—instead of a deliberate cutoff.
- Military activities
Oil has come under fire in numerous global conflicts during the past hundred years, sometimes as unintended collateral damage and other times through deliberate targeting. And that is certainly a risk in this case if indeed tanks roll and missiles take flight.
Short of actual combat damage, oil flows could be interrupted by workers’ inability to access oil terminals, electric power outages or disruptions to overland or seaborne oil cargo movements.
- Buyer embargos of Russian oil deliveries
Many observers have dismissed this risk element, highlighting the pyrrhic consequences of European importers choosing to deprive themselves of energy supplies when they are most needed. But sanctions on Russian oil imports could significantly affect oil markets in other regions, for example refinery operators in the US Gulf Coast region that import Russian crude and fuel oil.
Vortexa data shows c.200,000bl/d of Russian-origin fuel oil arrived at US ports in January, accounting for 39pc of total US waterborne fuel oil imports. Among the large US refinery systems taking Russian fuel oil cargoes last month were those of US independent refiner Valero, ExxonMobil and Chevron.
And these statistics may undercount the full volume of Russian fuel oil imported by the US, since some Russian-origin fuel oil is blended at and then re-exported from ports such as Rotterdam.
Oil traders should keep in mind that the potential European conflagration is taking place in the context of an already tight market facing low oil inventory levels and low spare production capacity—the market’s two cushions against supply disruptions. Opec+ also has a solid track record of failing to fully deliver on its rising production targets.
To be sure, a disruption of Russian oil supplies to European buyers will be met with barrels from both sources: inventory draws from both commercial and government stockpiles, and activation of what is likely to be among the last barrels of Opec spare capacity that can be deployed in short order.
Ironically, these measures, intended to offset a significant supply disruption, will further diminish the market’s remaining cushions, and the upward price response is likely to be robust, especially so if the world’s last potential sources of additional supply—restored Iranian export volumes and rebounding US shale—are not quickly forthcoming.
Europe’s geopolitical crisis could easily propel oil prices back to triple-digit territory, if not all the way to 2008’s record $147/bl, then at least to the $100-130/bl range that prevailed during 2011-14. And if market balance is not restored by offsetting supplies, that job will ultimately be achieved by demand destruction.
Clay Seigle is a Houston-based energy strategist.