First, even hovering around US$110pb as it is at the time of writing, Brent is up around 40% year-to-date. By any standards, this is an oil shock.
Second, granted that no two oil shocks are the same, this one is
distinctly different in that it began long before the Ukraine crisis
thanks to a sharp uptick in demand as the economic impact of the
pandemic faded. With war in Ukraine, we now have a supply side shock
too.
Third, the supply side shock is despite the world pumping at least as
much oil today as it was before Russia invaded Ukraine — possibly more
after OPEC+ agreed on 2 March to increase output by a further 400,000bpd.
Fourth, sanctions on energy have been minimal to date: Canada, the UK and the US
alone have announced embargoes on imports of Russian crude and oil
products. The US ban is by far the most serious; even so, Russia
accounts for only around eight percent of the 8.5mbpd of crude and fuel
the US imported in 2021. Nevertheless, the loss of petroleum products
will hurt; and some refineries will need refits to move away from Urals crude which is high in sulphur — which undoubtedly underpins Washington’s now suspended soundings of Venezuela, whose crude is also ‘sour’, as an alternative supplier.
Even putting to one side Moscow’s retaliatory threat to cut gas exports, the EU’s resistance to an embargo on Russian oil is understandable. Oil accounts for over 70% of the bloc’s energy imports
and 30% of this (i.e. 3.5-4mbpd) comes from Russia. However (and
fifth), in Germany in particular there is mounting pressure for a
re-think from both politicians and academics. Thus, further escalation in Ukraine could yet see Europe fall into line with the US.
Sixth, ‘self-sanctioning’ by the private sector is already taking significant amounts of Russian crude off the market. As The Economist
puts it: “…supplies of Urals crude…are no longer moving — despite 25%
price discounts. Western firms, loth to find themselves stuck with
unsaleable cargo, are pre-empting possible sanctions. Many also fear a
public backlash….” This is being compounded by foreign banks refusing to
issue letters of credit for Russia trades.
Seventh, the amount of crude which Russia could quickly divert to
‘friendly’ Asian markets is very limited — less than 1mbpd according to
independent energy analysts Rystad Energy. Thus, we could easily see
2-3mbpd removed completely from global markets within days.
Eighth and finally, alternative sources even for this relatively modest volume are not straightforward.
Consider:
- Even if the Biden Administration enjoyed better relations with the shale producers, output could not be increased by more than 700,000bpd this year according to Pioneer’s CEO Scott Sheffield speaking to the FT on 4 March.
- After the annual dinner
between representatives of OPEC+ and US shale producers last week,
Mr.Sheffield urged Washington to mend fences with Riyadh. But within
OPEC+ only Saudi Arabia and the UAE have spare capacity; furthermore, as
the 10 March Newsletter makes clear, MbS may have his own reasons for refusing to budge from OPEC+’s current trajectory.
- Iran could quickly put more oil on markets from its 60-70m barrel stockpile. However (and unsurprisingly), Moscow is now blocking final agreement on the JCPOA and Tehran appears reluctant to break with its ally.
- The IEA is prepared to release “as much oil as is needed” from its 1.5bn barrel strategic reserves.
But the release of 60m barrels earlier this month left markets
underwhelmed, suggesting that the Agency would have to go really big to
have a worthwhile impact on prices.
These factors are understood and, therefore, priced in already to an
extent. However, other important factors do not appear to be. Notably,
the EU’s plan to reduce its imports of gas from Russia by two-thirds by
the end of the year is bound to add upward price pressure on oil too
even if Rystad Energy is correct that most of this can be replaced from
other sources.
This is where OPEC+ needs to be careful. As The Economist notes:
…the market will adjust to soaring prices the hard way, through
what economists call ‘demand destruction’ …a jump in crude prices to
$200 a barrel could induce ‘voluntary’ cuts of 2mbpd, with another 2mbpd
not consumed as incomes are squeezed.
Looking at oil in isolation, The Economist concludes that,
at the “current price, the world economy can, with luck, withstand the
shock” even though “high prices will outlast the war” across the board.
This includes food (and fertiliser), the subject of a third, and even more sobering, 12 March article,
“Grainstorm”, which notes that already big importers of Black Sea wheat
across the MENA region are scrabbling for more supplies. This at a time
when central bankers are already struggling with the biggest inflation
challenge in decades; and when the head of the IMF, foreshadowing a cut
in global growth forecasts, feels obliged to say that she still expects positive growth this year.
This third article concludes as follows: “The war in Ukraine is
already a tragedy. As it ravages the world’s breadbasket, a calamity
looms.”
Possibly Riyadh in particular thinks higher oil revenues can be used
to offset higher food costs. However, insofar as this would even amount
to a ‘policy’, the history of food price-related turmoil in the MENA
suggests that it is a very high risk one.