Russia-Ukraine crisis: Implications for global oil markets
After weeks of tensions, Russian President Vladimir Putin ordered Russian troops to invade Ukraine, prompting an international sanctions response targeting Russia’s economy but not directly its oil supplies or energy payments. But as sanctions on Russia intensified and as financial institutions started to refuse financing Russia-related transactions, including opening letters of credit or clearing payments and as some companies became reluctant to purchase Russian crude, Brent on March 2 (the time of writing) was trading above $110 for the first time since 2014.
Looking forward the market focus should not only be on whether the oil sector will be directly targeted by sanctions, but also the crescendo effect of self-sanctioning along the oil supply chain all the way from marketing to financing to shipping. Fears over energy sanctions and the ambiguity over the banking sanctions have already seen companies avoid purchasing Russian barrels, pushing prices to new multiyear highs and shaving-off shock mitigation policies such as the SPR releases. Also, it has become clear that traders holding Russian crude on their books are struggling to clear cargoes and this has been reflected in widening differentials and rising shipping and insurance costs.
The next stages for Russian crude supplies are highly uncertain but some possible impacts include:
– Massive shifts in trade flows and sharp adjustments in price differentials to reflect shifts in Russian crude exports. Particularly, there could be a greater re-redirection of flows from Europe to Asia, but there are limits to such re-direction and not all Urals previously destined to Europe will flow into Asia.
– Russian oil companies could offer sweeteners to buyers to make their barrels more attractive, for instance shifting cargoes from FOB to CFR basis. Also, in response to more extensive self-sanctioning, Urals and ESPO could be offered at discounts so large that cargoes would eventually clear, potentially as masked cargoes or via ship-to-ship transfers. But there are limits to this strategy given the large volumes of Russian exports and the intensification and widening of sanctions.
– Self-sanctioning escalates over the coming weeks leading to a reduction in Russian production and supply disruptions at a larger scale.
In the current environment of ever rising tensions, one should also not also exclude the possibility that in an escalation situation where Russia struggles to clear its barrels, weaponizing energy becomes the next chapter in Russia’s ongoing standoff with the West. As these are still early days, a scenario in which Russian oil supplies get disrupted in a sudden manner should also be considered. This will exert significant pressure on both market balances and prices in the near-term and for most of 2022. In the short term, potential responses to ease the price pressure are likely to come from the supply side. The current plan of OPEC+ to return withheld supplies back to market, Iran fully returning to the market and non-OPEC production growth particularly in North America accelerating, these combined supply responses can help fill any potential supply gap. The planned SPR releases will offer little support to a potential shortfall. But in such scenario the demand responses will also play their role and become more visible beyond the near-term. In terms of products, the market and refiners appear less flexible faced with constraints both in terms of costs and feedstock availability. Also, the impacts of the current shock will extend beyond the short-term and beyond balances and prices. The recent crisis will elevate energy security (including oil security) in policy makers’ agenda with long-term consequences for governments’ energy policies including their energy transition.