Prices Spike as Supply Shortfall Deepens

Brent crude futures soared to almost $130 per barrel on Tuesday as the US and the UK announced bans on imports of Russian oil.

The move sent a powerful signal that Western nations are willing to accept economic pain by cutting off supplies from the world’s biggest oil exporter.

Current prices incorporate a large geopolitical risk premium, but they also reflect a very real disruption of supplies at a time of tight supply-demand fundamentals.

Not Enough Oil

Russia's exports have already fallen sharply since Moscow invaded Ukraine as buyers shun its oil for fear of falling foul of a rapidly expanding list of sanctions.

Global oil flows are likely to be further disrupted, now that the US and UK are imposing formal bans on imports, with the possibility that others could follow their example.

Oil markets had already been in deficit early this year, with demand exceeding supply, according to Energy Intelligence balances. This drained inventories at a time when they should have been rising.

Immediately before the war began on Feb. 24, supply and demand had moved into almost perfect alignment, at 99.6 million barrels per day each.

Balances had been on track to enter a period of surplus for a few months, before returning to deficits again from June.

However, the Ukraine crisis transformed these balances into a large shortfall at a stroke.

Earlier indirect sanctions against Russia and an abundance of caution among buyers have already led to a plunge of 3 million b/d in Russian exports so far.

This outage could rise by a further 2 million b/d by the end of this week, shipping data and trader conversations indicate, taking the total disruption to 5 million b/d.

Opec spare capacity — the normal supply cushion in a crisis — stands at 2.5 million b/d, according to Energy Intelligence estimates.

An increase in supply by key members Saudi Arabia and the United Arab Emirates would help ease the pressure. But the group could not fill the gap on its own — unless, of course, their non-Opec ally Russia is able to restore normal flows.

Other options for bridging the shortfall are few.

OECD commercial crude stocks of 1.33 billion barrels could cover a 5 million b/d supply gap for 266 days.

But that would not create long-term supply balance, and those stocks would have to be replenished swiftly to avoid even more dramatic price spikes.

Partial relief could come from an estimated injection of 1.2 million-1.3 million b/d of Iranian oil, if a nuclear deal is reached in Vienna and those volumes return to the market swiftly.

The other main source of flexible supply, short-cycle US shale production, would take longer to ramp up.

The global shortfall also depends on the extent to which the slump in Russian exports deepens, and how long it lasts.

But right now, the market looks desperately short of supply.

Big Risk Premium

Brent crude futures closed on Tuesday at $127.98/bbl, a gain of $4.77. US benchmark West Texas Intermediate ended $4.30 higher at $123.70.

Analysts estimate that the Russian supply impact is now adding about $15-$20/bbl to a pre-existing risk premium of around $10-$15/bbl.

“The longer the disruption, the more likely a breakthrough to $150/bbl,” said Abhi Rajendran, head of oil market research at Energy Intelligence.

This week's projected reduction in Russian exports would reduce its crude supplies to about a third of their prewar level of 4.7 million b/d.

This would essentially leave only 1.6 million b/d of pipeline crude exports flowing — roughly half of which goes to Europe and half to China.

In all, Russia typically exports a total 7.5 million b/d of crude and products.

By beefing up its sanctions against Russian oil, the US hopes to deal a severe blow to Russia, even if it comes at the cost of higher gasoline costs for US consumers.

“In the light of the tragedy we're seeing on television in Ukraine … maybe we should start inconveniencing ourselves,” Mike Muller, head of Vitol Trading, said over the weekend.

Europe Vulnerable

The US embargo will affect a fairly modest amount of Russian oil: crude imports of about 200,000 b/d in 2021 and around 300,000 b/d of unfinished oils.

Those should be relatively easy to replace.

In contrast, several European countries have large exposure to Russian energy imports and finding alternative sources of supply will be more difficult.

Recognizing that, the UK is looking to phase out imports from Russia by the end of this year. The US ban will take effect immediately.

The EU's executive body announced a plan on Tuesday to slash the bloc’s imports of Russian natural gas by two-thirds by the end of this year.

But so far at least, it has not developed a plan to ban or limit imports of crude oil and refined products.

Financial sanctions announced by the US and its allies will also impede other countries’ imports of oil and other goods by making it more difficult to pay for them.

“The US sanctions will scare companies in Europe and around the world into not buying Russian oil,” Omar Najia, global head of derivatives at BB Energy told Energy Intelligence.