The Big Picture

Opec Waits Out Volatility

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  • The war in Ukraine is intensifying the consumer drive for energy security as Western consumers work to wean themselves off dependency on Russian energy imports.
  • As the push to tap more non-Russian oil supplies puts Opec-plus cohesiveness under a spotlight, the accelerating energy transition means Russia and Opec are likely to strengthen their alliance.
  • For now, China appears to be emerging as the true winner in this conflict, underscored by reported strategic discussions to price Saudi crude imports in yuan.

Pressures for immediate Opec-plus action to boost supplies should subside in line with the $30 per barrel price fall of the last week. And given the looming prospect of an Iran nuclear deal, Opec's big Mideast Gulf producers are likely to politely brush off calls to boost production from consumers like UK Prime Minister Boris Johnson, who was in Abu Dhabi and Riyadh this week. Huge volumes of Iranian crude and condensate in storage mean the market impact of a nuclear agreement would likely be both significant and rapid.

Meanwhile, initial falls in Russian oil exports of some 2.5 million barrels per day as a result of sanctions uncertainties have not been sustained, and flows have since stabilized. Russian crude exports so far in March appear up versus last month, according to data intelligence firm Kpler. But, warned the International Energy Agency (IEA) this week, sanctions on Russia should begin to bite soon. From April, it said, up to 3 million b/d of Russian supply will start to go off line. Equally, lower economic growth as a result of the conflict will knock off almost 1 million b/d of demand this year, the OECD energy watchdog projects.

It is impossible to discern the extent to which OECD partisanship may be playing into the IEA's analysis of an April drop-off. Russian products exports are likely to take the biggest hit, relative to crude, as refinery operations increasingly face shortages of critical chemicals and spare parts. But crude production could mostly soldier on, unless fresh sanctions are imposed. Initial signs are that Opec will opt to keep its powder dry until some real market clarity emerges, and breaking ranks with Russia becomes unavoidable.

Renminbi Revolution

Reported discussions on Saudi Arabia starting to price crude exports to China in yuan remain murky. But if realized, it represents the first major chink in the armor of the petrodollar system since 1974 when Riyadh agreed to price all its crude sales in dollars. China was already slowly moving in this direction, launching the Shanghai crude futures contract in yuan in 2018 and taking steps to internationalize and digitalize the yuan. But clearly the Ukraine war sanctions have rammed home to Beijing its vulnerabilities under the current payment system.

More tangibly, last week saw state Saudi Aramco finally make a breakthrough on its strategic drive to enlarge its downstream position in China, after having pursued several joint-venture refineries there over the past decade. The state-owned behemoth took a final investment decision on its 35% stake in the 300,000 b/d Hapco integrated refinery-petrochemical project in northeastern Liaoning province, scheduled to start up in 2024. Aramco also last week signed a preliminary agreement with Sinopec to study expansion at their existing 280,000 b/d Fujian joint-venture refinery.

It is hard to rule out that it is Ukraine that has enabled the stars to align on Hapco — with Beijing seeking to boost security of supply in light of the threat to Russian imports, and Riyadh looking to lock in demand.

World Energy War I

Energy is playing the pivotal role in the conflict. Russian President Vladimir Putin’s assumptions of a relatively muted response to the invasion as a result of Western dependence on Russian energy likely helped shape his decision to invade. Now, the West is prioritizing bringing on alternative supplies in a bid to undermine Moscow’s revenue streams and enable greater energy independence. That's seeing a succession of power-brokers beating a path to the Gulf, where producers have found their geopolitical clout boosted by the current energy crisis.

A day before the UK prime minister's visit, White House Mideast Adviser Brett McGurk was reportedly in the Saudi capital. But Washington’s efforts to try and charm a loosening of Riyadh’s grip on the supply faucet keep hitting a brick wall. Saudi Crown Prince Mohammed bin Salman this month also reportedly refused to take calls from US President Joe Biden given Biden's criticism of the kingdom over its role in the Jamal Khashoggi murder and practice of engaging only with King Salman.

Japan’s prime minister, too, had talks this week with Abu Dhabi Crown Prince Sheikh Mohammed bin Zayed al-Nayhan. And Chinese President Xi Jinping is due to visit Saudi Arabia in the next month or so.

A Tough Call

The pressures to take action have been relentless. Perhaps more persuasive than pleas from what Opec increasingly views as unreliable Western partners will be the state of the global economy, where evidence is mounting that recession, and with it major demand destruction, is a very real risk.

But right now there are sound reasons why producers are not heeding the calls. First, market volatility — and the current downward trajectory of prices — means any increase in supply risks triggering a full-on bull stampede. Then there is the all-important strategic relationship with Russia. Opec-plus market management co-led by Moscow seen as central to Riyadh’s energy transition survival strategy, while notably, the United Arab Emirate's foreign minister was in Moscow this week to discuss global energy security.

Third is the Iran factor: It makes sense to wait to see if an Iran deal is agreed and what its impact is, along with Russia's supply trajectory, before making any major supply move. Last is the awareness that any decision to increase output will trigger potentially acrimonious and damaging negotiations over how to revamp Opec-plus quota targets.

In a sense, 2022 was always going to be a difficult year, with quota renegotiations and mounting energy transition pressures. A Gulf pivot to China has been under way for a while. What the Ukraine war has done is to accelerate processes and amplify the impacts of policy missteps. But Opec is not alone in feeling the stress. The war is likely to have few winners, and Putin’s high-stakes gamble has created a treacherous policy terrain for all parties. What's clear is that the consequences of this conflict will be far-reaching, reshaping global security architecture, energy flows and investment.

Military Conflict, Security Risk , Sanctions, Opec/Opec-Plus, Macroeconomics
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