Oil Markets Could Struggle With Fresh Disruption

Oil markets may have taken sanctions and other disruptions from the Ukraine crisis largely in their stride, but market analysts are starting to raise red flags about their ability to cope with any further disruption to supply this year.

“We are at the lowest levels [of spare crude capacity] for a long time,” Saad Rahim, chief economist at trading giant Trafigura, said at the CERAWeek by S&P Global conference in Houston this week. “And when was the last time we had a year without some form of geopolitical disruption in the oil market? I can’t think of one.”

Rahim said the world is “probably not” ready to cope with such an event.

Helen Currie, chief economist at US oil company ConocoPhillips, similarly spoke of “levels that are relatively low in terms of flexibility and cushion,” adding that this “should get a lot of people’s attention.”

"The global supply system arguably has limited capability to respond" to a major disruption this year and potentially next year "in a sizable way," she said. "It’s an issue policymakers should be aware of."

Oil markets have been roiled over the past year as Russian oil flows were rerouted to Asia, and alternative supplies made their way to Europe — initially as a result of voluntary actions by European buyers but then consolidated by EU embargoes on Russian crude in December and products in February. Europe and others imposed parallel sanctions on shipping services for Russian oil.

A G7 price cap provided a mechanism for Russian oil to keep flowing to other markets — and the impact on Russian volumes and global markets has been fairly limited so far.

But analysts and others say the combination of market restrictions, growing global demand and lower strategic reserves raises questions about the ability to cope with any further supply disturbances — especially with supply-demand balances expected to tighten in the second half of the year.

Stretched by Demand

Torbjorn Tornqvist, CEO of oil trader Gunvor, said that Russian crude “is finding its home,” with the price cap working by keeping oil “flowing but at a lower price.”

However, he noted that strong demand growth this year — generally forecast in the 1.5 million-2 million barrels per day range — could stretch markets as 2023 progresses. He predicted that “the spare capacity question” will return around midyear or in the second half, with the potential to drive crude prices higher.

Frederic Lasserre, Gunvor’s global head of research and analysis, estimated spare capacity at 2 million-2.5 million b/d “max, max, max” — noting that some countries, particularly Saudi Arabia, are reluctant to open their taps fully.

“Today we are living with a very tight spare capacity,” he said. “That’s why it was so key to have the price cap, which was making sure that the Russian crude could flow — because we have no spare capacity to replace [those] volumes.”

Energy Intelligence estimates Opec-plus spare capacity, excluding Russia, at 2.9 million b/d. Levels tightened to around 2 million b/d in early 2022, but expanded again with Opec-plus’ decision to cut a headline 2 million b/d from November.

Chevron CEO Mike Wirth also expressed concern about the “new rigidities” in oil markets that are limiting the amount of swing capacity and stretching the logistics system.

“There's now a lot of constraints. You can't sell to this country. You can't buy from that country. You can't insure that ship. You have to sell at this price," he said, which creates the potential for an event like Abqaiq to have a different response. The 2019 drone and missile attack temporarily took out more than half of Saudi Arabia’s output, but was largely shrugged off by markets.

Trafigura’s Rahim noted that after Abqaiq, the world was able to draw on strategic inventories — but these have been depleted by US drawdowns in the past year.

Ben Luckock, co-head of oil trading at Trafigura, also cited major inefficiencies in the system as a result of the price cap and EU embargo, saying this is taking a toll on the market and will likely create problems longer-term.

TotalEnergies CEO Patrick Pouyanne used even stronger language, calling the price cap “very dangerous” since it creates an “official” oil market and a “gray” or even “black” oil market, injecting “dislocations” in what should be a singular global market.

Pouyanne also questioned its efficacy: “I don't understand why we need to do it, because honestly, the Indians and the Chinese are smart enough to negotiate better sets of good discounts [for Russian crude] without any cap.” He expressed concerns that the cap will be “complex to remove” now that it’s in place.

Opec Less Worried

Opec Secretary-General Haissam al-Ghais seemed more sanguine, however.

Asked about Opec’s position on the redirection of Russian oil to Asia — a major growth market for Mideast producers — he said: “It’s not something that really concerns us. The markets have always … seen redirection of flows, whether it’s related to geopolitical events or demand centers being created and others disappearing. This is typical.”

Al-Ghais noted that Russian oil production “has been resilient and [has] managed to find new homes.”

On demand, he said Opec is “cautiously optimistic” about China’s reopening and the “phenomenal growth in Asia,” and is more concerned about “the slowdown we see in Europe and the US in terms of the financial situation, inflation.”