SCENARIOS: Possible impacts of Russia invasion on oil markets
Quantum Commodity Intelligence – Oil prices hit fresh eight-year highs during trade on Thursday, after Russia launched a full-scale invasion into Ukraine to send Brent crude prices above $105/b for the first time since 2014.
Traders are closely watching for political signs of what, if any, market-impacting sanctions will be brought to bear by the EU, UK and US to deter further incursions.
The below is a set of scenarios that could play out over the next few days.
IEA coordinates release of crude
The US, Japan, the IEA and the UK were reported to be in talks to discuss releasing more crude from reserves into the global market. Those countries, plus India, agreed back in November to release additional supply when crude was approaching $90/b. Any release would only provide a stop-gap measure until a more broader increase in supply be found to quell prices.
OPEC+
Pressure is expected to increase on the OPEC+ group to ramp up production of crude to quell sustained high prices, with collective output already falling some 900,000 bpd under target, according to the latest IEA figures.
In practice, only Saudi Arabia and the UAE have the available capacity to increase exports at short notice, but energy ministers from both countries said earlier this week that OPEC+ should stick with the current policy of increasing output at the rate of 400,000 bpd/month.
The US is likely to hold more sway over Saudi Arabia than its OPEC+ partner, Russia, but even if Saudi Arabia and the UAE are pressured into higher production levels the new quotas will have to be ratified by the wider OPEC+ group.
Iran
Another option for the US to get additional barrels onto the market is renewing the 2015 nuclear agreement with Iran, which could unleash an additional 1.3 million bpd of crude and condensate within a matter of months.
Reports from talks in Vienna this week have been more optimistic on getting a deal over the line, but the Democrats will be wary of handing a political victory to the Republicans ahead of the midterm elections, particularly if any deal looks hurried or leaves the US looking weak.
Shale boost
Triple digit Brent will unleash a flood of US shale oil by the end of the year, according to analysts at Rystad which predict an extra 2.2 million bpd (around 2.4% of global production) of extra US tight oil could be produced if Brent stays above $100/b. Total production from US core producing regions – the Permian, Eagle Ford, Niobrara, Bakken and Anadarko – would hit 9.9 million bpd by the end of the year from 7.7 million bpd over the last three months of 2021.
But analysts at the Dallas Federal Reserve warn the gains will be capped in 2022 even with elevated crude prices. "Difficulties attracting capital, a challenging labour market, strains on international supply chains for equipment makers, and time lags between price movements, drilling and marketing all argue against a surge in domestic production in 2022," they noted.
Credit crunch
The global oil market is greased by trade finance offered by banks, who offer letters of credit to buyers of oil to fund the purchase of cargoes that can cost tens of millions of dollars. Ambiguity over possible sanctions and who would be the subject of them has already resulted in banks being slow and refusing to offer guarantees to buyers of Russia's oil on Thursday, according to market sources, and there are fears that even the threat of future sanctions could hit existing supply.
The powerful impact of insurance has also been seen in the energy markets. Insurance companies were loath to touch Iranian companies and commodities after the signing of the 2015 nuclear deal despite being legally allowed to do so, largely over fears that they may be tarnished should the deal fall apart. Any refusal to insure goods could also drive up the cost of energy from Russia.
Plastics, gasoline prices to soar
Russia is a big exporter of naphtha and the price of the main petrochemical and gasoline feedstock relative to crude – the crack - soared to fresh pandemic highs on Thursday morning, particularly in Asia, where the main global benchmark for naphtha lies. Asia is structurally short naphtha, and fears that there will be even less supply from Europe to the region helped propel prices higher. The difference between Asia and European prices for March, April and May have now reached parity when Asia normally trades at a premium. The Baltic Sea port of Ust-Luga is the single largest source of naphtha to northwest Europe, accounting for around one third, or 500,000 mt/month, last year, according to analysts.
Naphtha prices were aided by higher LPG prices, as the latter rose sharply on the back of a 30% rise in natural gas prices as LPG can be used as an alternative to natural gas for heating. Physical cargoes of naphtha unloading into Japan were marked at $918/mt CIF Japan by Quantum on Thursday at 1630 Singapore time. That means the crack versus Brent hit $185/mt, a pandemic high.
Asian diesel and gasoil supply to Europe to rise
Europe is structurally short gasoil and imports the road transport and heating fuel from Russia, Saudi Arabia and India. Russia accounts for roughly half of the imports of diesel and gasoil to Europe, which can vary between 4 and 6 million mt a month. The main diesel exports hub is the Baltic port of Primorsk, which is scheduled to export around 1.6 million mt of ultra low sulfur diesel in February.
Any disruption to Russian supply due to sanctions or supply chain issues will likely result in soaring low-sulfur gas oil futures, which could pull additional gasoil supply from Saudi Arabia and India at a time when Chinese exports of oil products is capped by export quotas meant to help the country cut emissions. The US Gulf, where exports have faded over the last few years, may also step-up production and shipments of diesel.
Rising need for diesel would come as global stocks are at a 17-year low, according to analysts FGE. Indian exports of diesel have been in an upward trend for most of the past year as limited demand has allowed for an increase in supply, while the US has seen overall product exports fall. Both countries are facing record prices at pumps and lawmakers fear inflation at multi-year highs will destroy economic growth.
European cracks, however, only marginally outpaced those in Asia as of 1630 Singapore time, and the exchange for futures – Asian 10ppm swaps minus low sulfur gasoil futures – has widened by $3/mt to -$25/mt, opening the arb from Asia to Europe.
Bunker fuel hub of ARA to be hit
Russia is the largest supplier of residual fuel oil to Europe. Baltic Sea exports reached 9 million mt, or accounted for around 40%, of all fuel oil delivered to ARA in 2020, according to analysis by Vortexa. Any obstruction of flows would have a devastating impact on the global fuel oil market, and in particular the trading hub of ARA, the home to the benchmark fuel oil grades of 0.5% marine fuel and high sulfur fuel oil. The 0.5% marine fuel grade is largely made by blending residual barrels with middle distillates.
European refineries struggle, demand for light sweet crude will jump
Aside for the rationalisation over the pandemic years, which has seen around 700,000 bpd of European refinery capacity shut, Europe's beleaguered refiners are highly dependent on Russia for both Urals crude and vacuum gasoil (VGO). While alternative crude sources can be shipped into the region, the replacement of VGO would be trickier. Russia exported 5.05 million mt of VGO to Europe in 2021, according to Vortexa, and is the only large-scale supplier of VGO to Europe.
The upshot is demand for light sweet crude will increase, as refiners naturally shun sour crudes that require products that need desulfurization.
Shipping rates, particularly larger vessels, to jump
Ukraine's plea for Turkey to close the Bosphorus and Dardanelles straits in the Black Sea – a major artery of Russian oil supply - to Russian vessels, as well as the airspace, was dismissed as fanciful by ship brokers.
Ukraine's request may only have applied to warships and military aircraft, although the Ukrainian ambassador to Turkey was not clear in his media address. The Black Sea oil market has been quiet this week, and flat rates for handy-size cargoes have been drifting lower, pegged at between 260 to 270 worldscale points Thursday.
"If there is any disruption to loadings from Russia, then rates will probably slip lower," one broker said. Meanwhile, a sanction against Russian oil exports will likely cause an explosion in rates for larger vessels, such as Aframax, Suezmax and VLCC rates, as the world seeks to secure and store barrels.
"At the moment, we are all just temporising, watching the screens, but if there are sanctions, the roof will come off shipping rates," a source said. Ukraine itself exports mainly fuel oil, and the country is an importer of distillates.