By Alex Kimani
- Evidence of war crimes in Ukraine bring EU closer to full ban on Russian crude.
- Experts warn of extreme volatility in the event of an embargo on Russian oil.
- EU sanctions on Russian oil and gas would send a strong signal that Russian oil is unlikely to regain its former market in Europe for an extended period.
Crude oil prices have continued to move over a wide range, with a weakening trend last week reversed this week by renewed EU momentum towards sanctions on Russian oil.
Last week, Crude oil prices posted their biggest one-week loss in nearly two years, thanks to an apparent breakthrough in peace talks between Russia and Ukraine. Front-month U.S. WTI crude (CL1:COM) plunged 12.8% to $99.27/bbl and while Brent (CO1:COM) fell 11.1% to $104.39/bbl, the biggest weekly percentage decline for both benchmarks since late April 2020.
Previously, European countries walked back threats of sanctioning Russian oil after Russia promised to scale down military operations in the north of Ukraine. The promise sparked hope that the war in Ukraine may finally begin to de-escalate.
But damning evidence of serious war crimes coming from Ukraine suggests that Russia could face more severe sanctions, including a ban on its oil by European nations.
Volatility remains extremely high across energy markets, with 30-day realized annualized Brent volatility increasing 2.2ppt w/w to a 22-month high of 79.2% on 4 April, while Dutch Title Transfer Facility (TTF) gas for May delivery rose EUR 5.714 per megawatt-hour (MWh) to EUR 109.523/MWh.
And the experts are warning that the situation is likely to remain this way for months to come.
Ban on Russian Oil Imports
The flow of “bloody money” to Russia must stop, Kyiv’s mayor has said as the West prepares new sanctions on Moscow after dead civilians were found lining the streets of a Ukrainian town seized from Russian invaders. Since Russian forces withdrew from northern Ukraine, turning their assault on the south and east, grim images from the town of Bucha near Kyiv, including a mass grave and bound bodies of people shot at close range, have prompted international outrage.
Indeed, commodities experts at Standard Chartered are now saying that the atrocities against Ukrainian civilians revealed by the withdrawal of Russian forces from areas north and east of Kyiv have made it very likely that EU countries will impose sanctions on Russian oil in the coming months. In the United States, Treasury secretary Janet Yellen has warned of “enormous economic repercussions” from the Ukraine war. Yellen is set to brief a House committee on Wednesday about the state of the global economy as the U.S. and its allies prepare more sanctions against Russia.
According to StanChart, the EU’s most likely immediate measure–i.e., imposing sanctions on coal–will do little to placate member states and public opinion for a significant ratcheting up of the pressure on Russia. The experts say the sanctions will likely eventually result in a complete cessation of Russian oil exports to Europe, though questions remain on the potential timing of an EU agreement on sanctions, its speed of execution, and whether any exemptions would be allowed for specific oil products or specific refineries.
Russian Oil Output To Remain Depressed For Years
So far, Russian oil and gas exports to the EU remain largely unchanged since only the Baltic States have announced a 100% ban on Russian energy imports. Poland, a major thoroughfare for Russian energy supplies, has also been more proactive than most, after it took steps to block Russian coal imports and announced steps to halt Russian oil imports by year-end. Poland–home to the ~1.3mb/d Druzhba pipeline that carries Russian crude to several points in Poland, Germany, and the Czech Republic–directly consumes ~330kb/d of Russian crude and imported ~9.4mt of Russian thermal coal in 2020, accounting for ~5% of Russian exports.
The EU currently gets about 40% of its natural gas from Russia, which powers everything from household heating to factory production, and makes up around 25% of the bloc’s total energy consumption. StanChart estimates that Russia’s oil flow to Europe before its invasion of Ukraine was 4.5 million barrels per day (mb/d), roughly evenly split between crude oil and oil products. That flow was worth about USD 115bn of export receipts to Russia in 2021 but is now closer to an annualized value of USD 170bn at current prices.
However, StanChart says that a move towards explicit EU sanctions on oil imports would keep Russian output below 8.5mb/d for several years, good for a 3mb/d decline compared to pre-invasion levels, and introduce further downside to already low expectations for Russian oil output. Further, EU sanctions on Russian oil and gas would send a strong signal that Russian oil is unlikely to regain its former market in Europe for an extended period, if ever. EU sanctions will also likely increase the pressure on key countries, and particularly India, not to increase their imports from Russia above pre-invasion levels; up to now, part of the pushback from other users of Russian oil has been that they could not be expected to refrain from extra purchases if EU governments were not explicitly limiting their own use.
Assuming no increase in Iranian oil exports or in OPEC output beyond that specified in the current OPEC+ schedule of increases, StanChart estimates the average monthly deficit at 1.4mb/d, potentially reaching 2.7mb/d deficit in December. The average gap is less than the fall in Russian supply as the market was tending towards an H2 surplus before the invasion of Ukraine due to offsets on the demand side. However, the experts note that a sustained 1.4mb/d gap is still highly significant, particularly when starting from a base of very low inventories. To cover the gap and allow inventories to rebuild, the balance needs to loosen (through a combination of less demand and more supply) by about 2mb/d for the remainder of the year. An additional loosening of 1-2mb/d in Q2 would also help to minimize the price pressure caused by the short-term dislocations as trade flows readjust.
Iran Can Bridge The Supply Gap
StanChart says the supply gap does not appear to be unbridgeable, adding that U.S. investment banks that have labeled the current situation as the biggest supply shock in history are wide off the mark.
Indeed, the analysts say the shock will be substantially less (in both absolute terms and relative to the size of the market) than the Iranian oil crisis in the early-1950s, the Iraqi invasion of Kuwait in 1990, and the 1973 oil embargo. In fact, a deal in the Joint Comprehensive Plan of Action (JCPOA) talks in Vienna alone would be enough to cover most of the supply gap, as would even a significantly delayed OPEC reaction to Russia’s inability to reach its OPEC+ targets.
The commodity experts say that in the final analysis, economic self-interest and the maintenance of OPEC’s credibility as a stabilizing force in the market will eventually lead to higher OPEC output. However, they concede that supply shocks and oil price volatility will likely dominate markets in the near-and mid-terms.