Oil prices continued to surge in Monday morning trade as the market reacted to supply disruptions stemming from Russia’s ongoing invasion of Ukraine and the possibility of a ban on Russian oil and natural gas.
Can the world economy function without Russian oil?
Bank of America analysts noted that if Russia's oil is cut off, the market could face a 5-million-barrel shortfall which could push oil prices to $200 per barrel.
US Secretary of State Antony Blinken, on Sunday said, “We are now in very active discussions with our European partners about banning the import of Russian oil to our countries, while of course at the same time maintaining a steady global supply of oil."
The latest considerations follow a stream of sanctions that have already had a significant impact on the Russian economy but have not yet been able to halt Putin's advance into Ukraine. The move, if agreed upon, has long been considered the "nuclear option" as a ban on Russian oil could weigh on global supply in an already tight market.
Bank of America analysts noted that if Russia's oil is cut off, the market could face a 5-million-barrel shortfall which could push oil prices to $200 per barrel. The situation is compacted by stalling talks with Iran over a potential new nuclear deal.
Pouring oil on troubled waters
Russia produces close to 11 million barrels per day of crude oil. It uses roughly half of this output for its own internal demand, which presumably has increased due to higher military fuel requirements, and exports 5 million to 6 million barrels per day.
Today, Russia is the second-largest crude oil producer in the world, behind the US and ahead of Saudi Arabia. About half of Russia’s exported oil – roughly 2.5 million barrels per day – is shipped to European countries, including Germany, Italy, the Netherlands, Poland, Finland, Lithuania, Greece, Romania and Bulgaria.
Nearly one-third of it arrives in Europe via the Druzhba Pipeline through Belarus. These 700,000 barrels per day in pipeline shipments would be an obvious target for some kind of sanctions, either by banning financial payments or refusing deliveries via spur lines at the Belarus border.
In 2019, Europe stopped accepting deliveries for several months from the Druzhba line when crude oil flowing through it became contaminated with organic chlorides that could have damaged oil refineries during processing.
Russia’s oil shipments fell noticeably as it redirected flows to avoid the Druzhba line.
China is another large buyer: It imports 1.6 million barrels per day of Russian crude oil. Half comes via a special direct pipeline, the Eastern Siberia Pacific Ocean pipeline, which also services other customers via a port at its endpoint, including Japan and South Korea.
According to ICICI Securities, Germany’s relationship with Russia is one of mutual dependence, as Russia-supplied natural gas runs a large proportion of its electricity – and France, Austria, Netherlands and Italy also depend on Russian gas and oil to only a slightly lesser degree.
Analysts say that sanctions on Russia would cripple the EU economy (causing an EU recession) for at least half a year, although the US and OPEC countries could eventually replace most of the oil & gas lost to the EU from sanctions on Russia. Says Prasenjit Basu, Chief Economist at ICICI Securities
Analysts say the risk of a recession in the US is currently low but would accentuate if energy prices continue to spiral. The US Fed Reserve is faced with difficult options. It can either undertake sharp rate hikes to tame inflation or allow the current stagnation to turn into a full-blown recession. These choices will keep markets on the edge for the next few months.
What if countries stop buying Russian oil?
Sanctions against Russia’s oil industry would have a greater impact than limiting natural gas flows because Russia’s oil receipts are higher and more critical to its state budget.
Russia earned over US$110 billion in 2021 from oil exports, twice as much as its earnings from natural gas sales abroad. Since oil is a relatively fungible global commodity, much of Russia’s crude exports to Europe and other participating G-7 countries might wind up being sent somewhere else. That would free up other supplies from sources such as Norway and Saudi Arabia to be redirected back to Europe.
Russia’s oil has high sulfur and other impurities, so refining it requires specialized equipment – it can’t be sold just anywhere. But other Asian buyers can take it, including India and Thailand. And Russia has special supply arrangements with countries like Cuba and Venezuela.
Who will fill the supply shortage?
Rising oil prices will encourage more production. Saudi Arabia and the United Arab Emirates can produce an extra 3.5 million barrels per day.
The United States can also produce more, having become the world’s top oil and gas producer in 2021. The International Energy Agency (IEA) estimates that the global oil supply will soar by 6.2 million barrels per day on average in 2022, compared to an increase of 1.5 million barrels per day in 2021. That’s why the global oil market should tip back to surplus later this year—unwinding the upward price pressures.
For How long EU can sustain
Until the summer, the EU would likely be able to survive large-scale disruption to Russian gas supplies, based on a combination of increased LNG imports (to the limited extent this is technically possible) and demand-side measures such as industrial gas curtailments.
However, this would come at a cost for the EU economy and might even result in some countries (those more exposed to Russian gas and less interconnected with other EU countries) having to take emergency measures.
But, should a halt of Russian gas be prolonged into the next winters, it would be more difficult for the EU to cope. On the supply side, some spare import capacity is available but reaching the scale required to entirely replace Russian volumes would be at best very expensive, and at worst physically impossible.