The Russian invasion of Ukraine has dominated headlines in the past week and will likely continue dominating them until some form of a ceasefire is agreed upon. In the meantime, it has further enhanced already strong bullishness on energy markets and even reversed the beginnings of an outflow from oil positions by large investors. Thanks to the estimated imbalance between demand for crude oil and the supply of the commodity, prices have been on a more or less uninterrupted rise for the past few months. Large investors such as hedge funds have been strong buyers and bullish betters, and recently, as is the pattern of hedge fund behavior, many had started to wind down their bullish positions, Reuters’ John Kemp wrote in his latest weekly column on the hedge fund industry and oil.
In four of the past five weeks, Kemp reported, hedge funds reduced their net long positions on oil from 761 million barrels across the six most traded contracts to 714 million barrels. And then Russia invaded Ukraine.
Fears of disruptions in the supply of Russian oil and gas, especially for Europe, reached a fever pitch in the first days of the invasion with expectations either that Russia itself would turn the taps or that the EU and the U.S. would sanction the flow of oil and gas. So far, neither has happened. What has happened, however, is what pretty much looks like an all-out economic war.
The European Union, the UK, and the United States, along with Canada, have been slapping sanction after sanction on Russia, for now overwhelmingly targeting its financial industry as well as any foreign assets the government and the central bank of the country might have abroad. Several Russian banks have been cut off from the SWIFT system, sparking additional fears of energy supplies as all international trade deals go through the system. Russia has retaliated, and by the look of it, the retaliation may not be over.
All this has added substantial upside momentum to oil prices, and they may still go higher. Canada this week banned Russian oil imports in what amounted to little else than a symbolic move, but what Prime Minister Justin Trudeau said was a move that “sends a powerful message.” The EU, the UK, and the U.S. are clearly not done with the sanctions, and this is feeding fears that oil and gas could be next. Russia has also hinted that retaliatory energy sanctions are on the table.
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The U.S. State Department has been adamant it would not touch oil and gas, which is hardly surprising given that its allies in Europe are heavily dependent on Russian oil and gas, and that the U.S. itself imports quite a lot of Russian crude. However, the situation seems to be of the “Never say never” kind, which makes it fraught with uncertainty. And, apparently, it could yet get worse.
According to hedge fund celebrity Pierre Andurand, traders are currently in denial about just how much worse things could get in oil markets, which is why prices are not as high as they should be.
“I don’t think there’s anyone trading now who has actually seen large supply disruptions that have impacted the price,” Andurand told the Wall Street Journal this week. “They don’t want to believe in bad news, a bit like the beginning of Covid.”
The very comparison with the pandemic could probably send benchmarks higher, but to counter it, there was the news of negotiations beginning between Moscow and Kiyv yesterday. The negotiations paused at the end of the day, but the Russian side reported that a general agreement had been achieved on several items on the agenda.
It might be this news that curbed the upward potential of Brent crude, sending it back to $100 after it topped $105 earlier this week. Yet the situation remains highly volatile, not least because fundamentals remain imbalanced with tight supply and strong demand.
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By Irina Slav for Oilprice.com
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There is also the possibility that Russia might retaliate against sanctions by halting its global oil and gas exports.
Either case, it will cause Brent crude to rise further to even $120 and gas and LNG prices to hit unheard of levels. This will very adversely affect the global economy and inflict considerable damage on both the economies of the United States and the EU.
The United States is the world’s second largest importer of crude oil after China importing 9.0 million barrels a day (mbd). It is highly vulnerable to oil price shocks and therefore its economy could suffer very considerable damage.
The EU which is dependent on Russian gas supplies for more than 40% of its needs and 30% of oil will be the biggest loser sinking deeply into more ferocious and more damaging energy crisis. This could reduce its economic growth to zero.
Moreover, the entire LNG exports of the United States, Qatar and Australia could hardly replace Russian piped gas supplies to the EU amounting to 200 billion cubic metres (bcm) and 15-16 million tons of LNG. The EU’s LNG import infrastructure is very limited. Furthermore, Russian piped gas is far cheaper than LNG. Russia can still sell its gas and oil exports to China.
Only a peaceful settlement of the Ukraine crisis could now calm down the highly volatile market and prices.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London