commodity commentary. Crude oil market at the crossroads

The global energy market is currently in a state of nervousness over the ongoing Russia-Ukraine war. A clear end is nowhere in sight. In particular, the conflict has serious implication for the European Union which is riding on the horns of a huge dilemma over sanctions-related response.

The EU is under tremendous pressure to place an embargo on the import of Russian energy products. However, it is well-known that Europe is substantially dependent on Russian oil for its energy needs. Any push to ban Russian oil will have serious implications for the continent as it will impact 7 million barrels per day (mbpd) of oil.

Importantly, refiners in Europe will be forced to find suitable substitute for Russian Urals (medium sour crude) and it is not going to be easy. There is the real risk that downstream product quality will suffer.

The question then is whether other producers will raise output quickly. But according to OPEC, its members have limited spare capacity and will not be able to fully meet the supply shortfall that may arise out of a possible EU embargo on Russian oil.

Any EU push towards embargo will further tighten the already stretched global oil market. In the event, there is the real possibility of a big upside risk to crude oil prices. Already reeling under inflation, the world possibly cannot afford further price spike at this point in time.

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How the Russian invasion of Ukraine concludes is the key to unraveling the uncertainty of the energy market at present.

Supply risk

Bullish and bearish factors both are operating simultaneously. Supply risk is the biggest bullish factor. In addition to the already tight supply-demand fundamentals and political instability, Russia’s average output has been falling since February. Putin’s recent statement expressing disappointment over peace talks cannot be brushed aside.

Easing of lockdown restrictions in Shanghai is seen as a spur for more demand. Speculative interest in the oil market is continuing. Financial investors have placed huge bullish bets which exert an exaggerated impact on oil prices.

Bearish factors

At the same time, bearish factors point to demand risk. Due to high prices and inflation worldwide, demand growth is slowing. OPEC has revised its 2022 demand forecast down by 480,000 barrels per day to 3.7 mbpd. Concerns over new corona virus variants in China refuse to go away.

In the US, rig count has been rising steadily as President Biden has taken a U-turn on his fossil fuels policy. Currently, the US oil output is back to April 2020 levels. Importantly, release of strategic reserves of 180 million barrels by USA plus 60 million barrels by members of International Energy Agency has provided a supply cushion.

So, two scenarios emerge. If EU bans Russian oil, there will be a massive price spike that can potentially take crude oil to $150 a barrel. However, when the war ends (it has to end sooner or later), Brent will first correct towards $90 and gradually move to $85 and then $80 a barrel possibly in the second half of the year.

(Excerpts of author’s speech during the recent IMC Chamber of Commerce webinar on inflation outlook. The author is a policy commentator and commodities market specialist. Views are personal)

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