Large oil supply curtailment remains unlikely

Paul Sheldon

Chief Geopolitical Advisor at S&P Global Platts

Russian President Vladimir Putin stated plans to “partially” reduce troops near Ukraine on February 15, but uncertainty will persist as long as his intentions remain strategically ambiguous. Developments over the coming days and weeks will shed more light on prospects for de-escalation, but odds of some type of attack will remain near a toss-up as long as large troop numbers remain on the Ukraine border.

On February 15, the Duma recommended recognising two separatist regions in Ukraine’s Donbass as independent, highlighting higher odds of a limited military operation than a broader invasion.

In any case, we still do not expect a notable curtailment of oil exports, either from US sanctions or Russia voluntarily holding back volumes. In the event of military incursion, US financial sanctions could cause dislocations, due to caution among oil buyers, while risks of disruptive cyberattacks would also rise.

As we recently noted, disruptions to 250,000 b/d of Druzhba flows through Ukraine or 485,000 b/d of oil exports to the US could be backfilled at some cost, but would not materially affect global balances. Iran-style secondary sanctions on Russian oil exports are highly unlikely, given US and EU sensitivity to rising prices.

Similarly, we do not anticipate Russia cutting oil shipments to Europe, which would jeopardise market share and longer-term economic interests. Limited export capacity heading east also makes it difficult to re-route 2.7 million b/d of crude exports to Europe. But markets will understandably remain tense, as global spare capacity ex-Russia is currently 2.6 million b/d and will fall to 1.8 million b/d by May.

A greater risk could be to Russian medium-term development, either through direct restrictions on investment in Russia’s oil sector, or by sanctions fallout triggering a tax hike on upstream oil producers. Russia’s 2022 fiscal breakeven price of $65/b Brent and $600 billion plus of financial reserves creates notable leverage in the current energy price environment. Therefore, even if the situation de-escalates in the weeks ahead, Ukraine tensions and uncertainty for energy markets would last longer.

In the unlikely event of a large supply disruption from Russia, market focus would quickly shift to the amount of spare capacity available to offset losses. Excluding Russia, we estimate the volume Opec+ could bring online for a short-term response at 2.6 million b/d, 88 per cent of which is in Saudi Arabia (1.25 million b/d) and the UAE (1.0 million b/d). By May, Opec+ quota hikes will reduce this figure to a less comfortable 1.8 million b/d, 96 per cent of which is in Saudi and UAE. With global oil demand set to grow by 4.5 million b/d in H2 2022 over the first half, markets will remain concerned by disruption threats in Russia, Libya, and elsewhere.

In addition to Opec+ spare capacity, Iran is the other source of potentially large near-term supply growth. As described in our February 9 Spotlight, our reference case still assumes a limited deal by April to freeze Iran’s nuclear programme is the most likely of several plausible outcomes. The details of a potential interim deal are unclear, but our reference case assumes 500,000 b/d of resulting oil export growth in April-May. The second most likely outcome in our view is talks continuing for months or more, with exports stuck around 700,000 b/d. A comprehensive return to the 2015 JCPOA is also a possibility, which we estimate would facilitate 1.5 million b/d of export growth within 12 months of sanctions relief, half of which would come in the first three months.

In the unlikely scenario of a large Russian supply interruption, talk would inevitably return to additional SPR releases from the US and elsewhere. We already forecast 430,000 b/d of net outflows from the US SPR through April, and another 280,000 b/d during Q4 2022 from the next batch of Congressionally mandated sales. However, a supply emergency could realistically trigger a coordinated release similar to 2011. In June of that year, a 1.4 million b/d disruption in Libya caused President Obama to order a 30 million barrel emergency release, in conjunction with a similar amount from other IEA countries.

When added to the ongoing deliveries, this scenario could test the limits of US export infrastructure. Nameplate drawdown capacity at the four SPR facilities totals 4.4 million b/d, although deliveries from facilities near Houston and Nederland/Beaumont would require space on local pipelines and terminals. Therefore, the ability to deliver SPR barrels, above commercial volumes, is likely between 1.5 and 2.5 million b/d.