UNEXPECTED CRISIS

Unexpectedly for all, March 2022 became a real hot month for the global oil and gas market. If two years ago, due to Russia's withdrawal from the OPEC+ deal to curb oil production, global oil prices set their new lows of the past twenty years, 2022 was a year of historic highs.

Global prices of hydrocarbon have been on the rise amid Russia's military actions in Ukraine and the ensuing harsh economic sanctions imposed by the West. Claims that European and other consumers may refuse to buy Russian energy resources (oil, coal and liquefied natural gas) have also contributed to this rising trend.

On March 7, the price of spot natural gas in Europe set a new historical record hitting $4,000 per 1,000 square cubic metres (scm) as opposed to $2,150 per 1,000scm three days earlier. The average TTF price for February was $935.

Brent and WTI are also approaching all-time highs.

On March 7, oil prices rose to their highest since 2008 ($150) reaching $139 per barrel, while WTI surpassed $130. Analysts at JPMorgan Chase & Co. believe Brent could reach $185 per barrel by the end of the year.

Voluntary waiver

Main contributor to the price surge over the past two weeks has been market fears over real or possible supply disruptions from Russia. Meanwhile, the recent decision of the Biden administration to stop importing Russian oil has played an instrumental role here too. Despite certain risks to its own economy, Washington decided to stop imports of Russian energy sources, as well as to ban American investments in the Russian energy sector and financing of foreign companies investing in this sector.

According to President Joe Biden, the US has made the decision after close consultations with allies and partners around the world, especially in Europe. However, the White House understands that European countries will not be able to join the ban.

The US Department of Treasury has already announced a cut-off date for oil, oil products and coal imports from Russia as April 2022, 22 @ 00:01 Eastern Time.

At the same time, US authorities admit that this decision will not pass unaffected for domestic fuel consumers. Therefore, they expect gasoline prices in the country rise further. They have already passed the all-time high of $4.17 per gallon in a couple of days.

JPMorgan predicts that the US abandonment of Russian oil supplies threatens the US with ‘huge financial losses’.

On the other hand, the US is much less dependent on Russian energy imports than Europe. In 2021, Russian supplies reached just 8% of all US energy imports, or 3% of consumption. Therefore, refusing such volumes can hardly be considered critical for the US economy.

Britain has also supported the American decision. British authorities have announced their intention to phase out purchases of Russian oil over the coming months. A transition period will be required to give markets and businesses time to adjust to the new realities and find a replacement for Russian oil, which currently accounts for 8% of UK consumption.

According to Bloomberg, the decision will also affect refined products, particularly diesel. However, it will not apply to deliveries of Russian natural gas to the UK.

According to British statistical data, UK oil imports from Russia last year reached around £4 billion ($5.3 billion). Russia's imports of oil and refined products accounted for 13.4% of the UK's total imports of these products.

EU has not imposed any ban, but the European Commission said that by the end of 2022, the EU plans to cut Russian natural gas supplies by two-thirds and to import liquefied natural gas (LNG) from Qatar and the US instead of Russian supplies. As expected, only few European importers are willing to give up Russian imports. Dutch Prime Minister Mark Rutte has openly stated that he did not support abandoning oil and gas supplies from Russia immediately because it is unsustainable for the EU member states.

“I will not support oil and gas supplies from Russia today. That is impossible, because we need those supplies, and that is an inconvenient truth,” Rutte stated.

German Chancellor Olaf Scholz has once again ruled out the possibility of stopping Russian energy imports. He said that the US is an exporter of gas and oil, which is not completely true for Europe though.

There is an alternative

Meanwhile, Russia at different levels warns of dire consequences for global consumers in case they refuse to buy Russian energy resources. For example, Russian ambassador to Washington Anatoliy Antonov said that this would lead to significant fluctuations on global markets, as well as have a negative impact on the interests of companies and consumers, primarily in the US.

Russian Deputy Prime Minister Alexander Novak predicted catastrophic consequences for the world market if Russian oil is abandoned. “The price surge will be unpredictable—more than $300 per barrel, may be more. The volume of Russian oil on the European market cannot be replaced quickly; it would take more than a year, and it would be much more expensive for European consumers. Under such circumstances, they will be the main victims,” Mr. Novak said.

According to Rystad Energy, if Washington's Western allies support the decision to completely ban Russian energy imports, it could create in the market “a hole of 4.3 million barrels daily (mbd), which cannot be patched quickly by other supplies”.

Now that Washington has officially rejected the purchase of Russian fuel, we can expect its next move to be reaching an agreement with Iran by lifting sanctions on oil exports from the Islamic Republic. The parties have recently made notable progress in the negotiations, which can lead to conclusion of a full-fledged agreement at any moment. This will make it possible for Iran to re-release to the market 1-1.5mbd over the next few months. These volumes will not replace Russian oil, but can cool off the market a bit.

Another option is Canada, which is ready to supply 1mbd of heavy oil to the US. But Canada has its own demands: to stop blocking of the Keystone XL pipeline at the Canada-US border, which the Biden administration stopped in January 2021. Other possible alternatives include heavier grades of oil produced domestically as well as in Mexico.

Washington is even considering Venezuela, with which it cut off diplomatic contacts back in 2019. A delegation of US diplomats visited Caracas last week and experts believe they may have discussed a possible resumption of oil exports from the country. Following the meeting, which was the first high-level meeting in several years, the parties agreed to hold another round of negotiations, the Venezuelan leader Nicolas Maduro said.

The US is also in talks with OPEC countries. The UAE has already announced its intention to increase oil production. According to Youssef Al-Otaiba, UAE ambassador to Washington, DC the Emirates will recommend other OPEC members to increase oil production amid the highest in a decade oil prices due to Russia's military operation in Ukraine.

Meanwhile, the UAE Energy Minister Suhail Al-Mazroui twitted that his country will comply with the terms of the OPEC+ agreement in adjusting oil production volumes. According to the current plan, the cartel will increase production by 400,000bpd each month.

Compulsory discounts

Contrary to the statements of Russian officials, oil export restrictions will be extremely painful for Russia as well. The British analytical company Capital Economics believes that the sanctions will cause Russia's GDP to fall by 25% and the dollar exchange rate to rise to 200 roubles. Inflation in the country could then reach 30%.

If, however, European countries refuse to import Russian oil, Russia can divert its flows to Asia, given the strong demand for oil in China, for example. However, it will have to consider selling oil to China at discounted rates. After all, attracting new consumers requires certain incentives.

However, things will be much more complicated with gas for both European countries and Russia. For Europe because it is still impossible to replace these volumes with other sources, including LNG, and for Russia because its export infrastructure is mainly focused on the European market.

Although there is no direct ban on Russian oil, many companies already refuse to buy it individually. As a result, Russian Urals is trading at a steep discount to the benchmark grade. Traders point to the inability to buy Urals because of sanctions against Russian banks—a fact also acknowledged by the Russian government.

The Great Exodus

Another blow, primarily to Russia's investment portfolio, was a massive withdrawal of foreign companies from the Russian market. Major foreign oil and gas companies such as BP, Shell, ExxonMobil and Equinor have announced their withdrawal from Russian projects and joint ventures. Some of them have even refused to buy Russian oil and gas. However, they are not just passive investors in a number of joint ventures, as the implementation of individual projects depends, by and large, on the technology and human resources of foreign partners.

For example, British BP said, due to pressure from the UK government, it would give up 19.75% stake in Russian oil giant Rosneft, which it has owned since 2013. The company also announced it would not charter ships owned or operated by Russia, where possible, and would not make new purchases of Russian oil and gas. However, the company has warned that it might have to abandon its last promise to buy fuels should “the security of energy supplies is threatened”.

Norwegian oil and gas group Equinor has decided to stop new investments in Russia and start the process of exiting Russian joint ventures. Equinor has operated in Russia for more than thirty years and has a cooperation agreement with Rosneft, under which both companies have developed fields in Eastern Siberia.

Exxon Mobil, the largest US oil and gas company, has officially announced the suspension of its operations in Russia. The company officials said that ExxonMobil ceased operations in the Sakhalin-1 project as the operator of the project. They will not invest in Russia either.

British-Dutch Shell announced its intention to phase out participation in all Russian hydrocarbon projects, including oil, oil products, gas and LNG. The company is withdrawing from joint ventures with Gazprom, including 27.5% in the Sakhalin-2 LNG project, 50% in Salym Petroleum Development and Gydan Energy JV with Gazpromneft. It will also end its involvement in the Nord Stream-2 project. “As an immediate first step, the company will stop all spot purchases of Russian oil. We will also close petrol stations and production of jet fuel and lubricants in Russia,” the company statement said.

French Total, Italian Eni and Swiss Glencore have all said they would stop investing in new projects in Russia. The German company Wintershall Dea, Gazprom's longstanding partner, also decided to reconsider its position in Russia.

The withdrawal of major oil and gas majors from Russian projects decreased the price of stock shares of Russian companies considerably.

Russian Security Council considers the ‘great exodus’ of foreign companies from the Russian market as a purely political move and promises harsh and categorical response, while Russian members of parliament proposed nationalising the property of the outgoing companies and organisations. There is already a list of 60 companies to be nationalised. So far, however, the Russian government's response has been limited to a temporary ban on foreign businesses divesting from Russian assets.

The pen boycott of the Russian market, despite Moscow's threats to take tough and adequate measures in response, suggests that the sanctions will be long-lasting. It is true that currently they cause tangible damage not only to Russia, but also to the countries that imposed them. And no expert can predict how long this situation will last.