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Ukraine: ‘I’m surprised the oil price hasn’t hit US$130 a barrel yet’ – energy trading expert Q&A

Vladimir Putin talking over a microphone at the Kremlin
All in: Vladimir Putin. EPA

Energy prices shot up after Russian President Vladimir Putin shocked the world by ordering a full-scale invasion of Ukraine. Oil is trading over US$100 (£75) a barrel for the first time since 2014 and natural gas prices jumped back towards the highs of late last year, although both eased a little the day after the invasion.

With consumers and businesses already struggling with high inflation everywhere from fuel pumps to power bills, and the world economy facing an uncertain recovery from the COVID pandemic, we asked Adi Imsirovic, a Senior Research Fellow at the Oxford Institute for Energy Studies and former oil trader, for his take on what happens next.

How was the energy market before the invasion?

Prices were already high because the market is very tight right now. The countries in the Opec+ world oil cartel couldn’t even produce enough oil to meet their quotas, and this wasn’t necessarily deliberate. We had an almost unexpectedly good rebound in demand after COVID, which created a lot of pent up demand. The key was probably all the economic stimulus from governments and central banks.

How important is Russia to the global oil and gas market?

It’s one of the biggest oil producers in the world, producing over 10 million barrels of oil and condensate each day, of which about 7.5 million, including refined oil products, are exported. Crude oil exports are about 4.5 million barrels, of which at least two-thirds goes west, mainly to Europe. The remainder of Russian oil exports are products like diesel, petrol or naptha, and again much of that goes to the west. In all, Russia satisfies around a tenth of world oil demand, so it’s huge.

For natural gas, Russia is second only to the US, producing some 1.7 billion cubic metres each day compared to 2.5 billion from the US. Overall, in terms of Russia’s energy revenues, about four-fifths comes from oil and the rest from gas. About 40% of Europe’s gas imports come from Russia.

How do you think Russian oil and gas exports will be affected by the war?

The severity of this attack and impact on global politics is such that I can’t see any sanctions working unless they include energy restrictions, and denying Russia access to the international Swift system which handles payments between banks.

Russia’s oil, [known as Urals oil], normally trades at a discount of about US$1-US$1.50 per barrel to North Sea Brent crude, but this has currently widened substantially to about US$10 because people are worried that there may be issues with payments. At the same time, shipping owners are avoiding Russian ports, freight rates involving Russia have gone up, and so have insurance rates for consignments. With around two thirds of Russian crude and products moving by ships rather than pipes, this means it’s only a matter of time before you may start to lose Russian oil from the market.

Brent crude price (US$/barrel)

Oil price chart
Trading View

I am therefore actually hugely surprised that oil prices haven’t gone much higher. I would have expected US$120 or US$130 quite easily. It’s true that the geopolitical risks of a war in Ukraine were probably to some extent “priced in” to the oil price – before the invasion, I might have said they made up US$10 of the price. But with the Russians going all in to topple the Ukrainian government, I can only see things getting more complicated in the energy market, meaning prices rising much higher.

Shutting off Russian gas is a more difficult calculation because Europe relies on it so much, but ultimately if I’m right about Russia losing access to Swift, it may happen. And to be clear, it’s not that there isn’t enough gas on the market – Qatar can easily meet Europe’s gas requirement at the expense of other customers – it’s just that prices would have to rise accordingly.

Natural gas price (UK spot, pence/therm)

UK natural gas price chart
Trading Economics

Could speculators drive up prices even higher, like when oil hit nearly US$150 a barrel in 2008?

Speculation definitely impacts energy prices, but it’s not just starting today. The rise in the oil price from about US$70 to US$90 per barrel was probably driven partly by speculation and not entirely by supply and demand. One reason why speculators haven’t bid the price much higher after the invasion is because they have already made a decent profit from betting on higher prices. But again, that doesn’t mean the price won’t go higher. It would take a very brave person to short oil right now (in other words, bet that the price will fall).

Who stands to be affected by restricted supplies?

Big importers of Russian crude, such as Dutch and UK refineries, can switch to other blends, but it’s less easy for, say, Mediterranean refineries, particularly Italy. They are configured for grades such as Urals light along with Iranian light and Arabian light. They have already lost Iranian light because of sanctions and so losing Russian crude would be an additional problem.

Equally affected will be inland refineries in countries like Germany, Austria and the Czech Republic. They were literally built on pipelines from Russia, so don’t have much storage capacity. They do also receive oil from pipelines from places such as Wilhelmshaven, Rotterdam and Antwerp, but the potential loss of Russian crude for them would still be serious. When refineries do not refine, they lose money and the price of products such as petrol (gasoline) and diesel goes up for all of us.

To help keep refineries like these functioning, it would make a lot of sense for Joe Biden to lift the Iran sanctions to loosen up the market a bit. Although Iranian production wouldn’t increase right away, they have some 80 million barrels of oil sitting in ships, which could make a big difference to the market.

Russian Lukoil refinery at Khaliningrad
The loss of Russian oil will have a huge effect on the global market. Nadyzima_klgd

Besides Russian crude, the loss of oil products would also be very painful for certain customers. Together with the UK and France, Germany is a big buyer of Russian diesel. A lot of heavy fuel oil actually goes to the US for blending into lighter types of domestic oil, as a substitute for the loss of Venezuelan imports due to sanctions. There’s also lots of Russian product (so-called components such as naphtha) blended into petrol (gasoline) and sold on to the Americas.

Many western companies such as Vitol, Glencore, Trafigura as well as the trading arms of BP, Total and Shell, are heavily involved in trading Russian crude and products. The system is such that a lot of Russian oil is prepaid (paid before delivery). So restricting oil supplies may hurt companies like these (or at least the banks behind the deals) a few months before it starts to hurt the Russians.

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