Global Oil Markets Volatility To Increase In May

Key Insights

• Crude oil market heading for dramatic changes in May.
• IEA and OPEC differ on-demand future.
• Russian fall-out and OPEC spare capacity to push up prices.

Crude oil is heading to unchartered waters as the impact of possible European energy sanctions on Russia are looming over the market. At present, the votes are still out, but the pressure inside of the EU capitals is building up as the military onslaught of Russian troops on Ukraine continues.

A full-scale oil and gas sanctions regime is still not there, as Germany and others are still wary to commit themselves. However, global oil and gas market parties are getting worried about the impact of EU sanctions in the coming weeks, some already are taking drastic steps to minimize their exposure to oil and gas trade with Moscow.

IEA foresees slow down

The International Energy Agency (IEA), the energy watchdog of the OECD countries in Paris, reported that it expects sanctions and buyer aversion on Russian oil and gas are already taking effect in the market. The IEA expects that Russian oil and gas production and sales will be hit severely in May, possibly showing around 3 million bpd going offline after May. At the same time, the Paris agency indicated that it sees Russian losses to be around 1.5 million bpd.

The decline in Russian oil production however is going much slower than the IEA expected before. Still, a decline of 1.5-3 million bpd in the current markets is going to be a very hard hit.

OPEC expects demand to hit 100 million bpd

OPEC, the world’s leading oil-producing and exporting group, currently still cooperating with Russia and several other non-OPEC members, has reported that it expects global oil demand not to increase as fast as formerly was expected. The oil group stated that high crude oil prices, combined with a struggling Chinese economy and logistical constraints globally, are putting a damper on global oil demand growth.

OPEC stated that it forecasts global oil demand to grow by 3.67 million bpd in 2022, which is a 480,00 bpd lower increase than a month ago.  Officially OPEC relates the slowdown of demand growth to the re-emergence of Omicron in China, causing major lockdowns and economic slowdown, but also on high crude oil prices. The latter is causing some demand destruction according to the oil group.

Still, looking at real figures, global oil demand is going to break the 100 million bpd level by the end of 2022 still, which would mean that global oil demand is heading to the record levels seen in 2019, pre-COVID. The IEA is expecting for Q2 2022 a demand-supply situation that is balanced, at a level of 98.3 million bpd. The OECD watchdog also expects that demand growth will flatten due to increased inflation and economic constraints.

Call on OPEC under pressure

Still, the impact of the Russian oil decline is not yet clear to most. Taking out around 3 million bpd in the next weeks will push supply to critical levels, leaving a major gap in place to be covered by others. As OPEC officials already have reiterated they will not be able to counter this in the market. The oil group in this holds a totally other position than the messages coming from the IEA or Washington are saying. The IEA still expects OPEC to fill in the gap, combined with increased US oil production. Both factors are however very unlikely.

At the present OPEC+ is producing already 1.5 million bpd less than was agreed. These shortfalls, even within OPEC itself are to be increase further. Nigeria, one of OPEC’s leading producers, has already warned that the oil group is out of real spare production capacity. The main reason for this is underinvestment in upstream the last years in several member countries, while others are still hit by internal turmoil, such as Iraq and Libya. Main other OPEC members are already since years under severe international sanction regimes, such as Iran and Venezuela.

In March OPEC reported an increase of only 57,000 bpd to 28.56 million bpd, lagging the 253,000 bpd rise that OPEC is allowed under the OPEC+ deal. In its report, OPEC indicated that Russian output will decrease by 530,000 bpd, but expects US shale oil to increase by 880,000 bpd in 2022, in comparison to 670,000 bpd last month.

Commodity traders hold key

The main dark horse at present in the market is the position that international oil majors and commodity traders will take with regards to Russian (or Russian-origin) oil volumes. The media onslaught on Shell’s Russian oil trades have caused a rethink in the market it seems. The largest oil traders are currently openly stating that they are reducing their exposure to Russian oil and petroleum product purchases from May 15 onwards. Officially the latter is being put in place for fear of potential EU energy sanctions.

However, other issues such as compliance to EU sanctions on international financial system or public opinion are also having their impact. At present, deals with Russian energy giant Rosneft are being wind down. Gazpromneft is also being hit. From May 15, most traders will be cutting any trades with Russian oil parties.

The inclusion of Russia’s state infrastructure firm Transneft, which is the owner of the key ports and pipelines, in the sanctions is also playing a major part. Traders such as Trafigura already openly has said it will be complying to all sanctions. Vitol at present is not yet clear in its reporting.

Major European refiners and ports have become reluctant to process Russian crude. The total picture is now that Russia is fighting an uphill battle to reach markets, even without new sanctions in place.

The only outlets or clients available to Russia are still in Asia or some parts of the Middle East. In a move to entice Asian clients even more, Russian president Putin has openly stated he is willing to sell crude oil and natural gas to friendly nations at any price. China and India are currently the largest recipients of Russian energy. India is still very much in the market, but Chinese parties are questioning already future Russian oil deals. The possibility of US-EU sanctions on Asian parties is already forcing Chinese refineries to reassess their options.

May decisions increase volatility?

In the coming weeks, oil markets can go into crisis mode, if Russian oil production and exports decline as expected. OPEC will not be able to provide the necessary multimillion barrels needed, while US tight oil production is still too low. Demand however is still strong enough to push up prices, maybe even to a new record level in 2022, breaking the $130 mark again. China’s fledgling economy however is holding the key to the answer.