The world is facing an oil shock that is unmatched in history

The oil market is facing a totally unexpected situation and one that is unparalleled in modern history. In just over a year, this market has undergone an absolute and radical turnaround. If in mid-2020 the problem was the lack of space to store all the oil that was left over (consumption collapsed with the pandemic), now crude oil has become a scarce commodity. The world is facing an unprecedented shock comparable by its nature. This supply problem can even generate scarcity or rationing of some derivatives oil such as diesel, as recently warned by several traders From the market.

A barrel of Brent oil is trading at the end of this week in the $120 area, multiplying its price by more than six since the worst of the pandemic in 2020. However, crude oil could still be far from its peak. The intensification of the war in Ukraine may force Western countries to impose new sanctions that include oil, which will undoubtedly push up the prices of Brent and West Texas even more (and lead us into a recession, according to the team). of Commerzbank research).

Experts from the German bank comment in a note published this Friday that a total embargo on Russian crude “is by no means off the table (Germany has already presented its roadmap to reduce Russian oil imports to zero). In In particular, if the situation in Ukraine continues to deteriorate, pressure to stop oil imports into the EU is likely to increase again.” It is a double-edged sword. Hurting Russia with an embargo also means hurting (a lot) the European economy: Russian gas and crude oil are key to the Old Continent.

Taking all of the above into account and the fact that no one knows for sure where the conflict in Ukraine is heading, it can be concluded that this oil shock is unmatched throughout history by its very nature (sanctions and repudiation of oil from the world’s second largest producer), they assure from the raw materials team of the Dallas Federal Reserve in an analysis published this week.

“Traditionally, oil supply shocks have arisen because of internal or social conflicts in oil-producing countries or because a military conflict has destroyed oil production facilities and industry, as was the case with the invasion of Kuwait by Iraq in 1990,” explain economists at the Dallas Fed.

On the contrary, the supply shock this time is different and its duration is an enigma: “The main reason why Russian exports of crude oil and refined products are suffering since the invasion of Russia is because of the refusal of financial institutions to support such transactions. The developed world has turned its back on Russian oil almost entirely (the spread between Brent and Urals crude is already over $30). Later, the US and the UK decided to officially veto Russian oil, but the damage to exports had already been done beforehand.

Oil out of Russia

To this must be added some specific events that are approaching the supply side to a perfect storm. From Julius Baer they comment in a note that “due to alleged storm damage, a key export terminal for oil from Kazakhstan has been closed, which is depriving the market of much-needed supplies.”

Kazakhstan is a major oil producer that relies on a pipeline linking the Caspian Sea oil fields to Russia’s Black Sea oil terminals for its imports. Earlier this week, the port operator assured that due to storm damage, the terminal would close for repair and maintenance work.

“Obviously this disruption comes at a very unfortunate time for oil buyers… There are alternative trade routes, such as through the Caucasus, but these routes can only marginally offset the shortfall. The risks of an oil price increase from longer duration are increasing considerably,” they say from Julius Baer. This makes Western countries accelerate the search for alternatives to Russian oil and that of its allies (Kazakhstan is a country very close to Moscow), although for now this search has not borne fruit.

Are there real alternatives?

The alternatives to replace Russian oil are deficient to say the least. On the one hand, OPEC has been reluctant to even try to replace Russian crude with its own production (particularly from Saudi Arabia and the United Arab Emirates) if they could do so. On the other hand appear Iran and Venezuela, whose oil is also under sanctions. Even in a scenario of rapid lifting of these sanctions, these countries cannot multiply their oil production overnight. Not even using their full potential can they supply the more than 3-4 million barrels a day of Russian crude oil and derivatives that the International Energy Agency calculates will disappear.

In this way, the only quick and real solution is the release of strategic reserves, although its impact will also be limited. According to calculations by the Dallas Federal Reserve, the US could release up to 4.4 million barrels of crude per day from its Strategic Petroleum Reserve (SPR), but only for about three months (the IEA is studying another possible release of reserves in a coordinated way). Additional volumes could be released after that period, but at a much slower pace.” So there is no real alternative in the short term if the war continues and the sanctions are prolonged.

“Thus, unless the Russian oil supply shortfall can be contained, it seems necessary for the price of oil to increase substantially and remain high for a long period to eliminate excess demand for oil (demand destruction). peak price would depend on the size of the oil supply shortfall. this demand destruction be favored by the recessive effect of the higher prices of natural gas and other basic products, especially in Europe”, they assure from the Dallas Fed.

also the gas

“Another dimension in which the current event differs from historical precedent is that the reduction in Russian oil exports has been preceded by a cut in Russian natural gas exports to Europe. Natural gas is used for home heating, for power generation, and in industrial production. For example, it plays a central role in the production of fertilizers. The resulting price increases to varying degrees have spread throughout the world through the liquefied natural gas trading“, comment the experts of the Dallas Fed.

This, in turn, leaves the European Union somewhat cornered. At first glance one might think that Europe has the capacity to cushion the impact of the scarcity of natural gas and oil by using more intensively nuclear and coal power plants, but the truth is that “Europe also depends on Russia for 40% of its coal supplies and, more importantly, for natural coal and enriched uranium,” the Dallas Fed report said.

For example, Spain has large reserves of uranium, but the obstacles to its exploitation prevent its use and make us dependent on imports of Russian uranium (38% of imports) to keep the country’s nuclear power plants in operation.

Finally, and to complete the overview, it is also relevant to study the impact on food, which gives this shock another differentiating air compared to those suffered in the past. The effect of the Russian invasion is not limited to energy markets. Russia and Ukraine together account for 29% of world wheat exports.

The disruption to Black Sea exports coupled with financial sanctions on Russia mean supplies of wheat and other grains are more than likely to shrink in 2022 and beyond. The decrease in supply, together with the shortage of fertilizers produced from natural gas, will push up world food prices and reinforce the inflationary effects. The Dallas Fed believes that “bad” inflation is here to stay, largely due to this supply shock that has no comparison in history.