Oil Is at a Premium:
The New Reality

Since the conflict between Russia and the Ukraine burst onto the world’s news agenda in late February 2022 oil has been at a premium. As the accompanying chart shows, the price of Brent crude — a barometer for the global oil market — shot up in March of this year and remains well above US$100 a barrel, although more recently oil traders speculate crude prices might dip because of a worldwide economic recession and a general tightening of the money supply by the US Federal Reserve and other major central banks.

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Chart showing the trend in Brent crude oil price in US$ June 2021 – June 2022

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Source: Hargreaves Lansdown, June 2022.

 

With the European Union (EU) seeking to move away from purchasing Russian oil, the onus is on finding new sources. In this context, supplies from the Gulf are crucially important. This explains the reason for Boris Johnson’s visit to Saudi Arabia this past spring and President Biden’s trip to the Middle East in July.

 

Daniel Yergin, author of The Prize and a leading energy analyst, points out that the EU will need to replace approximately two million barrels of crude oil a day previously imported from Russia – much of it shipped from the edge of Siberia along the Druzhba pipeline (see map below). To make things more challenging, the infrastructure refining capacity across much of Eastern Europe is built to handle Russian crude, notably the Urals blend, so a lot of money will have to be spent on adjusting capacity for new supplies of crude. Additionally, there is a particular shortage of diesel fuel—a commodity where Russia is a significant supplier.

 

Fortunately, there is an alternative source of supply via the Adria pipeline (see map) on the Croatian coast. This is likely to fulfil an important role in coping with the demand for oil through imports from the Middle East. Yet the Adria pipeline has been starved of investment in past years and a major refurbishment is required to raise capacity. But, given the current impasse in Ukraine, there will likely be a major upgrading of this neglected infrastructure—needs must.

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Source: Financial Times, 15 March 2022.

 

In the Netherlands, Germany and the UK, this infrastructure bottleneck is less of a problem as many refineries are geared to Middle Eastern types of crude.

 

In light of the Ukraine conflict and a global shortage of oil and gas we are likely to see the major consumer nations investing in oil and gas energy until renewable sources become more widely available. After all, it takes a long time to build a nuclear power station or hydro-electric dam. They do not come on-stream overnight.

 

Global demand for oil is currently hovering at around 100 million barrels a day. A surge in demand in the Far East combined with an uptick in aviation and road transport – now returning to their pre-Covid pandemic levels – suggests that this daily total will increase by 5% over the next twelve months. Underpinning this rise in demand is the developing world; the International Energy Agency (IEA) reckons that 80% of next year’s growth will come from non-OECD (Organisation for Economic Co-operation and Development) countries. The IEA judges that global oil supply will struggle to meet this anticipated surge in demand, despite some signs that prices are starting to level off. The Paris-based energy think-tank, in its forecast for 2023, predicts that demand next year may grow by 2.2 million barrels to 101.6 million barrels a day, driven by a rebound in demand from developing countries.[i]

 

The Gulf, and in particular Saudi Arabia and the United Arab Emirates, are essentially the only major sources of crude oil to take the place of oil Europeans imported from Russia. Earlier this year, the 23 members of OPEC+ agreed to increase production levels by 648,000 barrels a day to supply the global market in July and August—a major surge in output. However, as things stand, many OPEC members are struggling to raise output levels with only Saudi Arabia and the United Arab Emirates having any substantial spare capacity. Significantly, Aramco, the Saudi national oil producer, is investing to increase its maximum daily capacity to 13 million barrels by 2027.

 

Aramco has also raised prices on its long term contracts for both its Asian (representing around 60% of all its crude exports) and European customers. The Saudi oil giant pumped an average of 10.2 million barrels a day in the first three months of this year. But oil producers such as Aramco warn that major consumers have consistently under-invested in refining and supply capacity because their focus was overly concentrated on renewable sources of energy. As Amin Nasser, Aramco’s CEO, remarked ‘The (Ukraine) crisis is just indicating to us [that] you are running the whole world with not enough spare capacity.’[ii]

 

Higher crude prices have translated into soaring revenues. In the first quarter of this year, Saudi oil revenues climbed by US$49 billion, an increase of 58% on the same period in 2021. For the full twelve months of 2022, it is estimated that the Kingdom of Saudi Arabia may generate US$250 billion in total oil revenues.

 

Around a third of all seaborne oil cargoes pass through the Strait of Hormuz, making it one of the most important shipping lanes for crude oil. Further south there is another trouble spot to oil supplies along the Yemeni coast. It is therefore no surprise that the Western allies, led by the US, recently reorganised their naval task force in the region with a view to blocking essential supplies to the rebel Houthi (Ansar Allah) fighters in Yemen, and maintaining the safety of oil tankers sailing along the coast.

 

In practice, the Ukrainian conflict has obliged the major oil consuming nations to review their sources of supply for the crucial hydrocarbons that power their economies. Integral to this review is a new onus on security of supply, and military backing to ensure reliable supplies of oil and gas.

 

28 June 2022

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References

 

[i] International Energy Agency, Oil Market Report - June 2022, IEA, Paris, June 2022, https://www.iea.org/reports/oil-market-report-june-2022.

[ii] Roula Khalaf and Tom Wilson ‘Energy shock shows need to rethink green transition, Aramco chief says,’ Financial Times, 23 May 2022, https://www.ft.com/content/f8cc1070-abbe-4489-9c4d-1569eb836195.