The Last Barrel: Was it worth it?

The invasion of Ukraine is transforming the world outlook for the supply, demand and price of hydrocarbons and the pace and cost of the energy transition. While the precise timing of future bans on Russian commodity imports are difficult to predict, a major restructuring of energy trade routes is underway. Russia has demonstrated high resilience to the unprecedented pressure imposed by the EU and the U.S. While Russian crude output is expected to remain high for the remainder of the Northern Hemisphere summer, it is expected to decline due to a countrywide economic downturn and a drop in refinery runs and crude exports. 

The country ramped up crude production in June and July following a 1 MMbopd drop in April. However, the July total almost recovered to the level seen before the start of Russia’s conflict with Ukraine in late February. The growth was driven primarily by higher refinery runs while crude exports shrank after reaching record levels that exceeded 5 MMbopd in April and May. 

Loss of supply. With the global economy teetering on recession and energy prices structurally higher, there a risk that some global supply will be lost. Europe’s push for more LNG as it looks to reduce Russian pipeline gas has pushed spot prices to record levels and is supporting strong demand for coal. At the same time, supply-chain risks are growing and inflation is increasing costs across the energy sector. With increased use of coal, further advancing the energy transition could be more expensive and potentially prove more carbon intensive. 

“It’s inconceivable that Europe will abandon its diversification strategies and return to any meaningful dependence on Russia,” said Massimo Di-Odoardo, VP at Wood Mackenzie. Based on the assumption that Europe bans all Russian commodities by the end of 2024, prices will be structurally higher. And a ban on Russian gas will be more challenging than that of other commodities. The west can live without Russian commodity exports and we are seeing a new trade balance taking shape. Increasing domestic coal production in China and India will compensate lower seaborne availability. “But the biggest risk to Russian oil production is in the long term and relates to the loss of access to western partners, technologies and services,” Di-Odoardo continued. 

Increased demand for LNG. A report emphasizes that a future ban on Russian natural gas will see competition for LNG intensifying as Europe competes with Asia for limited supply growth through 2026. Across all hydrocarbons, LNG looks the most compelling investment option over the next few years. A large increase in LNG project investment is being supported by a rapid increase in European LNG demand, with U.S. developers looking to fill the space. As a result, there is a potential for 50 million tonnes/year of new U.S. LNG capacity that will take final investment decisions over the next two years—and this could double if Europe bans imports from Russia by 2024. Despite disruptions to Russian exports, global supply chains are now emerging as the biggest concern.  

Replacing Russian gas. The European Commission has proposed a deal to accelerate natural gas imports from Egypt in a bid to reduce its reliance on Russian gas. With Egypt ramping up efforts to become a major LNG player through increased exploration, production and infrastructure. It also intends to modernization, which will put it in a good position to expand energy exports to Europe while addressing African energy demand. Owing to its close proximity to European markets as well as its success as a gas exporter, Egypt has emerged as an ideal supplier for Europe in the wake of the Russian-Ukraine conflict. 

In 2021, Egypt exported approximately 8.9 Bcm of LNG, with 63% destined for Asia and 31% for Europe. In June, the European Commission proposed a deal between EU states, Egypt and Israel. Expected to be signed at the end of June 2022, the deal will usher in a new era of trilateral trade while strengthening European energy security. 

Russia circumvents sanctions. Russia’s seaborne crude exports are flowing unabated, despite EU regulations that prohibit dealings with the country’s state energy companies. Shipments persist even as Ukrainian President Volodymyr Zelenskiy renews calls for more sanctions against Moscow. Overall crude shipments edged lower in the seven days to May 20, but showed little clear impact from the EU restrictions that came into effect on May 15. A total of 32 tankers loaded about 24 MMbbl from Russian export terminals, according to vessel-tracking data and port agent reports. That put average seaborne crude flows at 3.44 MMbopd, down 3% from 3.55 MMbopd in the week ended May 13. 

While self-sanctioning of Russian crude by European companies has diverted flows to Asia, so far it is having little impact on the overall level of crude shipments. That may begin to change in the coming weeks, after the new restrictions came into effect on May 15, though there was little evidence of a dramatic slowdown in the immediate aftermath of those curbs coming into force. 

Justification? Vladimir Putin’s justification for Russia’s invasion of Ukraine was that the NATO-leaning country was a constant threat and Russia could not feel “safe, develop or exist.” Really? What country would invade Russia? As for development, the war has essentially destroyed Russia’s hydrocarbon trade with the EU, cutoff supply chains and sent energy prices skyrocketing fueling inflation. And what about all the gas pipelines running from Russia into central and western Europe? It has also severely damaged the EU economy and sent world stock prices into a tailspin that shows no signs of abating. Oh yes, let’s not forget the unnecessary death and destruction. The question is Mr. Putin, was it worth it? 

About the Authors

Craig Fleming

World Oil

Craig Fleming Craig.Fleming@WorldOil.com