Last week started well enough for the oil market. Brent scrambled above $70/bbl for the first time in two months. Alas, the positive momentum proved fleeting. A mid-week wobble consigned the two leading crude markers to their first weekly drop in four. Underpinning the angst among oil bulls was the runaway spread of the Covid-19 virus in India. The country has been more or less paralysed by a brutal second wave. That said, the rate of positivity is showing signs of easing, though daily new infections remain alarmingly high. What’s more, daily deaths are still holding above 4,000.
Sentiment was also given a knock by reports the US and Iran have made progress on reviving a nuclear deal. Diplomats taking part in talks expressed optimism that an agreement would be reached. Iran’s president subsequently declared that Washington was ready to lift sanctions on his country’s oil. All in all, it seems to be only a matter of time before the sides involved put pen to paper on a new nuclear accord. Or perhaps not. Fresh doubts of a breakthrough emerged over the weekend. To begin with, the Biden administration said it had not yet seen whether Iran will comply with its nuclear commitments. And secondly, the speaker of Iran’s parliament revealed that the UN’s nuclear watchdog would no longer have access to its nuclear sites.
In any case, the spectre of Iranian sanctions relief looms large over the oil market. Indeed, investors are bracing for a fresh wave of what will surely be heavily discounted Iranian crude. Indian and European refiners are reportedly already making preparations to buy Iranian oil in the second half of this year. Yet for all this alarmism, an aggressive ramp up in Iranian production and exports is unlikely to stall the drawdown in global oil stocks. Additional supply from Tehran is poised to be absorbed by the market as a result of a vaccine-spurred surge in demand over the coming months.
In view of this, the price outlook is still skewed to the upside. Option bets on oil prices rising above $100 for the December 2021 Brent contract have jumped, with open interest on calls nearly tripling in May, according to JP Morgan. In the meantime, the European crude benchmark will have its sights on overcoming the $70/bbl barrier. Yet this will not be plain sailing. Pricing pressures are delicately balanced amid a tug-of-war between the reopening of the US and European economies and a wave of fresh Covid restrictions in Asia.
Russia steps on the gas pedal
Russia has been making headlines for all the wrong reasons over the past month. First, there was the build-up of Russian forces on the eastern Ukrainian border. Then there was the cyber-ware attack on the Colonial Pipeline for which the Biden administration held Russian hackers responsible. All the while, the non-OPEC heavyweight has drawn the ire of its OPEC+ peers after falling foul of the group’s supply cut pact. In short, Russia is firmly back on the naughty step.
Moscow has fought for and won concessions from OPEC+ for small increases in its oil production every month since the start of the year. Even so, the largest non-OPEC partner in the alliance has increasingly flouted its cap over the last several months. By its own admission, Russia’s compliance with the OPEC+ supply cut pact was below 100% in April. The country was permitted to increase production by 130,000 bpd in April but instead produced 10.46 mbpd, up from 10.25 mbpd in March.
Russia has since said it will strive to stick to the accord. Under the terms of the OPEC+ agreement, each country must compensate for any excess production with cuts of equivalent volume below its quota by the end of September. Estimates for Russian total overproduction currently stands at around 1 mbpd. It is inconceivable to think that Russia will trim production over the summer months to account for its non-compliance. Quite the opposite. From this month to July, Russia has got the green light to further increase its output by 114,000 bpd.
And it’s not wasting any time. Russia’s oil and gas condensate output from May 1 to May 10 rose to an average of 10.51 mbpd from 10.46 mbpd on average in April. What is more, it is also ramping up crude shipments. Russian Urals oil exports from Baltic ports rose by 25% between May 1-10 compared to April 1-10, Reuters calculations showed. Furthermore, Russian oil pipeline monopoly Transneft recently said that crude oil exports via the Druzhba pipeline are seen rising 10% month-on-month in May to 3.1 million tonnes, Interfax news agency reported.
So, why the mad dash to boost output? Well, for starters Russia has repeatedly outlined protection of its market share in the international market as one of its main goals for 2021. But there is a more pressing issue, namely the view that oil consumption will peak much sooner than previously expected. The fallout from the Covid-19 pandemic will, among other things, accelerate the energy transition towards a low carbon future. Decarbonisation plans are being fast tracked in developed economies much to the unease of Russia’s oil industry. Russia remains poorly positioned to take advantage of the global energy transition to cleaner and renewable sources of energy. After all, Russia’s electricity generation from renewable sources, excluding hydropower, will be just 1% by 2024.
All in all, Russia is signalling that it is preparing for a permanent decline in crude demand by making the most of its oil resources while it can. But Russia’s crude supply growth prospects are limited. According to the Energy Ministry’s base-case scenario, production levels will gradually increase, but not to pre-pandemic levels, reaching an estimated 11.1 mbpd by 2029 before ultimately dropping to 9.4 mbpd in 2035. In other words, Russia may have passed peak oil output. Because of these projections, Russia needs to monetize its oil wealth while it can. A revised oil strategy will see Russia maximize monetization from crude exports prior to reaching peak production levels between 2027 and 2029. Russia knows that the fossil fuel era is nearing its endgame and will endeavour to sell every drop of the black stuff that it can.