All eyes are on the European Union as it seemingly edges closer to imposing an outright ban on Russian oil imports. The likelihood of an EU embargo on Russian oil took a big step closer to becoming a reality yesterday. This came after Germany, the bloc’s de facto leader and main opponent of a ban on Russian oil imports, softened its opposition to the move. The country’s economic minister described a Russian oil embargo as “manageable” thus paving the way for direct restrictions in a matter of days.
Staying in the region, some European traders have started to pay Russia for gas sales in roubles, according to Reuters. Energy companies in Europe are said to be opening Russian accounts to pay for gas after Moscow cut off supplies to Poland and Bulgaria. In response, Brussels warned European buyers of Russian gas that they will be in breach of sanctions against Moscow if they accept Kremlin demands for payment to be completed in roubles.
Meanwhile, with European leaders locked in a bout of “will-they-or-won’t-they” regarding a ban on Russian oil, OPEC+ looks set to stick to a gradual output increase at its next meeting. Sources close to the producer group hinted that it will add another 432,000 bpd in June as previously agreed. These modest increases, together with mounting Russian production losses should ensure the supply side of the oil equation remains constrained for the foreseeable future.
All this made for a supportive backdrop for oil prices. Not even downbeat US macro data could undermine the positive mood. The US economy shrank unexpectedly in the first quarter of this year for the first time since the second quarter of 2020. US GDP fell by 0.4% in 1Q, or 1.4% on an annualised basis. Surging inflation, the Omicron variant, and supply chain problems all dragged on growth. Yet this contraction will most likely turn out to be a blip rather than a sign of things to come. The US economic recovery is still on track hence the Federal Reserve will not be deterred from lifting US interest rates sharply. Sure enough, the dollar index extended its recent surge yesterday and hit a 20-year high against a basket of currencies.
What a difference a month makes
Russian output proved more resilient than expected in March. Russian March crude and condensate production data came in at 11.01 mbpd, implying that supply dropped by 70,000 bpd compared to February. It’s a different story this month. Average production of crude oil and gas condensate between April 1-19 was 10.11 mbpd, official data showed, down 8% from March levels and steeper than the 4-5% decline forecast by the Russian government. Tellingly, on April 19, crude and condensate production was 9.86 mbpd, which is a whopping 1.15 mbpd less than the average output from the previous month and the lowest since July 2020.
Russia’s crude oil production is in a precipitous decline. And it took another step lower this week. Exxon Neftegas ceased production at its Sakhalin-1 operations. The three fields that make up the Sakhalin-1 project produce a combined 230,000 bpd of oil and condensate. Against this deteriorating outlook, Moscow took the step of announcing that it will cease providing data on output and exports. Nevertheless, it is safe to say that Russian output is currently running below 10 mbpd.
Given the large amount of self-sanctioning we are seeing with Russian oil, it is likely that output will only decline further in May and beyond as term contracts expire. What’s more, the EU is preparing a sixth round of sanctions which is likely to include specific provisions against Russia’s oil industry. This will give more reasons for Western refiners and traders to shun Russian oil. For its part, Moscow’s requests for payments in roubles is also deterring buyers. A Rosneft tender for the sale of 38 million bbls of oil with payment in roubles went unsold earlier this week.
In short, fewer and fewer people are buying Russian oil. And Russia doesn’t have space to store oil, so the lack of demand is forcing producers to halt output. Once production is shut in, oil producers might be capable of restoring only about 70% of the original output. In other words, the country is undergoing a permanent loss of supply. The longer-term impact to Russian oil output could therefore be far greater than the 3 mbpd currently forecast by the IEA.
Russia’s Finance Minister Anton Siluanov told reporters this week that the country’s oil output could decline 17% this year. If the full-year 2022 estimates come true, this projection means Russia looks set to produce an average of 9.13 mbpd this year, the lowest since 2004 and the most significant decline in production since the immediate post-Soviet era. All things considered, there can be no return to the pre-war status quo. We are past the point of no return for Russian oil production. Russian oil will not be flowing West like in years gone by anytime even if the Ukraine conflict ended tomorrow. The upshot is that the global oil balance will tighten considerably over the summer period. When it comes to Russian oil output the only way is down.