Russian Oil Could Recover to Pre-war Levels, Despite Western Sanctions

By: Harry Altham, Energy Analyst, Market Analysis EMEA & Asia

Mon, 20 Jun 2022, 11:26

Russian Oil Output Could Recover to Pre-war Levels, Despite Western Sanctions

Harry Altham

Energy Analyst, EMEA & Asia

The oil complex has found support after a dramatic selloff on Friday. At one point, Brent had lost $9 in the space of eight hours, amidst concerns of an escalating inflation crisis that is causing increasingly negative economic forecasts. Though there is widespread consensus that demand destruction is not expected to be a major factor in energy markets until after the summer, demand in the United States is below seasonal averages and beneath predictions by the IEA; petroleum products supplied trail forecast demand by around 1.1%, which equates to around 100k bbd. The response by the FOMC to raise the fed funds target rate by 75bps was designed to demonstrate to markets that the Federal Reserve will control the general price level, but markets are now assessing decreasing job vacancies and sky-high energy input costs as barriers to economic growth. As wages become increasingly stagnant, we believe inflation will start to have a marked effect on oil product demand, and this might be most visible in U.S. gasoline and kerosene markets (the U.S. is heavily dependent on gasoline for transport). This could see a sharper than usual post-summer seasonal decline in demand, which could prevent average Brent prices reaching the $150 Q4 price forecasts made by JP Morgan.

Russia's production has surprised its own energy minister

Russia’s oil production is on course for full pre-war recovery, as demand from China and India grows despite Western sanctions on Russia. Chinese imports of Russian oil reached a record 2.03M bbd in May, even as domestic demand wobbled due to COVID lockdowns and stop-start attempts to exit restrictions. This is up from 1.6M bbd in 2021 and makes Russia the largest source of oil for China, overtaking Saudi Arabia (1.89M bbd in May). Meanwhile, India imported 740k bbd from Russia in May, which is 8.4 times more than the 88k bbd imported in 2021; both countries are expected to increase imports further as the huge discounts on Russian crude secure strong margins for refineries. The increase in demand from Russia and China covers 28% of Europe’s pre-war demand for Russian oil, and the rise in exports to Asia has enabled production to rise to 10.71M bbd in the first half of June (5% increase versus May’s 10.2M bbd). Russian Prime Minister Alexander Novak now expects Russia’s output to be above 11M bbd by the end of 2022; this represents a dramatic shift from the 17% decline in production he predicted just two months ago. However, we believe Europe’s declining demand for the remainder of 2022, possible demand weakness due to COVID in China, and relatively limited alternative markets in Asia could limit Russian production growth. Output above 11M bbd would substantially help to balance oil markets amid tight global inventories and robust demand; we will continue to monitor production data as Russian oil is a critical cog in the global oil wheel (Russia is the third largest producer, and second largest exporter of oil globally behind Saudi Arabia).

Source: Russian Energy Ministry, StoneX

MANAGED MONEY BULLISHNESS GROWS IN DIESEL MARKETS

Hedge funds have increased the net long in both NYM Heating Oil and ICE Gasoil, in a sign that last week’s price weakness failed to deter longer-term concerns around fundamental tightness in global diesel markets. In Gasoil, 96.5% of fund open interest is long, which we believe demonstrates an extremely bullish consensus among market participants; funds have not been this long relative to shorts since 26th October 2021 (98.3%). That said, Friday’s selloff saw Brent and WTI move beneath their 50-day moving averages for the first time in a month, and both benchmarks entered oversold territory intraday for the second time since December (other time being 5th May). We believe any further negativity in oil markets (if at all) will revolve around Fed Chair Jay Powell’s meetings with both houses on Capitol Hill this week; he is expected to be questioned on the consequences of rising interest rates on the economy, including wages and employment rates.

Source: ICE, StoneX

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