One year on – and with the confrontation along the Ukraine/Russia border potentially coming to a head – the math hasn’t quite played out. At home, elevated pump prices are dominating the headlines, and runaway inflation rates already at multi-decade highs look set to accelerate further as supply chains struggle to cope with a spurt in energy demand. With looming mid-term elections, and the control of both the Senate and the House of Representatives at stake, that energy dynamic is seeing a near complete reversal, triggering talk from Washington of ill-conceived moves like a reestablishment of a ban on US crude exports.

Global gas prices have surged past recent peaks as Europe sucks in higher volumes, potentially irking some of the US’ existing clients in the region and in Asia – mostly all emerging nations that are already dealing with their own battles of rising costs and public discontent. On top of all this, a crisis brewing thousands of miles away risks derailing a domestic agenda that was perhaps closest to the heart – the energy transition. 

Can the US meet the rising call on its oil?

Claudio Galimberti, Senior Vice President of Oil Markets, Head of Americas Research:

"First, the macro picture. Oil markets are understandably rattled by the rising confrontation with Russia as it is the world’s second-largest crude oil producer after the US and the second-largest exporter after Saudi Arabia. But the unease is even more so due to OPEC+ and its inability – or dare I say, unwillingness – to close the current supply gap. Crude markets are manifestly in short supply, with a deficit of around 1.5 million barrels per day (bpd) in January, as demand averaged 82.2 million bpd against supply of 80.7 million bpd. This spread is set to widen to more than 2 million bpd over summer.

I argue that this shortage has been single-handedly engineered by Saudi Arabia and its key allies, primarily the UAE.

Why so? Rystad Energy estimates that the Kingdom currently sits on more than 2 million bpd of spare capacity, and the Emirates on 1.1 million bpd, with a total of 6.1 million bpd for OPEC+, excluding exempted members such as Iran, Venezuela, and Libya. Yet OPEC+ didn’t increase its production, even from the skimpy 38.1 million bpd delivered in January against the pledged 38.8 million bpd, and on 2 February only rubber-stamped to roll-over its previously agreed 400,000 bpd increase for the month of February. Too little, too late. I firmly believe that the Kingdom and its allies have been growing comfortable with the current lofty oil prices. In fact, while $90 per barrel Brent is quickly restocking their government coffers with US dollars, it appears to no longer trigger – or at least not yet – a disproportionate response from US producers, or a visible destruction in oil demand. I think that this strategy may in fact turn out to be short-sighted.

Before turning to the US, let’s review Russia. I do not believe that a war between the military superpower and Ukraine, with a potential indirect support from NATO, would result in disrupting oil production in the Siberian fields. It could, however, put at risk some of its crude exports. The Southern Druzhba pipeline flows through Ukraine (250,000 bpd of throughput), while the port of Novorossiysk (460,000 bpd) is just off the east of Crimea and south of the Sea of Azov – a possible epicenter of any confrontation given its location along the border of the two countries, although Russia is most likely to gain the upper-hand in this territory. A conflict could also trigger an increase in oil demand by raising the natural gas price further and thus driving the switching from gas to oil in the power generation sector – we already saw this phenomenon in some Asian countries in 4Q2021, which resulted in approximately 500,000 bpd of additional demand. 

The last thing oil markets need right now is an additional supply outage or an unexpected demand increase. Against that backdrop, the key question is whether the US may partially or fully fill this gap, and if so, by when? It is a matter of timing, or more appropriately timeliness. Rystad Energy forecast that US oil production will increase by 900,000 bpd – from 11.7 million bpd to 12.6 million bpd by December this year. Yet – and this is crucial to note – our expectation is already baked into our global balances outlook, showing a tightening crude market in 2022. What could then change in the event that oil prices stay in the upper $80s and lower $90s per barrel through the rest of the year, as highlighted in our bull case? Very little in the short term, as production response takes time. We estimate that December 2022 exit rate is only going to be 200,000 bpd higher than the base case, and this difference is not going to tip the global crude balances. However, US producers would hit the pedal in full throttle in 2023, resulting in a colossal production increase of approximately 1 million bpd by the end of 2023 – despite investors demanding higher return and oil bosses pledging firm capital discipline. This in turn would flood a likely oversupplied global market by then – especially if a nuclear deal is reached with Iran. Sounds familiar?

This explains my earlier comment about OPEC’s strategy being myopic. I will also add that any move by the US government to release crude from the Strategic Petroleum Reserve (SPR) at any point in time in 2022 – like the one carried out last November – would be totally useless to quell a price rally, given the temporary nature of such an action and the structural shortage in the market.

In a nutshell, these are the key variables I see playing out in the coming weeks:

• Oil markets face growing risk of further tightening in 2Q and 3Q

• OPEC+ looks comfortable with this bullish oil price outlook despite having sufficient spare capacity to respond

• A military confrontation in Ukraine would further tighten the market balance by disrupting parts of Russia’s export capability and increasing oil demand

With high oil prices, US producers will respond, but the impact, which would be massive, won’t be evident until 2023. Although the US is an energy superpower, the Biden Administration has no margin of maneuvering to reduce oil prices in 2022 – this lies entirely in OPEC’s hands

Gas market dislocation & distortion

Emily McClain, Vice President of Gas Markets:

"European gas prices have surged, increasing back above $30 per MMBtu in the wake of the heightened tensions. This, paired with current storage inventories in Europe continuing to remain below the five-year average, has resulted in significant global market uncertainty this winter. However, I expect the US will be partially shielded from the international tensions, with an improved production outlook for 2022 keeping the Henry Hub price at around $3.50/MMBtu.

European prices of TTF will skyrocket if Russian supplies are cut off and we will see a dynamic switch, wherever possible, from gas to all other energy sources – more hydro, biomass, coal, nuclear and liquids. If Russian gas supply is upended, heightened uncertainty and concerns will push up US prices as well – but I do not expect them not remain capped overall, after perhaps a brief surge to $4.50 or $5.00, since the US already has healthy storage inventories and steadily rising supply levels. Rather, I argue that US gas price volatility resulting from market uncertainty would have to be short-lived. Why? The US simply does not have sufficient infrastructure in place or planned. This concern has now been increasingly risked across all gas basins and stems from a lack of investment, along with political and environmental challenges that have hindered progress on several proposed projects.

Europe, however, will need a significant supply of incremental LNG as domestic production is already strapped. In theory, US gas output could ramp up further, but US LNG export facility utilization rates are already maxed out. That’s creating a perfect condition to see more US cargoes getting re-routed to Europe from Asia and other places. Our data shows US exports make up nearly half of the total share into Europe, but it will be difficult to say how much more could be rerouted and from where. US LNG export volumes to other regions have been declining across the board with Asia and South America both falling 60% since their peak in July 2021. Over this same time period, Europe has continued to increase its share of US cargoes, making up over 55% of LNG exports from the US. This uptick has been the primary driver for the increase in total LNG export volumes.

Since US LNG feedgas facilities are already operating at max, any impact on US gas markets will be the indirect result of higher oil prices associated with geopolitical premiums amid an escalation in tensions. Rerouting volumes to Europe and away from other gas-deprived regions is a stark reminder of the current gas supply crunch and the serious impact it can have on key demand centers. Given the supply imbalance and sky-high prices in Europe and Asia, the call on the US to build more infrastructure to connect low-cost natural gas to global markets is growing sharply. While the need is immediate, it will take a few years before any meaningful ramp up in infrastructure and export capacity is realized, keeping markets on edge for now. 

In summary, here are the some of the key gas market variables I see playing out in the coming weeks:

• The US gas market is partially shielded from international tensions given strengthened supply and healthy storage inventories

• Higher gas prices will be short-lived as there is not adequate infrastructure to handle a strong supply response if prices remain elevated

• LNG facilities are operating at maximum capacity, limiting the ability of the US to provide additional volumes. Instead, existing LNG supply volumes will continue to reroute to Europe and away from regions like Asia and South America, forcing global markets to remain tight

From the oil and gas and energy perspective, a culmination of factors – some unexpected and some beyond control – mean the stalemate with Russia may come home to bite the US administration in more ways than one. Returning the spotlight on an industry that Biden and his team promised to move away from risks alienating his party’s younger and more impatient voters, who have called for swift action on climate change. At the same time, high gasoline prices and rising inflation could mean he will not get the same level of support in the mid-term elections that he got in 2020.  

The administration is finding out the hard way that navigating the transition right in the middle of an energy crisis is filled with challenges and tough trade-offs. In fact, any region or country in the middle of a transition faces the risk of a crisis, especially in circumstances that are beyond their control. Europe is a classic example - it has significant renewable resources in its energy mix, which should make it more robust to external pressures, but its energy balance can crumble at any time due to its dependency on fossil fuels imports.

In essence, while the energy transition remains the long-term goal of the US administration and will take time to unfold, the current energy crisis sternly confronts us with the reality of high prices and tight supplies, which forces us to acknowledge the absolute necessity to be investing in fossil fuel through the transition and to get the timing right, in order to successfully shift away from traditional sources toward a future of renewables.

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