Strategy Note /

Who can plug the oil hole left by Russia?

  • A blanket ban on Russian energy remains unlikely, but if one occurs global energy players will need to fill the gap

  • OPEC members have theoretical spare capacity, but face fundamental and political constraints

  • Venezuela and Iran thus may become important players once again in the global energy markets

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

ETM Analytics
10 March 2022
Published byETM Analytics

What hole will a total Russian oil ban leave?

Russia's invasion of Ukraine and the massive humanitarian crisis it has created has made Russia the pariah of the world. Sanctions have been levied, companies have pulled their operations, and major global economies have shunned Russian energy products, even given the dependence that Europe has on the nation's exports. The US and UK have announced full bans on Russian crude imports, but their dependence on Russia is small and will not have a material effect on the market. Europe does not have the space to make such a move, suggesting that most of Russia's exports of 7mn bpd of crude are currently expected to survive the sanctions and bans. The question is, however, what will happen if the situation deteriorates and a blanket ban is implemented and who will fill the gap. Furthermore, what will happen once the war is over and Russia remains shunned from the rest of the world?

The usual options look very limited

Looking at current estimated spare capacity levels of most oil producers, we see that there is room to make up what will be lost if Russia is evicted from the global market. Total estimated spare capacity of global producers, excluding Russia, currently sits at around 7.9mn bpd, according to Rystad Energy data. The Saudis and the US lead the way, with the majority of producers with high levels of spare capacity belonging to OPEC. Herein lies the problem. OPEC has consistently said that they are not willing to ramp up production in order to bring prices down. They argue that the war is what has driven prices to current levels, and not their lack of output. One cannot really argue with this, especially knowing that high prices will continue to buffer their government books. The current estimated average fiscal breakeven rate for OPEC producers is at around $100 per barrel. This is elevated compared to historical levels, suggesting that excess revenues from current prices will be more than welcome as many OPEC-member governments are struggling fiscally at the moment.

Furthermore, even if OPEC has the theoretical capacity to make such a production shift, the reality is very different. The issue here is that producers have been struggling to ramp up production owing to idiosyncratic issues such as conflict, ageing infrastructure, or limited investment. In general, OPEC+ has been undershooting its quotas in recent months, with the shortfalls for the likes of Angola, Guinea and Nigeria not offset by greater output from mainstays such as Saudi Arabia and the UAE. The total compliance rate for OPEC+'s production quotas for January was 130%. This is the highest it has been in two years and underscores the actual lack of capacity. Even though there are some members who can raise supply, including Saudi Arabia and the UAE, OPEC’s policies are set up to punish those who produce more than their quotas set out at the monthly ministerial meetings. Saudi is the de facto leader of OPEC, so it will not want to set a precedent that allows for countries to ignore their production quotas without having to reduce supply later to make up for the infraction. Therefore, there will unlikely be any emergency supply increases, with another gradual increase only expected at the next meeting at the start of April.

Shale fail

The US shale industry has often been touted as a viable option for when global supply deficits deepen as a quick and efficient source of more possible output. However, the Biden administration's policies have impacted the willingness of the sector to raise output. Firms are choosing to take any windfall profits and distribute them back to shareholders rather than invest in new output. A company will not want to invest into a market where prices are expected decline and legislation is expected to tighten even further. Furthermore, the US currently faces a shortage of workers, trucks and completion equipment. This will limit the extent to which output could increase even if firms were more willing. Current estimates from CEOs of major firms operating in the Permian Basin are that the most we could see is an additional 130k bpd. While this estimate may be a little pessimistic, it is clear that no one in the industry sees scope for an increase in output to anywhere near what will be required to match the loss of global supply from Russia.

Will the US look to the lesser of two evils?

One option that is currently being explored is the lifting of sanctions on Venezuela. Venezuela sits on one of the largest oil reserves across the globe, and has significant scope to increase output to match global demands, even after years of neglect and underinvestment. Last year, Venezuela produced 800k bpd of crude. While this is nowhere near what Russia produces, it is estimated that the country could have capacity of up to 1.3mn bpd within a relatively short time frame. Longer-term, output could rise to 3mn bpd or even higher. These levels were last seen in the 1990s and even as recently as 2013, when Venezuela was a global energy powerhouse. Given new technology and investment, the country's vast reserves could become a lifeline for the global market if it is forced to survive without Russian supply. A key actor to watch here, however, is Iran. Venezuela currently imports light-oil from Iran to help it thin out its thick crude, without which it could not transport what it drills to its exporting ports.

Returning Venezuela to the global market, however, will be no easy task. President Maduro is aligned strongly to Russian President Putin. However, Russia's recent actions have potentially weakened this alliance. Maduro also knows that Russia may lose global influence due to this war, and will look to the US as a way to potentially increase his influence through the energy markets. We have seen the start of negotiations that are most likely aimed at lifting the sanctions on the Latin American nation. Venezuela has recently released US citizens that it had been holding prisoner, in what is surely an act of appeasement towards the Biden administration in order to push for the lifting of sanctions.

Trading a nuclear deal for more oil

Iran remains a major wildcard for the global energy markets. Data firm Kpler estimates that Iran had 100mn barrels in floating storage as of mid-February. This suggests that it could add 1mn bpd, or 1% of global supply, for about three months. Following this, new output could increase from around 2.5mn bpd currently to 3mn bpd over the next six months or so, with this increasing further over time. Currently, Iran's spare capacity is estimated at around 1.2mn bpd, but previous output figures suggest that its longer-term capacity could be closer to 4mn bpd, with 2.8mn bpd of this being available for export.

The Russian invasion of Ukraine has, however, complicated talks between the US and the Middle-Eastern nation. Iran's top security official has also accused the US of delaying political decisions needed to revive the deal, highlighting how tension remains high between the two. Russian officials have said that they need guarantees from the US that sanctions imposed on Russia over the invasion of Ukraine won't affect Russia's dealings with Iran. This has sparked concerns amongst diplomats, and will complicate the negotiations. However, optimism is still high that a deal will be reached soon.

What does the oil market look like without Russia?

Even though sanctions on Russian energy exports have not been fully implemented, Russian exports are falling as traders do not want to be caught on the wrong side of a trade that they cannot execute or escape. Russian oil has been offered at massive discounts in recent weeks, often attracting no bidders at all despite the reduced prices. In effect, private actors are pseudo-sanctioning Russian oil already, providing the boost to prices that we have seen this month so far.

If Russian energy flows to the rest of the world are disrupted further, we could see oil prices surge even higher, with many analysts calling for $150 to $200 per barrel. This will be unpalatable for many, causing significant demand destruction, which will lead to an eventual market correction. Until this occurs, elevated oil prices will continue to fan inflation, creating a headache for global central banks given the negative impact on economic growth.

Bottom-line: The global oil market has been thrown into disarray by Russia's invasion of Ukraine. The sanctions imposed on Russia coupled with an unwillingness to commit to buying Russian crude by most traders have sent oil prices to near record highs amid concerns that demand will continue to notably outstrip supply. The world is now scrambling to find new sources of oil, with traditional and unsanctioned sources unlikely to be able to make up any shortfall in the market. Countries such as Venezuela and Iran thus become important players in the market once again, with the current energy crisis looking to be the catalyst that sees them return to global export markets. The problem is that Russia's vast share of the global market will be near impossible to replace, especially over the near term. This suggests that a global supply deficit is likely to remain entrenched for the foreseeable future if Russia crude continues to be shunned by global market actors.