Part 2: EU Sanctions, OPEC Policy and Energy Prices

On the 3rd of June, the European Union implemented its sixth package of sanctions against Russia in response to Russia’s invasion of Ukraine.?

As part of the latest round of sanctions, EU announced that they would ban all imports of oil from Russia that are brought by sea. The sanctions, which are set to take place in a phased-out manner by the year-end, could cut EU countries oil imports from Russia by up to 90%. The specification to ban sea-based imports has been made to temporarily help countries like Hungary and Slovakia which are highly dependent on imports via pipeline as these imports would be harder to replace. However, Germany and Poland, which also import Russian oil by pipeline, say they will stop doing so by the end of this year.?

All in all, EU states have been importing 2.2 million barrels per day (bpd) of crude oil from Russia and 1.2 million bpd of oil products. The EU’s President says the sanctions will effectively reduce the EU’s oil imports from Russia to 10 or 11% of its current level.

Prior to the announcement, the global oil market was in a supply deficit of close to 1 million bpd. Following EU’s announcement, the Organization of Petroleum Exporting Countries (OPEC) decided, in its June 2nd Meeting, to modify their production increase deal to increase quotas for a production increase of 648,000 bpd in July and Aug, up from the previous 400,000 bpd monthly increase being followed in the previous meetings.

While this sounds like a big number in theory, let’s examine this a bit more closely. While OPEC has been increasing their quotas each month by 400k bpd, the actual increase in production has only been around 100-150k bpd in the last few months, primarily from Saudi Arabia. This is because of the remaining spare capacity, or the amount of room available for members to increase production for it to reach each member state’s maximum production capacity.

By July 2022, the remaining spare capacity of OPEC member states is expected to be around 1.6 million bpd, split mainly between Saudi Arabia and UAE. Given that the stipulated quota increase is split among members who don’t have the capacity to increase production, the actual increase in the months of July and August is likely to be around 340k bpd rather than the headline number of 648k bpd.

Saudi Arabia in particular is expected to average 10.9 million bpd of production in July-September, reaching 11 million bpd in August, out of its full capacity of nearly 11.5 million bpd. Saudi has only produced above 11 million bpd in November 2018 and April 2020, so it remains to be seen how long this level of production can be sustained and even more so if this increased production can be translated into higher exports.

All of this means that the additional OPEC+ supply will not be enough to offset Russian losses. With the odds of an Iran Nuclear Deal looking increasingly weak, it’s hard to find any remaining sources of supply to overcome the deficit.

The extremely tight nature of crude balances also means that the market will be very sensitive to short term supply shocks and future increases in demand. Summer driving, Atlantic hurricanes and winter heating demand will all be crucial themes driving oil and product prices going forward.