War in Ukraine scrambles world oil markets, offers a spur to U.S. production

War in Ukraine scrambles world oil markets, offers a spur to U.S. production

Energize Weekly, March 30, 2022

The war in Ukraine is leading to a pinch in Russian oil – through operational problems and sanctions – that could lead to a restructuring of world oil markets and a boost to U.S. production.

The International Energy Agency (IEA) estimates that starting in April there will be a loss of three million barrels a day of Russian production as sanctions take hold and buyers shun exports.

At the same time, OPEC and its 10 affiliated oil-producing countries are holding to its agreement for only a modest increase in supply of 400,000 barrels a day.

Saudi Arabia and the United Arab Emirates are the two OPEC members with substantial spare capacity.

“Faced with what could turn into the biggest supply crisis in decades, global energy markets are at a crossroads,” the IEA said in its March oil market report.

“Russia’s invasion of Ukraine has brought energy security back to the forefront of political agendas as commodity prices surge to new heights,” the agency said. “While it is still too early to know how events will unfold, the crisis may result in lasting changes to energy markets.”

To be sure, Russian oil is continuing to flow due to term deals and trades made before Russia invaded Ukraine. New business, however, has dried up.

“Urals crude is being offered at record discounts, with limited uptake so far,” according to the IEA. “Some Asian oil importers have shown interest in the much cheaper barrels, but are for the most part sticking to traditional suppliers in the Middle East, Latin America and Africa for the bulk of their purchases.”

Part of the shortfall may be offset by an economic slowdown brought on by higher commodity prices and the economic sanctions against Russia, which will reduce the demand for oil.

The IEA revised its forecast for world oil demand downward by 1.3 million barrels a day for the remainder of 2022, which results in 950,000 barrels a day slower growth for 2022 on average.

Total demand is now projected at 99.7 million barrels a day 2022, an increase of 2.1 million barrels a day 2021.

The remainder of the deficit will have to be made up by other oil producers. Hopes that an accord on Iranian nuclear activities could lead to an additional one million barrels a day on the market in the next six months have faded, the IEA said, as talks have stalled.

“Growth will come from the U.S., Canada, Brazil and Guyana, but any near-term upside potential is limited,” the agency said.

Drilling activity by large U.S. independent oil companies is already up almost 20 percent since November with a moderate increase likely in the coming months, industry analyst Enverus said in a report.

In November 2022, an average of 560 rigs were operating in the U.S., by last week that had climbed to 670, according to the Baker Hughes North American Rig Count.

Nevertheless, even in the face of higher oil prices – the West Texas Intermediate (WTI) crude spot price is up 68 percent since last November to $114 a barrel – several forces are restraining rapid expansion of drilling by U.S. companies.

The U.S. operators focused on shale oil drilling expanded rapidly in the last decade boosting production but creating balance sheet losses which led to a backlash from investors.

Companies changed course cutting capital budgets and operating costs and pushing more money into dividends and stock buybacks. The trend was heightened by the pandemic, which saw economic activity and demand for oil plummet. WTI spot prices dropped as low as $18 a barrel in April 2020.

“Public operators have been reticent to changing plans, citing their relentless returning of cash to shareholders that align with demands from Wall Street,” Enverus said. “However, we believe further capital budget increases are likely forthcoming from this segment.”

Enverus is forecasting in its base case a “surge” in oil production of one million barrels a day in 2022 and another one-million-barrel-a-day increase in 2023. Under the best conditions it could reach 1.5 million barrels a day.

The U.S. produced 11.2 million barrels of oil in 2021 down from a record high of 12.3 million barrels in 2019, according to the federal Energy Information Administration.

Other brakes on U.S. production include logistical and supply chain problems and rising costs spurred by inflation.
For example, the cost of frac sand, a key ingredient in hydrofracturing shale wells, has risen about 185 percent to between $40 and $45 a ton in the last year.

“The market is getting tighter in terms of availability, pricing is higher, and then even if you can source the sand, there are issues [such as] can you get the trucks to move it to where you need it?” William Janela, Credit Suisse analyst, told Axios.
The story is the same for diesel fuel which has risen sharply to $5 a gallon for the first time on record. The fuel is used to power rigs and the engines used in fracking.

“Infrastructure limitations, inventory, labor constrains and material and service cost inflation are significant headwinds to growth,” Enverus said.

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