May 15 2023
Ukraine has made no secret of its plans to launch a massive counter-offensive against Russia this summer. The expected battle looks like a critical moment for the direction of the war. Its outcome is likely also to be pivotal for the direction of oil and gas markets in 2023.
Prices have normalized since the shock of Russian troops marching on Kyiv last year lit up crude and natural gas markets. Dated Brent was assessed by Platts, part of S&P Global Commodity Insights, at $129.515/b on March 9, 2022, a day after US President Joe Biden signed an executive order banning imports of Russian oil, gas and coal. The benchmark was last assessed at $75.31/b on May 12.
A few months later, Dutch TTF month-ahead natural gas prices hit an all-time high Eur319.98/MWh in late August 2022, after Russia stopped the flow of gas through the Nord Stream 1 pipeline. The pipeline and its twin Nord Stream 2 were later damaged by several suspicious undersea explosions. European gas prices are now back to Eur35/MWh and storage levels are at a healthy 62% of capacity.
Despite the imposition of sanctions on Russian commodities and price caps designed to restrain the Kremlin's capacity to wage war but keep its oil and gas flowing, markets have returned to something resembling normality. This has come after the biggest discombobulation in world energy flows seen since World War II. But everything could change on the outcome of the battle ahead.
"The outcome of this summer's battles in the Donbas will bring the international order of politics and energy to an inflection point," wrote Carlos Pascual, senior vice president, head of Geopolitics and International Affairs at S&P Global Commodity Insights and a former US ambassador to Ukraine, in a recent analysis of the situation published May 5.
Russian medium sour Urals crude -- once a staple for European refiners -- has now flooded into Asia, where customers in India and China are happy to buy at a heavy discount. Russia-origin seaborne crude exports averaged 3.76 million b/d in April, the highest since April 2022 and 22% above average pre-war levels of 3.1 million b/d, according to S&P Global Commodities at Sea data.
Defeat on the battlefield this summer could pose an existential crisis for Russian President Vladimir Putin and his government, which has failed to weaponize energy despite disrupting flows and nurturing a closer alliance with OPEC. The Vienna-based oil producer group has repeatedly rebuffed criticism from the US for cutting production and its ever-closer ties with the Kremlin forged at a time when other intergovernmental institutions are distancing themselves from the regime.
Risks abound. The US and its NATO allies have spent the last six months arming Ukraine to the teeth with sophisticated equipment from tanks to cruise missiles and training its army. But Ukraine still wants more weapons. President Volodymyr Zelensky said in a television on May 11 that the attack could be delayed until more equipment arrives. Meanwhile, Russia's military has dug in. Defensive positions along a 900 mile front have been built, while Russia's military is bogged down in a bloody battle to seize control of the strategic crossroads of Bakhmut. The eyes of the world and especially oil traders should be focused on the struggle ahead.
The logic of Saudi Arabia's cooperation with Russia on oil policy could come under closer scrutiny in Riyadh should Putin's army and mercenary Wagner militia led by Yevgeny Prigozhin be routed this summer. A Ukrainian counter-offensive could also coincide with OPEC's next production-setting meeting, scheduled for the weekend of June 4. The encounter will be closely watched by countries in the 23-member coalition, which may wish to reconsider their ties with a country now branded a commercial pariah state on the losing end of a battle.
The campaign also looks like it will coincide with an expected tightening in oil markets, pushing up prices. S&P Global analysts see market fundamentals tightening from June through September, with peak seasonal consumption and sharply falling oil inventory levels. Dated Brent is forecast to near $90/b in the third quarter, depending on levels of stock draws in May.
Beijing and Delhi too will be closely monitoring the developments of the battlefield. Russia has now overtaken Saudi Arabia as China's biggest supplier of crude. Russian oil accounts for almost 40% of Indian crude imports, which is close to the estimated maximum of 40-45% that refiners could technically process given the quality of the crude. Both countries benefit from the price cap imposed on Russian crude.
The Platts-assessed Urals DAP West Coast India was at $62.67/b May 12, a $12.64/b discount to Dated Brent. Spreads have tightened significantly since mid-January when the differential assessment -- which captures the new flows in Russian crude into India -- was first launched. India and China, which have been eagerly cementing ties with key Middle East producers, may seek to re-evaluate their energy relations with the current Russian government if it faces a catastrophic and politically humiliating military defeat in Ukraine this summer.