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Credit FAQ: Wild Swings In Oil And Gas Prices: What Are The Drivers And Where Do We Go From Here?

(Editor's Note: An earlier version of this report included charts with monthly fuel prices. This version reflects those prices on a biweekly basis.)

The climate for the global oil and natural gas markets can best be described as one of extreme nervousness, uncertainty, and volatility. A plethora of factors are fueling it, including concerns about supply, rising COVID cases in China, and low global inventory levels. Geopolitical events, which are always a factor in oil prices, are probably a well-above-average influence given the crisis in Ukraine. In this report, S&P Global Ratings responds to frequently asked questions on the topic.

Frequently Asked Questions

What is driving the volatility in oil and natural gas prices?

Chart 1 


Before addressing this question, it's important to understand the state of oil markets before the Ukrainian invasion. Prior to the invasion, oil prices had steadily increased owing to global economic reopenings as well as continued supply discipline from OPEC and North American producers. The latter, seemingly having found fiscal religion at the hands of investors, remained disciplined with regards to capital expenditures and focused on improving the balance sheets and distributing cash flow to shareholders. Many of them targeted a total debt/EBITDA of under 2x at a midcycle price that was somewhere around $50/barrel. Moreover, OPEC was measured in bringing back the 10 million barrels of production it removed from the market during the pandemic to stabilize falling oil prices.

Chart 2 


According to the EIA, oil consumption since mid-2020 has persistently outstripped oil production, contributing to a decline in global oil inventories in all but one month from June 2020 through February 2022. As a result, total commercial oil inventories in the OECD have fallen to their lowest levels since mid-2014.

When inventories are this tight, disruptions to supply can cause severe price swings. Hence, the invasion of Ukraine sent oil prices skyrocketing and added a high degree of angst amongst traders and buyers. Also, many commercial end users stopped buying Russian oil because of concerns about getting paid, or sanctions, or reputational reasons. This in effect, created a de-facto ban on Russian crude and resulted in Russia discounting its crude by $25/barrel to find a buyer. At one point, according to some reports, approximately 70% of Russian oil exports was having difficulty finding buyers.

Russia remains one of the world's top three producers of oil and accounts for about 10%-11% of the world's oil supply. Following a spike in prices earlier in March, oil prices plummeted more than 20% as a result of a surge in COVID cases in China, raising concerns about oil demand. We expect oil prices to remain extremely volatile in the coming months as these factors and fears about sanctions remain in focus.

Chart 3 


Similar to oil, gas prices, especially the TTF in Europe, increased as well. Economic reopenings and producer discipline helped buoy the Henry Hub in U.S. The TTF price increase in Europe resulted from unseasonable weather patterns, a lack of wind in the North Sea and western Europe, insufficient wind and solar build-out, competitive liquid natural gas (LNG) markets in Asia and Latin America, and the retirement of coal-fired utilities at a pace that was not sufficiently replaced by renewables.

What does the U.S. sanction of Russian crude mean for the U.S.?

The impact is minimal. The Energy Information Agency reports that the U.S. imported approximately 8% of its total imported oil and petroleum products from Russia, which includes 3% of total U.S. imported crude oil last year. Russian Ural crude is a heavy sour crude and we believe the U.S. can replace these barrels rather easily. The U.S., U.K., Canada, and Australia have all banned Russian oil, impacting approximately 13% of Russia's exports.

What about possible EU sanctions?

A European sanction on Russian oil and gas is a far more complicated matter. Unlike the U.S., Europe has a heavy reliance on imported oil and natural gas. Dependency on Russian oil varies by each EU country, but overall EU reliance on imported oil and gas has grown over the last decade as a result of declining investment and production of hydrocarbons. The EU imports 90% of its natural gas demand. In addition, according to Eurostat, its net import dependency for imported oil and petroleum products reached 96% in 2020. Moreover, according to the International Energy Agency, 40% of the EU's natural gas consumption and approximately 26% of its crude oil needs are supplied from Russia, and approximately two-thirds of its petroleum product imports came from Russia. Russia exports approximately 5 million bpd of crude, with approximately half finding its way to Europe. .

It would be difficult for the EU to replace Russian hydrocarbons in the short term. Abrupt sanctions of Russian energy could likely cripple many EU economies. Nevertheless, the EU recently announced it is seeking to phase out its reliance on Russian energy well before 2030. It also stated that by the end of the year it will reduce its reliance on Russian natural gas by two-thirds. How that will be done remains to be seen and some EU members, like Germany and Italy, are far more reliant on Russian energy than others. The EU is likely to look to renewable investment and diversifying its sourcing of natural gas.

Over the longer term, it's likely easier for Europe to wean itself off Russian oil versus Russian gas. Most of the natural gas supplied from Russia comes into Europe through pipelines. Replacing that infrastructure would mean importing LNG into coastal facilities and require significant build-out of new pipelines that reach deep into Europe, whereas the oil markets are more liquid and would not require such expenditures. Moreover, according to Platts Analytics, the U.S. is already supplying roughly two-thirds of its LNG exports to Europe and, despite the potential of U.S. producers drilling for more natural gas, its export facilities are operating near full capacity. Expanding those facilities would take years and billions of dollars of investment.

With oil market so tight, where could additional supply come from?

Typically in periods of supply shortages the market has looked to OPEC to make up the deficit, primarily Saudi Arabia, which we believe has approximately 2.5 million barrels of spare capacity. So far, OPEC has been reluctant to produce more oil, preferring to stick to its targets to sustain high prices. OPEC also prefers to have spare capacity as a safety cushion in case of a serious crisis. To complicate matters, several OPEC members have been unable to increase production in line with previously agreed-on targets.

With limited spare capacity, the "call on OPEC" option has become "call on shale." U.S. shale that is, and all eyes are looking at the U.S. to respond. U.S. oil production fell by more than 3 million bpd between 2019 and early 2021, according to government data, but has bounced about halfway back. Nevertheless, U.S. producers are in a bit of a quandary. They have not faced political pressure to ramp up production yet, but if they do, that could rile an investor base that is looking for returns after investing in one of the worst performing sectors in the S&P 500 prior to last year.

In the event U.S. producers are called upon to produce more energy, it typically takes 3-6 months to bring a well to production. However, oil field service (OFS) companies may not be able to respond so quickly this time around due to severe logistical hurdles. These include labor and drilling equipment shortages. The previous downturns in the industry led to broad retirement of pressure pumping and other OFS equipment, with much of this equipment being utilized for spare parts. Also, many OFS workers who were let go in the previous downturn have found other employment and it will take time to bring any new employees up to speed. Lastly, there continues to be supply chain issues that have resulted in shortages of equipment, parts, and pipes.

What about Iranian/Venezuela production?

The on-again, off-again talks with Iran have only added to the oil price volatility. With the goal of lifting sanctions imposed by the Trump administration in 2019, the Biden administration has been trying to get Iran back into compliance with its 2015 nuclear disarmament deal. If Iranian production were to come back, Platts Analytics is forecasting 750,000 bpd of production by August plus 300,000 of exports from storage. However, negotiations have been made more difficult due to Russian involvement, and apparently Russia must sign off on any agreement with Iran. If sanctions were lifted against Venezuela, approximately 500,000 bpd could find its way back on the market.

What are some of the implications due to withdrawal by several major oil companies?

Several major oil companies including Exxon, BP, and Shell, as well as major OFS companies Halliburton, Baker Hughes and Schlumberger, announced plans to exit Russia and refrain from further investments, and/or cease purchasing Russian oil. Russia oil and gas companies have relied on Western knowhow to develop some of the more technically challenging fields. Losing this technical knowhow could make it challenging for Russian oil and gas companies to develop future prospects, particularly in challenging environments such as offshore fields in the Arctic, where a large part of Arctic resources lie, or its high cost unconventional shale resources.

This report does not constitute a rating action.

Primary Credit Analyst:Thomas A Watters, New York + 1 (212) 438 7818;

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