Oil markets head for horrendous summer with Russian production set to plunge

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  • Despite tough economic sanctions, Russia’s oil exports have increased this year as India clawed back its crude.
  • Yet analysts say Russian production is set to plummet as the EU prepares to ban around 90% of imports by the end of the year.
  • The impending decline is setting oil markets up for an “incredibly tough” summer, according to consultancy Kpler.

Despite Russia’s brutal invasion of Ukraine, the world has been unable to quell its desperate thirst for pariah state energy.

Quite the contrary: Russia now exports more oil than before the outbreak of the war, and soaring prices mean that it rakes in about $20 billion a month from foreign sales.

But the European Union’s agreement to ban most Russian oil imports should change all that. Analysts predict that Russian production will fall by around 1-2 million barrels per day, or 10% from current levels.

Oil prices have jumped more than 50% this year to around $120 a barrel, pushing gas prices in the United States to record highs of $5 a gallon.

Still, the oil market is heading for an “incredibly tough” summer, analysts say. The drop in Russian production will be felt, but demand will remain high as post-pandemic travel continues to rebound.

Russia’s oil exports have increased with the arrival of India

While other buyers shunned Russian crude, India stepped in to the rescue. Attracted by deep discounts on the Russian type of oil from the Urals, its purchases have increased from near zero to more than 800,000 barrels a day.

Russia has exported 7.8 million barrels of oil a day on average over the past three months, according to estimates by the International Energy Agency. This represents an increase from 7.5 million barrels per day in 2021.

Yet sales to Europe are about to take a dive. After much wrangling, the 27 EU members agreed in May to cut Russian oil imports by up to 90% by the end of the year.

The most worrisome thing for the market is plans by European governments to block ships from insuring Russian oil shipments, according to Claudio Galimberti, a senior analyst at consultancy Rystad Energy.

“It’s probably the most important measure,” he told Insider, especially if the UK goes ahead with its ban. “There aren’t many alternatives to London insurers at the moment,” he said.

As Russian exports fall sharply, facilities in the country will reduce production. Production, which stood at just over 10 million in May, will fall by around 1 to 2 million barrels a day, analysts estimate. The IEA goes so far as to suggest 3 million a day.

The production cuts will likely occur towards the end of 2022. But the markets are looking ahead and traders know they are coming.

“The immediate effect right now is going to be an incredibly tough, incredibly tight summer,” Viktor Katona, an analyst at energy analytics firm Kpler, told Insider.

Demand shows few signs of slowing down

The void will be difficult to fill. Although the OPEC+ group of oil-producing nations agreed to increase production earlier this month, the deal did little to stifle rising prices. An Iranian nuclear deal, which could unlock more barrels, seems a long way off.

Meanwhile, demand shows few signs of slowing. A record rise in gasoline prices has deterred some drivers, but not many.

“It’s really more a case of demand erosion in our view than demand destruction,” Suzanne Danforth, research director at energy consultancy Wood Mackenzie, told Insider.

“Gasoline demand, for example, is down maybe one percent from last year.”

The combination of lower supply from Russia and strong demand is a recipe for even higher prices, analysts say. Katona expects Brent to rise to around $135 a barrel this summer and stay there for months. Meanwhile, Goldman Sachs predicts Oil will hit $140 and could rise.

There are no easy options. With little hope for supply growth, a central bank-induced recession might be the only thing reducing demand.

“Insanely high interest rate hikes are coming — basically, that’s the best hope for lowering oil prices,” Katona said.

Read more: As Inflation Soars and the Fed Hikes Rates, UBS Explains Why It Sees a ‘Higher for Longer’ Oil Price and How Investors Can Take Advantage

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