Looming oil crisis: What now

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These moves will further increase crude oil prices, which in turn will stoke inflation across the world — particularly in the US and its allied nations in Europe, which are already reeling from inflation rates that are at their highest in decades. That is because Russia is the world’s second-largest producer of oil as well as the second-largest exporter.

The key question is: Can that gap be met? If so, to what extent and how soon? Moreover, unlike the US, Europe is heavily dependent on oil and natural gas imports from Russia. Can a US ban drive a wedge between its own foreign policy goals and those of its allies in Europe?

Why were oil prices rising even before the Ukraine crisis?

Crude oil prices have fluctuated quite sharply over the last two years. From $60 a barrel at the start of 2020, they fell to less than $20 in April 2020 owing to a supply glut in the wake of the pandemic. Since then, however, they have been steadily rising even before the Ukraine conflict caused them to skyrocket.

Vikram S Mehta, chairman and distinguished fellow, Center for Social and Economic Progress, said that, for one, the global demand was already outstripping supply. “On the supply side, there were many factors further contributing to this gap,” he said. These included:

n Russia has been holding back from providing additional supplies of natural gas to Europe. As the price of gas shot up, so did the price of oil as consumers shifted from gas to oil and coal.
n Continued underinvestment in oil and gas exploration because of the “public and regulatory aversion” to fossil fuels.

n “You can’t turn on the tap for additional supplies of oil as and when you want,” said Mehta.

n There is very limited “spare capacity” within the OPEC (Organization of the Petroleum Exporting Countries). “Only Saudi Arabia and UAE have spare capacity and they are refusing to play along as yet,” said Mehta.

It is into this already “tight” global oil market that the US ban has come into effect.

How big a player is Russia in the global oil market?

There are three large players in the global oil market, said Hetal Gandhi, Director, CRISIL Research. At 18%-19%, the US has the highest share in global output followed closely by Russia and Saudi Arabia, each with a 12% share. Within OPEC, it is Saudi Arabia that dictates. Together, these three control almost 45% of all oil. “That explains why Russia is so important,” she said.

Russia’s share in global exports is around 12%. “Russia supplies close to 5 million barrels a day to the global market and that is not an insignificant amount and a ban will immediately tighten the market further,” said Mehta.

Gandhi agreed but also pointed out that it is not just an issue of quantity alone. There are other dimensions to this gap such as the cost of production and quality of crude oil apart from the viability and cost of transportation. “For example, unlike Russian oil, Venezuela oil has more impurities and it requires a more complex type of refineries,” she said.

Then the individual country’s cost of production also plays a key role. Most new oil fields in the US produce at $40 a barrel, while those in Russia produce at around $20 and those in Saudi Arabia at around $15 a barrel.

So Russian supplies are not only the second-biggest, they are also the second-cheapest and of better quality than what a replacement like Venezuela may provide. That explains why banning Russian oil will be lead to higher costs for all concerned.

Can strategic reserves not help meet the gap?

Gandhi said strategic reserves are good enough only for emergencies. The top three countries in terms of such reserves are the US, China and Japan. Between them, they have 1500 million barrels. “At an average daily global consumption of 95 million barrels a day, that’s roughly 20-odd days of oil,” said Gandhi.

Moreover, she pointed out, it is an open question how far China will share globally.

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“That is why you simply can’t work without Russian oil supplies,” she said.

Can’t there be increased supplies from countries such as Venezuela and Iran?

Venezuela has the world’s largest oil reserves but producing oil requires more than just reserves. The country’s oil-producing apparatus is in disrepair partly due to the government’s mismanagement but also because of harsh US sanctions. Oil-producing companies are in debt and most don’t even have good quality drilling equipment, Gandhi said. Iran will not increase output unless it gets the nuclear deal with the US, Mehta said.

Production can be scaled up but it will take time, money and effort. Moreover, since individual production levels are quite low, several countries will have to come together and still they may not come anywhere close to matching the levels that Russia produces, Gandhi said.

Is there a difference in the dependence of the US and its European allies on Russian energy imports?

Yes, it is a big difference and that is what explains why the reactions of the US, the UK and the EU vary.

The US imports less than 10% of its energy requirement from Russia but European countries are much more heavily dependent on Russia.

Take the case of Germany, which is not just the most-industrialised economy but also the biggest decision-maker in the EU. While Russia accounts for 12% of all global exports of oil, in Germany it is a much bigger player, accounting for over 40% of that country’s oil needs. Similarly, Germany is also hugely dependent on Russian natural gas. Unlike India, which gets most of its energy from coal (75%) and oil (10%) and very little from natural gas, Germany gets 25% from natural gas — again hugely imported from Russia. Making matters more challenging is the issue of transportation, Gandhi said. Even if other countries were to come to Germany’s rescue by providing LNG, there will be a problem since Germany has no LNG terminals; it is completely dependent on natural gas pipelines from Russia. “You can’t build an LNG terminal in a day,” said Gandhi.