Oil Prices, Energy Supply In Focus As Russia/Ukraine Tensions Rise

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Oil prices have continued to move higher this week with Brent and WTI benchmarks reaching the upper $80s on Wednesday.

WTI Weekly TTM

Tight fundamentals and forecasts for strong demand in 2022 have fueled the rally, but geopolitical issues are also acting on prices. This week has seen rising tensions in Europe, a drone attack on oil truck tankers in the UAE, and an explosion on a pipeline between northern Iraq and Turkey.

Although neither the drone attack nor the pipeline explosion (caused by a fallen power line) caused any meaningful damage or impact to oil flows, tensions in Europe between Ukraine, Russia and the United States remain a significant geopolitical risk for oil markets.

Here is a look at the potential for a Russian invasion of Ukraine and how this might impact energy markets.

How Likely Is Russia To Invade Ukraine?

According to Congressman Brian Fitzpatrick, a former FBI agent who was stationed in Ukraine, U.S. intelligence reports say there is a greater than 50% chance that Russia will invade Ukraine in the next month.

White House spokeswoman Jen Psaki has indicated a similar assessment from the White House. At a briefing on Tuesday she said:

“We believe we’re now at the stage where Russia could at any point launch an attack on Ukraine.”

Although the American policy-making establishment seems fairly convinced that a military engagement between Russia and Ukraine is more likely than not, others are less certain.

According to the secretary-general of NATO, there is a risk of a military conflict, but it “does not appear imminent.”

Russia’s Deputy Foreign Minister Sergei Ryabkov denies that Russia intends to send military forces across the border, stating that there are “no plans, no intentions to attack Ukraine.”

Some analysts believe Russian energy sales to Europe are too important to the Russian economy for Putin to risk any kind of disruption that an invasion might cause. Other analysts believe that Russia is in good financial and economic shape to withstand economic pushback from the U.S. and the EU which might result from an invasion.

Other analysts think that Russia does not believe the military and political conditions are appropriate for a military intervention. For example, Eugene Chausovsky argued in Foreign Policy that based on an analysis of past Russian military engagements and non-engagements, the conditions in Ukraine do not meet Russia’s standard for an invasion.

Taras Kuzio argued in a piece for the Atlantic Council that a lack of popular support in Russia for a full-scale invasion of Ukraine will keep Putin from pulling the trigger.

Potential Responses

If Russia does invade Ukraine, the West is not prepared to respond militarily. Ukraine is not a member of NATO, so the organization is not required to defend Ukraine’s borders.

President Biden has also stated that he will not send American troops to the area. However, both the U.S. and the U.K. have pledged to send “defense weapons systems” to Ukraine, with the U.S. committing to provide Ukraine with $200 million in military aid including “Javelin anti-tank missiles, Stinger missiles, small arms, and boats.”

Other than defensive military supplies, the response from the U.S. to a Russian invasion would be primarily economic and financial. The U.S. has pledged “unprecedented” sanctions on members of Vladimir Putin’s “inner circle.”

There is little chance that sanctions on individual Russians would impact the market in a meaningful way. However, some analysts think that such sanctions would push Russia to retaliate by restricting the flow of oil, natural gas and coal to Europe. That, in turn, would impact the prices of oil and gas.

Germany has threatened “consequences” for the Nord Stream 2 pipeline, a major natural gas line connecting Russia and Germany that was recently completed but is not yet operational. The German foreign minister said “this gas pipeline could not come into service” if Russia continues to escalate the situation with Ukraine.

As a last resort, nations have discussed disconnecting Russia’s banking system from the international SWIFT payment system. There are some reports that this option is off the table because it would excessively destabilize global markets, but at a press conference on Wednesday afternoon, President Biden told reporters that: “If [Russia’s] going to invade, they're going to pay. Their banks are not going to be able to deal in dollars,” which seems to imply a threat to cut Russia off from the SWIFT system.

Possible Market Impacts: Destabilization, Price Spikes

Europe’s energy supply situation is already precarious, so a disruption in the supply of Russian oil, natural gas and/or coal would be disastrous. This could plunge European countries into darkness, shutting off heat and electricity to millions of homes and businesses during the winter months.

Energy prices in Europe would skyrocket. Oil prices would be immediately impacted and would increase globally. Natural gas and coal prices across various regions would also be impacted, though less immediately and significantly than oil prices, because these commodities are not traded as globally as oil.

It is likely that high prices in Europe would help redirect oil, natural gas and coal supplies from other parts of the world to European markets. However, there isn’t enough spare capacity globally in oil and gas to fully replace Russian supplies to Europe.

According to a Reuters report, the U.S. government has already spoken with several international energy companies about creating contingency plans to supply Europe with natural gas if the Ukraine conflict disrupts supplies. (Russia supplies the EU with about 1/3 of its natural gas needs).

The companies told the White House that natural gas supplies are tight and that they don’t have enough to spare to supply large enough quantities to Europe to replace Russian gas.

It is possible that under pressure from the White House, or with special dispensations from regulations provided by the White House, suppliers could increase oil and gas production and exports, or even postpone maintenance to certain fields in order to accelerate production, but there is no indication that they have committed to such plans.

Increased supply could help alleviate high oil and gas prices, but unless detailed contingency plans are put into place before a geopolitical conflict, the market will see a period of high prices while the logistical aspects are worked out and production and exports are ramped up.

Financially, disconnecting Russia from the SWIFT system would make it impossible for EU countries to purchase Russian energy in dollars. They could potentially shift purchases from dollars to Euros, but they would still have to find a way to transfer the funds.

The move could hurt Russian energy companies and weaken the ruble . However, Russia would be able to continue selling oil and gas to China, especially since Russia already accepts payments in yuan .

According to reports, the two countries already have an alternative system to SWIFT. In fact, other countries might join the Russia-China system, negating the U.S. advantage of controlling SWIFT. This could result in more Russian oil and gas heading to China, potentially displacing Middle Eastern supplies and destabilizing the OPEC+ group.

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