Oil and Gas - Not Benefiting Much from Strong Brent, but Gaining from Weak Ruble

Even though Brent jumped above $130/bbl at one point last week (up around 70% YTD at the peak) amid an escalation in the conflict in Ukraine and sanctions concerns, we expect relatively limited gains for the Russian oil sector (except via ruble depreciation), as the Urals discount has skyrocketed to $30/bbl and domestic product prices have declined moderately in ruble terms. The pressure on prices points to substantial problems with marketing crude oil and oil product exports this month, even as media reports suggest that Russian crude oil output has increased a further 0.5% m-o-m. While there is a high degree of interdependence between Russia and Europe in crude oil and oil product supply and this is unlikely to change dramatically anytime soon, the geopolitical situation is clearly creating logistical issues even in the absence of actual restrictions.> The conflict in Ukraine and the sanctions pushed Brent above $130/bbl at one point last week, while the discount in the Russian Urals price versus Brent surged to nearly $30/bbl on March 9 (from around $1/bbl at the end of last year and $4/bbl in the first half of February), indicating significant uncertainty and risks related to restrictions on Russian crude oil flows in the future. In a way, this market reaction was similar to the surge in European spot gas prices to an unprecedented $4,000/mcm early last week. However, TTF spot has since dropped below $1,200/mcm, as European authorities did not announce restrictions on Russian energy imports. Nonetheless, the Urals discount remains elevated at just below $30/bbl, even though Brent has fallen to around $100/bbl.> European crack-spread benchmarks have actually improved for light oil products and have deteriorated further for heavy products, indicating further improvement in refining margins. However, we believe the situation with Russian oil product flows and pricing is quite challenging at the moment. Domestic wholesale gasoline and diesel benchmarks are down 16% and 10% in ruble terms in March (versus the average February levels). Given strong European product prices and the ruble's depreciation, the domestic gasoline and diesel pricing discounts to export netbacks have reached an unprecedented $700/tonne (versus the $50-150/tonne average discounts last year). Based on Russian market regulation, oil suppliers in the domestic market are entitled to domestic excise compensation (the difference between export netbacks and fixed domestic benchmarks), which effectively reduces the discounts to $200-250/tonne. This represents about 20-25% of the export netbacks. If the oversupply remains, it could exert downward pressure on retail product prices, which would be unusual for the Russian domestic product market.> The elevated discounts for Russian crude oil and oil product prices demonstrate that the Russian oil sector is not gaining much from the strong Brent. However, the substantial ruble depreciation supports the Urals price at close to R10,000/bbl, which is quite beneficial for exporters with a predominantly ruble cost base. The current Urals price in rubles is two times higher than the average level for last year.> Based on the most recent monthly industry data, Russian companies export about 44% of the crude oil they produce (4.8 mln bpd) and send around 56% to domestic refineries (6.2 mln bpd). Roughly half of their oil product output is exported (mainly to Europe). The crude oil exports mainly go through Transneft pipelines, but about 2.2 mln bpd of crude oil goes to Europe via ports and the Druzhba pipeline and another 0.4 mln is sent to Europe outside of Transneft pipelines (so 2.6 mln bpd in total, or 55% of Russia's total crude oil exports). In April 2020, during the peak of Russia's Covid crisis, around half of the overall Urals supply to Europe was redirected to Asian markets.> Europe has not yet placed any restrictions on Russian oil and gas imports. However, the material discounts in pricing show that there are indirect restrictions at play (traders cannot take all of the cargoes because of potential sanctions concerns, while European companies may prefer crude oil deliveries from other countries). Including oil product deliveries, Russian crude oil and oil product flows into Europe (including flows redirected to other markets, including the US, which did introduce a ban on oil and gas imports from Russia) currently exceed 4.0 mln bpd (40% of total Russian crude oil production). This is equivalent to about 30% of European liquids consumption. While a significant redirection in crude oil and oil product flows is theoretically feasible at some point in the future, the interdependence between Russia and Europe makes this extremely challenging over a shorter time horizon, in our view. Removing the sanctions on Iran or Venezuela, which is being discussed by the US and Europe, would also not have much of an impact on the global balance in the near term given the lack of available spare capacity in both countries.