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Crude Oil: Fog of War or Legitimate Supply Issues?

Are oil markets 'voting' (their disdain against Russia's activities in Ukraine) or are there legitimate oil supply issues?

Author: Brynne Kelly 2/27/2022

The tension between world powers over the Ukraine situation, which has developed into one of the deepest crises in East-West relations for decades, has been front-and-center for the last few weeks.

One hopeful piece of news over the weekend was the announcement that Ukraine said it would hold talks with Russia at its border with Belarus -- near the Chernobyl exclusion zone -- after a call between President Volodymyr Zelensky and Belarus leader Alexander Lukashenko. "The politicians agreed that the Ukrainian delegation would meet the Russian one without preconditions at the Ukraine-Belarus border, near the Pripyat River," Zelenskiy's office said.

Zelensky has said he will not hold talks with Russia on the territory of Belarus, where some Russian troops were stationed before invading on Ukraine's northern border.

But Kyiv said Lukashenko assured Zelensky that "all planes, helicopters and missiles stationed on Belarus territory will remain on the ground during the travel, negotiations and return of the Ukrainian delegation".

Potential Supply Issues?

Natural Gas

The fighting continued in Kyiv and across Ukraine on Sunday, the fourth day of an invasion ordered by Russian President Vladimir Putin. About a third of Russia’s gas exports to Europe are sent through Ukraine.

In Kharkiv, Russian troops blew up a gas pipeline, which Ukraine’s State Service of Special Communication and Information Protection warned could cause an “environmental catastrophe.” The authorities urged residents to cover their windows with damp cloth or gauze. A similar warning was issued to residents of the Kyiv region because of thick smoke from the oil depot blaze in Vasylkiv, where a military air base is also located. Ukraine’s gas grid continued to supply customers as of 10 a.m. local time Sunday, the operator said, adding that it may make changes to the system to reduce risks of accidents “in areas where hostilities occur.”

As you can see from the map above, Europe is highly dependent on natural gas pipeline supply from Russia. With the threat of cutting Russia off from the SWIFT payment system, its puzzling to understand how this supply can continue without a standard payment vehicle. The only respite is that these are non-USD transactions (as European natural gas is denominated in local currencies). This is much different than global oil markets that are universally denominated in US dollars.

Crude Oil

Russian ballistic missiles also struck the city of Vasylkiv, south of Kyiv, and an oil-product storage caught fire, according to Ukraine’s Defense Ministry. There were no immediate details on casualties. Emergency services reported no threat to the local communities from the fire at the facility in the village of Kryachky.

Turkey on Sunday officially recognized Russia's attacks on Ukraine as a "state of war" and said it was implementing an international treaty giving Ankara the power to limit warships' passage through the strategic Dardanelles and Bosphorus straits. Of note: the Bosporus sees nearly three times the traffic of the Suez Canal.

Ukraine has officially asked Turkey to close the Dardanelles strait — and thus access to the Black Sea — to all Russian ships. The Bosphorus and Dardanelles gives Georgia, Ukraine, Russia, Romania and Bulgaria access to the Mediterranean Sea for trade. Watch the Brent/WTI spread for any market impact as a result.

The Bosphorus strait is a natural strait, located in northwestern Turkey, connecting the Black Sea to the Sea of Marmara. Also known as the Strait of Istanbul, this water way links the European part of the city from its Asian part and thus remains as a very strategic waterway in the region. It is also one of the world’s most important chokepoints for the maritime transit of oil. Over 3 percent of global supply or 3 million barrels per day, mainly from Russia and the Caspian Sea, passes through the 17-mile waterway that connects the Black Sea to the Sea of Marmara and eventually to the Mediterranean.

Being Russia’s only gateway from the landlocked Black Sea to the Mediterranean Sea and beyond, they are a potential chokehold for the country’s navy.

The Events That Shaped Last Week

Russian President Vladimir Putin on Sunday (2/27) ordered that the country's nuclear forces go on combat alert due to criticism made by NATO countries (Western military alliance) of the war he is waging against Ukraine.

Subsequently, the European Union responded by saying that it accepted Ukraine's request to finance the supply of fighter jets from countries in the bloc. Kyiv has lost a large, if uncertain, number of fighter jets in Moscow's offensive thus far.

"Authorities of leading NATO countries allow aggressive statements against our country, so I order the Minister of Defense and the Chief of Staff (of the armed forces) to put the Russian Army's deterrent forces into special combat mode." , the president said, according to state news agency TASS.

It's unclear what "special combat mode" means, but it's the first time such an alert has happened. In his speech announcing the war on Thursday (2/24), Putin said that any foreign interference in the action would lead to "consequences never seen before".

US Ambassador to the UN Linda Thomas-Greenfield told CBS that "this means that President Putin continues to escalate this war in a way that is totally unacceptable, and we have to deflect him from these actions in the strongest possible way."

But, how did we get here? It's no surprise that the world is surprised at Putin's actions. In fact, less than 2 weeks ago even Ukraine's president was in doubt about the imminent warnings posed by the United States about an impending invasion. The U.S. stated that it had intelligence that Russian commanders have received orders to proceed with an invasion of Ukraine, with commanders on the ground making specific plans for how they would maneuver in their sectors of the battlefield.

President Zelensky went on record saying he was demanding proof from US intelligence backing the new dire allegations that Russia is poised to go in: "There has been too much information about a full-scale war with Russia – even specific dates have been announced. We understand there are risks. If you have any additional information regarding the 100 percent guaranteed invasion of Ukraine by Russia on 16 February, please give it to us," he told reporters.

Here is a look at how the headlines have progressed over the last 7 days and got us to where we are today:

Sunday, February 20

* US Secretary of State Blinken on Ukraine: Everything we're seeing indicates that we're on the verge of an invasion

* Putin told France’s Pres. Macron that provocations by Ukrainian security forces were the reason of the escalation in Donbass - RIA cites Kremlin

* French official: Putin told Macron that Russian forces will leave Belarus following military drills

Monday, February 21

* There is war in Donbass, the situation is critical - DPR People’s militia

* DPR forces clash with Ukrainian military unit that attempted to reach the border with Russia - Sputnik.

* The Russian Federal Security Service claims that a shell fired from Ukrainian territory destroyed a border guard post in the Rostov area, no casualties reported - IFAX

* Ukraine Top Security Official Danilov: We Do Not Conduct Any Military Operations against Civilian Population

* France’s Pres. Macron proposes a Putin-Biden summit, which both parties accepted - Elysée.

* Kremlin says no concrete plans for summit with Biden over Ukraine

Tuesday, February 22

* Russian President Vladimir Putin late Monday decided to support a recommendation from his National Security Council to recognize the independence of the Donbas and Luhansk republics in eastern Ukraine, ratcheting up tensions with the West and pushing oil prices higher. The decision was promptly followed by a decree sending Russian "peacekeeping" forces into the two rebel republics. The twin moves are likely to trigger the start of the process in Europe and the US to implement sanctions on the Russian financial sector and strategic industries, some of which could include portions of its vast energy trade

* Germany orders withdrawal of key document needed for certification of Nord Stream 2 gas pipeline from Russia.

* Ukraine calls for an international reaction to Russia's recognition of separatists.

* Ukraine has no claim to sovereignty, according to Russian Foreign Minister Sergei Lavrov - IFAX

* Turkey’s President Erdogan has called Russia's recognition of separatist regions unacceptable, and urges countries to respect international law. - Official Media

* UK's Prime Minister Johnson: A package of international measures will be implemented immediately against Russia, also targeting those in Russia itself.

* EU's Foreign Min. Borrell: The EU is expected to make a decision on Russian sanctions on Tuesday, sometime in the PM.

* UK's Defence Min. Wallace: Putin has chosen to recognize rebel territories in Ukraine, including territory on the other side of the line of control.

Wednesday, February 23

* US equities slumped on Wednesday after US President Biden announced further sanctions against Russia, including increased penalties for the Nord Stream 2 pipeline and its executives.

* Actions the Biden administration took on Tuesday and may take soon to punish Russia's economy over its aggression in Ukraine are not intended to hit global energy markets, a senior U.S. State Department official said.

* Ukraine's president calls up reservists aged 18 to 60 for a maximum service of one year

* Nord stream 2 contract has been cancelled - Munich RE. Russian Gas transit agreement with Ukraine ends by 2024. Nord Stream 2 dead or delay will not impact for another couple of years.

* Early Wednesday, the President of Taiwan, Tsai Ing-wen, tweeted in support of Ukraine - while making clear that any attempts by China to 'take' Taiwan, now or later, will be met with force.

* Premiums for Russia Urals crude oil against the underlying Dated Brent benchmark have tumbled to the lowest levels in 17 years, with geopolitical tensions in Eastern Europe seen as a deterrent to purchasing Russian barrels, while elevated Brent prices have helped widen the gap between sweet and sour crude.

Thursday, February 24

* Early Thursday morning, any remaining skepticism that their country would invade was put to rest, when Putin declared a “special military operation” in Ukraine

* Oil prices broke above $100 a barrel for the first time since 2014.

* US efforts are aimed at ensuring China, and other competitors, cannot weaponize supply chains against the US - Senior Administration Official

* Ukraine's Foreign Minister Kuleba claims that Russia is launching a full scale attack from multiple directions.

* Ukraine’s President Zelensky has stated that we will provide weapons to anyone who wants them.

* NATO warns that Russia's actions will have geostrategic consequences, to hold virtual Leaders meeting on Friday.

Friday, February 25

* Ukraine’s President Zelenskiy calls on Russia’s Putin to sit down to talks. We Want Peace, If Negotiations Are Still Possible, They Should Be Held – RTRS

* Russian Foreign Minister: We Are Ready For Talks Once Ukraine's Army Stops Fighting

- No One Plans To Attack Ukrainian People

- We Do Not Want Neo-Nazis To Rule Ukraine

* Italy's Draghi: EU Sanctions Will Be Finalized and Adopted "Very Quickly"; a Second Package of Measures Also Expected, Including On Members of The Duma

Sunday, February 27

* Russian planes have now been banned from flying over nearly every EU country and Canada. Germany has broken its long-standing anti-military stance and sending weapons to Ukraine. Russia is also in the process of being kicked off of SWIFT, though there will likely be caveats for energy. In response, Putin has put Russia's nuclear deterrence forces on high alert.

* Ukrainian President Volodymyr Zelenskiy said Sunday afternoon that he agreed to peace talks on the border with Belarus (without pre-conditions), after earlier rejecting the Belarusian capital Minsk as a venue.

This culminated in oil markets opening over $5.00 higher on Sunday night as traders scrambled to put a dollar amount on this conflict and the associated risks.


The market is front loading risk premium. On Sunday, Citi revised global oil inventories to be tighter in Q1 than expected because of combination of stronger demand & weaker supply. They state that 'oil balances appear to be shifting to strong builds of 1.2-mb/d in Q2, 2.2-mb/d in Q3, & over 3-mb/d in Q4'. As a result, they revised their oil price outlook upwards in 2022 by $12 to $94.00. However, they maintain a downward trajectory for prices through the year and expect prices to reach $60s by year-end. Additionally, they expect a very well supplied oil market to emerge by 2h’22, if not 2q’22. this should blunt prices even with ongoing geopolitical risks

Calendar Spreads

One spread that highlights this front loading of risk premium is the June-22/Sep-22/Dec-22 spread (June/Sep vs Sep/Dec, black line below). As of last Friday, on a relative basis the front spread (June/Sep) was almost $2.00 over the back spread (Sep/Dec). This highlights how 'temporary' the market views the current situation and are positioning accordingly.

We see the same thing in one-month calendar spreads (below). Currently, the front spread on the board is the April-22/May-22 spread which settled close to it's highs last Friday ($1.70, blue line below).

Flat Price

The strength in the front of the market has helped lift prices across the entire oil curve. The calendar 2023 futures strip has risen $42 from it's 2020 low to close out the week last Friday at $77.05. Even calendar 2024 is above $70. Keep in mind, the period between 2023 and 2024 is when the bulk of the last round of US Strategic Petroleum Reserves (SPR) barrels that were borrowed during the first quarter of this year will need to be paid back as we detailed in our November 28, 2021 report.

That initial round of SPR loans are set to end in April of this year. However, last week President Biden stated that the US will release more barrels from it's SPR 'as needed'. Additionally, Japan's PM Kishida said "we won't rule out taking extra measures to deal with the predicted spike in energy prices". On top of that, there is some optimism that a deal can be reached with Iran which will lead to the lifting of sanctions and allow Iranian oil to hit the market. The potential for such 'policy' induced supplies has so far kept WTI prices below the psychological $100 level. Beyond that, there are looming fears that even broader policy changes such as banning US exports could upend markets further.

We also have sanctions placed on Russia by US and it's NATO allies. For now, the 'intent' is to punish Russian leaders and industry without impacting energy prices.

Traders are skeptical this perfect balance is achievable.

Bottom Line

Distrust of media headlines and uncertainty about where we go from here is cause for upside risk premiums in oil markets. However, the market seems to be narrowing in on the front of the market with the expectation that either a resolution to the current conflict or increased production due to high prices will alleviate the situation at some point.

Of Note Over the Weekend

  • China is being called on by the White House to condemn Russia's invasion of Ukraine.

  • Russia: There is a high probability an Iran nuclear deal can be reached by next week.

  • The European Union has agreed to prohibit all transactions with the Russian Central Bank.

  • BP Will Exit 20% Stake In Russian State Oil Giant Rosneft, To Take Charge Of Up To $25 Billion

  • Norway's Prime Minister: Norway's sovereign wealth fund will divest its Russian holdings.

  • Most border crossings from Ukraine into Poland and significant crossing points into Moldova are severely backed up, according to the US embassy in Ukraine.

  • EU states to provide Ukraine with fighter jets, according to Spectator Index on Twitter.

  • The United Nations Security Council has called a rare emergency meeting of the General Assembly on Ukraine on Monday.

  • The UK is considering prohibiting Russian ships from entering British ports, according to the Guardian.

  • All French nationals should leave Russia immediately, according to the French foreign ministry.

  • U.S. urges its citizens to consider leaving Russia immediately


EIA Inventory Recap

Weekly Changes

The EIA reported a total petroleum inventory BUILD of 0.90 for the week ending February 18, 2022 (vs a net DRAW of 4.40 last week). However, inventories at Cushing continue to draw.

YTD Changes

YTD total petroleum EIA inventory changes show a BUILD of 4.50 through the week ending February 18, 2022 (vs a net BUILD of 3.60 last week).

Inventory Levels

Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to surprisingly below historical levels and should continue to draw as long as backwardation in the market persists.


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