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Friday, May 2, 2014

$150 Oil

Nordea analyst Thina Saltvedt is out with a note on the impact of the crisis in the Ukraine on oil and its potential to send the EU back into a recession.

Thina says “memories have been awakened of episodes in 2006 and 2009 when Gazprom halted all Russian gas flows through Ukraine, amid pricing disputes, completely cutting off supplies to Southern Europe and partially other European countries.”  The kicker is that since the oil market has minimal back-up capacity, Euro oil inventories are low and there is no real substitute in the transportation sector for oil and a halt from Russia “will spark a sharp spike in oil prices and in a worst case scenario an oil crisis”.  Bear in mind also that year-end oil supplies of the OECD members were at 10-year lows.

Consider also that imported gasoline from Russia to EU adds up to “about 620k b/d, or 69% on a net basis”, which means EU is pretty dependent on Russian oil.  

“…refined product exports to Europe increased by around 15% (130k b/d) in 2013 and this trend is expected to continue”.

Saltvedt lays out Three Scenarios (2 weeks, 2 quarters, 2 quarters and beyond):

Scenario 1: A short-term halt to oil deliveries lasting only two weeks, pushing oil prices up by 10-20% (from Q1 average at USD 108/barrel).

Scenario 2:  one-half of Russian oil supplies to Europe is locked in, but this time for two quarters. Global spare capacity will fall to lows last seen in 2008 to 2.2% of global demand from the current 3.9%. We expect that Saudi Arabia’s spare capacity will compensate for some of the losses, but with a lag. Notably the ECB will not act against EUR/USD in this scenario, since it will see the advantages of a weaker EUR towards the USD for energy imports and increasing competitiveness for Euro-zone products and services abroad.

Scenario 3: oil supply disruptions are expected to lead to a cut in oil flows to Europe by 1.5m b/d and push oil prices up to USD 150/barrel. Saudi Arabia will increase production (the spare capacity buffer will fall), and the market situation will call for an IEA Strategic Petroleum Reserve (SPR) release (see box), but with a lag. As the market is concerned that the disruptions will be more severe than in scenario 2, the price spike is followed by a huge spike in risk aversion triggering a flight to safety by financial players away from risky assets, a widening of credit spreads – recipe for broad USD strengthening and we will likely see global rates go much lower. In this case the impact on the global economy would be much larger and the EU will most likely tip back into recession. 

And to close, what does this oil price spike mean for the potential spot price of EUR/USD?: