Oil Tops $120 as Traders Assess Likely Demand Destruction

Liubov Georges
By  Liubov Georges , DTN Energy Reporter

WASHINGTON (DTN) -- Oil futures nearest delivery on the New York Mercantile Exchange and Brent crude traded on the Intercontinental Exchange pushed higher in early trade Tuesday, with both the U.S. and international crude benchmarks trading above $120 per barrel (bbl) as market participants reassess long-term implications of geopolitical risk on global supply balances and potential for demand destruction from sustained high oil prices.

Demand destruction is the only factor that could rebalance the oil market at the current moment, according to analysts from Goldman Sachs, as production from OPEC and non-OPEC countries are likely to trail behind demand growth for some time now. Traders and banks are increasingly shunning Russian oil in the aftermath of the brutal conflict in Ukraine. Around 2.5 million barrels per day (bpd) of Russian crude oil cannot find buyers, according to traders, despite incredibly tight supply fundamentals. Even Indian and Chinese buyers are purchasing Russian cargos with a great deal of caution and under strict clauses that Russia must abide by when shipping oil.

"Commodity markets need to reflect not only these difficulties in paying for Russia's exports but, with little left to sanction, the risk that Russian commodities eventually fall under Western restrictions," Goldman's analysts wrote in a note to clients.

Against this backdrop, European Union pushed back against a proposed oil embargo on Russian oil -- a step that would accelerate inflation and plunge overexposed EU economies into recession. Economists estimate that $150 bbl crude oil would boost global consumer prices by another 2%. Inflation in the European Union has hit a record high level of 5% -- more than twice the target set by European Central Bank.

"Supplying Europe with energy for heat generation, mobility, electricity supply and industry cannot be secured in any other way at the moment. It is therefore of essential importance for the provision of public services and the daily lives of our citizens," said German Chancellor Olaf Scholz this week on why Germany has declined to support a ban on Russian oil exports.

With European Union drawing as much as 23% of its oil imports from Russia, it could take up to a year to diversify its supplies away from Moscow and build new energy infrastructure. Much of Russia's oil imports into the EU are shipped via a vast pipeline network, including Druzhba pipeline with capacity of 1.4 million bpd that could not be quickly replaced by another supply route. European refiners imported some 1.7 million bpd of Russian crude oil via tankers last year, 85% of which consisted of Urals crude, according to data from Kpler.

In terms of gas imports, Europe is using more natural gas than ever. Russia's share of total EU natural gas imports has risen from 31% in 2010 to 38% in 2020, according to Eurostat.

A series of dire forecasts have flooded media airwaves, including Russia's Energy Minister, Alexander Novak, saying oil prices would climb above $300 bbl, which would almost certainly crush the global economy.

Domestically, consumers already feeling the pinch from the escalating conflict in Ukraine. As of Tuesday morning, the cost of regular gas in the United States is $4.17 gallon -- a record high, according to AAA, up from $4.06 on Monday. Last week, the average cost was $3.60. The cost for diesel is also nearing the record of $4.84, which was also set in July 2008. The current price for a gallon of diesel is $4.75, over double what it was in October 2020.

To ease the pressure on the global oil market, U.S. officials are said to have initiated dialogue with the Venezuelan government of Nicolas Maduro to quickly lift U.S. sanctions on the country's oil exports that were under strict sanction regime since 2019. As of 2021, Petroleos de Venezuela SA, the country's state oil company, was producing about 800,000 bpd -- only a quarter of what it pumped in the 1990s. Some analysts suggest the country could lift production to 1.2 million bpd in under eight months, particularly if Chevron, the only major American oil producer in Venezuela, can step up production.

For the U.S., the move could be viable since the share of Russian oil imports accounts for only 3% of total oil imports. The vast majority of U.S. imports of Russian oil, some 354,000 bpd, are of unfinished oil products, alongside small volumes of residual fuel oil and distillate fuel oil. These could be easily replaced with Venezuelan and Canadian imports of heavy grade oil.

Near 7:30 AM ET, NYMEX April West Texas Intermediate rallied $2.31 to trade near $121.73 bbl, and ICE Brent May contract advanced to $126.11 bbl. NYMEX April RBOB futures gained 5.51 cents to $3.6272 gallon, and April ULSD futures spiked 22.25 cents to $4.1477 gallon.

Liubov Georges can be reached at liubov.georges@dtn.com

Liubov Georges