How easy it will be to shift trade flows depends on the appetite for key importers outside of the EU to increase their share of Russian oil purchases. Given the significant discount available for Russian Urals, we suspect the likes of India and China will increase the amount of Russian oil they import. This should in theory free up supply from other origins for EU buyers. Whilst OPEC is sitting on enough spare capacity to meet the EU shortfall, the group has been reluctant to increase output more aggressively than it currently is.
OPEC continues to hold the view that the market is balanced and that the volatility in the market is due to geopolitical risks. In addition, it is important to remember that Russia is part of the OPEC+ alliance, and so will have some influence on what the group decides when it comes to output policy. We do not think OPEC will tap more aggressively into its limited spare capacity, which suggests that the oil market will be in deficit over 2H22, which should see prices edge higher (Brent at $125/bbl over 4Q22). Demand destruction has helped to ease some of the tightness in the market although clearly not enough to fully offset the Russian supply losses we expect as we move through the year.
There are clear risks to our view. To the upside, the biggest risk would be if we were to see secondary sanctions placed on Russian oil. This would make it much more difficult for Russia to sell into markets like India and China, which would mean that the global market would be even tighter than we expect. We also assume that Iranian oil supply will grow over 2023. If this fails to materialise, it will leave the market tighter than we are currently predicting for next year.
On the downside, the potential for further Covid-related lockdowns in China over the course of the year could weigh on oil demand.
However, the bigger downside risk is if we see a de-escalation in the war or even an end to it (hopefully). This would likely see a significant amount of risk premium given back. Given the steps already taken by the EU, we do not believe that the EU would revert to its old ways and be highly dependent on Russia. However, de-escalation in the war could at least slow the process of moving away from Russian oil.