Oil prices approach US$100/bbl as Russia makes the first move
- Russia begins to show its hand as it recognises independence of separatist areas of eastern Ukraine and could potentially move in its military to these areas
- Whether this is the start of sustained hostilities or beginning of the end of the war, is difficult to call
- Limited options for the West at this point of time, but threat of war will continue to loom for a while, keeping oil prices elevated in the 90s or higher
- We will look to review our existing forecasts for Brent with potential upside bias, as the situation continues to unfold
Russia makes the first move. On Monday (Russian time), Russian President Vladmir Putin played his first major hand in the evolving great game that is Ukraine. Putin announced by way of decrees that Russia would be recognising the two breakaway regions of Donetsk and Luhansk as independent, and that Moscow would launch a “peacekeeping operation” into the area. This basically clears the decks for the Russian army to cross the official borders and move into eastern Ukraine, a move which Ukraine and its Western allies could claim as tantamount to an invasion of Ukraine, though some of these areas have for long been under de facto control of pro-Russian separatists, and the announcement is not technically an invasion or annexation of these territories either, unlike Crimea in the past.
What is the back story here? The eastern industrial areas of Luhansk and Donetsk (shown on map alongside) have been embroiled in a bitter civil war for years, with Ukrainian forces clashing often with Russian-backed separatists, leaving more than 14,000 people dead over the last eight years. The unrest started shortly after the Russian annexation of Crimea in 2014, and rebels and Russian “volunteers” from this majority Russian-speaking eastern part of Ukraine have since then tried to claim independence from Ukraine in a bid to become part of Russia. This was also the region from where the ill-fated Malaysian Airlines aircraft was shot down in July 2014. Russia had so far not recognised its official involvement in the bid for independence, but things are changing rapidly now.
Is this the start of war or is this the endgame? It is not immediately clear whether this move is intended by the Russian military as the start of the invasion of Ukraine that US and NATO allies have been warning about for the last few weeks or whether this is a move similar to the annexation of Crimea back in 2014, giving Putin more bargaining chips to bring the West to the negotiation table in lieu of limiting further hostilities and loss of civilian lives. In our view, this seems to be akin to Scenario 2 below that we had outlined earlier, where Putin would be keen to avoid a stalemate and take something out of the situation, while not going for an all-out invasion as the first move (as the US in particular has been projecting). What follows next is difficult to call – whether Moscow will use the excuse of defending the territories to threaten Ukraine with war or advance deeper into Ukraine by recognising the claims of these separatist governments or wait for the West to budge from their current positions before making the next move. It is also entirely possible also that Putin has achieved all he wants to from his current adventures – to scuttle Ukraine’s NATO ambitions, to show that US and NATO are not trustworthy allies given their lack of response options, and to even make sure the cracks within NATO and Western allies show, with Germany clearly not on board with the US on several fronts.
Previously anticipated scenarios of how the situation could unfold and affect oil prices
| Scenario | Fallout | Oil price trajectory |
| Russia invades Ukraine within a few days | Russia claims swift victory, NATO responds with some sanctions, but makes sure it doesn’t shoot itself in the foot | Sharp increase in oil prices towards US$100-110/bbl and even upwards, depending on nature of sanctions, but not sustainable at those levels for ever |
| Russia de-escalates but does not withdraw completely | Situation drags on for some time but ultimately Putin will need to show some results (read: recognition of breakaway provinces?) | Oil prices hover around US$90-95/bbl, seeking direction from incremental news flow |
| West accedes to some of Russia’s demands in future rounds of talks | Threat of imminent war averted | Oil prices fall back to US$80-85/bbl |
Source: DBS Bank
What now? How does the West respond? US and EU countries have gone into emergency response mode and are expected to come up with limited sanctions to condemn Russia’s move to attack the sovereignty and territorial integrity of Ukraine. The US has issued an executive order placing sanctions on the two breakaway regions. Later, President Biden announced further sanctions on two Russian banks, as well as on the country’s sovereign debt and on three individuals. European Union countries have agreed to impose a limited set of sanctions “targeting those who are responsible” for Russia’s recognition of the rebel regions. UK’s Boris Johnson has said that UK will immediately institute a package of economic sanctions and will impose further sanctions if there is more “irrational behaviour” from Russia. Britain has threatened to cut off Russian companies’ access to US dollars and British pounds, and pledged to target Russian oligarchs, given that London has become the Western city of choice for the super-wealthy of Russia and other former Soviet republics. Germany has meanwhile, halted the certification process of the contentious Nord Stream 2 project, sending spot gas prices in Europe shooting up.
We don’t think these are major deterrents yet to Russia, and real economic sanctions will be tough to impose, given Europe’s dependence on Russian oil and gas. We have explained the energy markets situation earlier in our previous note. Since the US will not be able to make up for the loss of Russian gas in case the situation arises, it is unlikely that the West will be able to put up a fully united front when dealing with Russian advances hereon. Hence, we reckon Russia could hope to win this war on the diplomatic front without a shot fired in anger.
Meanwhile, Brent crude oil prices went very close to US$100/bbl before retreating. After reports of President Putin’s announcements emerged, Brent crude oil prices temporarily went north of US$99/bbl, before moving back to around US$96.7/bbl as we write, as further aggressions haven’t occurred and the Russian oil minister was quoted speaking against high oil prices. According to reports, Russian Energy Minister Nikolai Shulginov indicated that high oil prices, while good for Russia’s budget, impacts oil demand growth and growth in other sectors of the economy, and feels optimal oil price should be around US$55-70/bbl.
If oil supplies are disrupted, OPEC unlikely to emerge as a hero, given current constraints. OPEC has in the past played the role of swing producer and adjusted production to ease supply shocks if possible. Now, oil at US$100/bbl is necessarily not something that OPEC countries would want, despite the attractive revenues, as it leads to some demand destruction globally and high inflation even in their own countries. In the case of war, OPEC may be expected to increase production, but surplus capacity is low, some OPEC members are struggling to meet even existing production quotas, and it may be tough for the ones who can increase production (Saudi, UAE, Kuwait etc) to increase unilaterally, bypassing the existing OPEC+ production cut agreement, to which non-OPEC allies are also party, including Russia. So, it will definitely be a delicate issue to discuss at the next OPEC+ meeting, and seems unlikely that Russia will be happy to lose market share while Gulf countries gain, thus limiting OPEC+ group’s ability to stray too far away from the pre-decided 0.4mmbpd per month increase for the next few months.
Iran nuclear deal – the only moderating factor? US-Iran nuclear deal is among potential moderating factors for oil price in the near term. Discussions on reviving the Iran nuclear deal has been ongoing in Vienna since late last year, and in recent days, indications have been that a deal may be imminent, possibly before the end of February 2022. However, experience has shown that delays are likely. Whenever the final agreement is signed, though, it will definitely have a one-off negative impact on oil prices, and potentially wipe off some of the current geopolitical risk premium, but timelines are quite hazy at the moment, so we wouldn’t count on it.
Overall, looks like current levels of very high oil prices could persist for longer than we earlier estimated. With Russia likely more interested in a diplomatic solution first than a direct invasion, the threat of war and subsequent sanctions et al could keep oil prices at current levels for weeks, if not months. Thus, while fundamentally, oil prices do look overheated to us at current levels, we will need to factor in geopolitical risk premium for a longer period. Thus, there is upside risk to our existing forecasts for Brent for 2022, especially in 1H2022, and we will review our forecasts, as the situation in Ukraine continues to unfold.