Among the many concerns when Russia invaded Ukraine six months ago was the potential impact on oil production, as Russia is the second-largest producer in the world. While this fear has not materialized, the price of West Texas Intermediate (WTI) crude is still nearly 25% higher than at the start of 2022. We believe there are three key drivers keeping oil prices higher in the near-term:  

  1. The pending expiration of support from the U.S. Strategic Petroleum Reserve (SPR)
  2. Limited production options from OPEC+ (the 13 countries within the Organization of the Petroleum Exporting Countries, and the 10 allied countries, which includes Russia)
  3. Energy cost concerns in Europe

The SPR: Oil Market Insurance

In 1975, Congress created the SPR, authorizing the capacity to store 714 million barrels of crude oil to protect the U.S. from oil market volatility and ensure a guaranteed inventory of energy supplies. For perspective, based on 2021 oil consumption data, the total stockpile equates to roughly 44 days of oil inventory for the U.S.

The Biden administration has tapped the SPR several times to alleviate high oil prices. The first was in November 2021, well before the Russia-Ukraine war began. The largest drawdown was announced on March 31, authorizing the release of one million barrels of oil per day for six months. Based on Bloomberg data, one million barrels per day equals approximately 5% of daily U.S. consumption, which is a notable amount, but not enough to flood the markets. As of August 19, the Department of Energy has already sold more than 132 million barrels into the market, bringing SPR stockpiles toward a 40-year low. 

Figure 1. SPR Total Inventory, Barrels of Oil
SPR down to the lowest level in nearly 40 years 

 

As of 8/19/2022. Source: Bloomberg, L.P.

View accessible version of this chart.

While these releases have helped lower global crude oil and gasoline prices, the March 31 authorization will expire in just two months, and the potential for supply-demand imbalances remains. Since March 31, total U.S. oil production has only increased by 200,000 barrels per day, whereas the SPR has been increasing supply by one million barrels per day. In other words, there has been a modest increase in production from U.S. energy companies after accounting for SPR deliveries. This suggests energy prices will not materially decline without support from other major oil-producing countries.

OPEC+ Capacity Constraints are Real  

OPEC+ capacity constraints are real

Global oil markets have remained tightly balanced since the onset of the pandemic, as slow increases in U.S. oil production combined with OPEC’s unwillingness or inability to meaningfully raise output continues to constrain supply levels. Unlike other business cycles when oil prices were above $100, the major oil producers of OPEC+ have resisted calls to significantly increase oil production. 

Based on U.S. Energy Information Administration data, we estimate there are few countries with spare capacity to fill the void created by bans on Russian oil. Many member countries are still struggling from both the pandemic and years of underinvestment in energy infrastructure, which has prevented the group from capitalizing on higher oil prices this year.

Figure 2. Oil Production, Consumption and Inventories 
Not counting on spare capacity from OPEC+


As of 7/31/2022. Source: U.S. Energy Information Administration (EIA), PNC

View accessible version of this chart.

The OPEC+ meeting that ended on August 3 led to an agreement to raise production by a modest 100,000 barrels per day for September. However, the amount is well below President Biden’s expectations following his visit to Saudi Arabia on July 17 to appeal for higher oil production. That decision in turn leaves oil-import nations, within Europe in particular, in a concerning position due to reliance on Russian oil.

Europe: Still time to avoid a worsening energy crisis

Whereas the U.S. is energy-independent, European Union (EU) countries remain heavily dependent on foreign oil. Approximately 29% of crude oil and 45% of natural gas EU imports come from Russia. Despite this dependence, the EU it is set to ban approximately 90% of Russian oil imports beginning on December 5. Due to the lengthy delay between when the ban was finalized in May and when it goes into effect, Russian oil production has had time to fully recover from the lows at the onset of the war. High oil prices and limited interruption of oil production have provided much-needed support to the Russian economy this year. In fact, despite sanctions against the Russian banking system and the unprecedented SWIFT ban on the Central Bank of Russia, the ruble has strengthened 24.1% year to date versus the dollar. In contrast, the U.S. Dollar Index (a basket of developed market currencies) is only up 13.7%. 
 
 Figure 3. Russian Oil Exports
Russian oil production has yet to be impacted by sanctions

As of 8/23/2022. Source: Bloomberg, L.P.
View accessible version of this chart.
 

While bans on natural gas remain less stringent, natural gas has become the key focus of the EU energy crisis, as it is the primary power source for electric utilities in most European countries, according to Bloomberg data. In our view, there has been some retaliation from Russia on the pending EU oil ban, as Russian natural gas producers have sporadically reduced or halted shipments to the EU in recent months. As a result, continental Europe is facing an unprecedented spike in energy costs. Natural gas prices have jumped nearly 500% from last year’s levels, thereby increasing electric utility costs by similar amounts.

We believe the current level of energy prices in the EU is not sustainable without the region falling into recession. We can envision three options for Europe’s energy path forward:

  • Scenario 1: Cap energy consumption
    EU countries could seek to cap energy consumption, as other resources such as coal or nuclear energy would take too long to come online in the near term. While this option could lower economic activity even further in the EU, investors should not expect monetary stimulus as the European Central Bank is expected to raise its policy rate another 50-75 basis points at its September 8 meeting to help combat spiking inflation.

  • Scenario 2: Resurrect the Iran nuclear deal
    Since 2018, sanctions have prevented Iran from exporting a significant amount of its oil despite being home to approximately 10% of the world’s oil reserves. Just as controversial as lifting sanctions and renewing the Joint Comprehensive Plan of Action (also known as the Iran nuclear deal) may be, it could also have a significant and immediate impact on alleviating high global oil prices.

According to Bloomberg data, Iran is estimated to have 50-100 million barrels of oil in storage that could be quickly delivered to global markets. Given Iran’s alignment with Russia on the global geopolitical stage, this scenario may be a major tailwind to lower oil prices in the near term; however, the probability of an immediate resolution remains highly uncertain. We continue to monitor any potential breakthroughs on a compromise.

  •  Scenario 3: Terminate the Russian oil ban
    A last-resort option would involve a termination of the scheduled ban on Russian oil imports. This option is a low probability, in our view.

Where do we go from here?

With the coming expiration of SPR deliveries, limited spare capacity from OPEC+ and the ongoing Russia-Ukraine war impacting European energy markets, we continue to expect oil prices to remain elevated in the near term. From a technical analysis perspective, $86 per barrel for WTI crude continues to be a major level of support , but we also do not foresee a new catalyst on the horizon that would cause prices to mark new year-to-date highs either. Despite our outlook for oil markets, as well as the tough decisions ahead for the EU, we are not in favor of making significant asset allocation changes, such as eliminating exposure to developed international markets.

 Figure 4. WTI Crude Oil Intra-day Lows (per barrel)
Oil price support holding at $86 

As of 8/26/2022. Source: Bloomberg, L.P.

View accessible version of this chart.

While the energy crisis facing the EU remains significant barring a near-term resolution, our asset allocation rationale is due in part to the divergence between the European economy and the fact that most revenues from European-domiciled companies are generated globally. For example, the top revenue source for the MSCI World ex USA Index is the U.S. at 20.3%! Combined with Canada, the total for North America is 27.8%, which is nearly on par with all of Europe at 28.5%. Even within small-cap equities, the MSCI World ex USA Small Cap Index generates just 35% of revenue within Europe compared to 84% within the U.S. for the S&P 600®. As a result, consensus 2022 earnings growth for the MSCI World ex USA is still positive at 4.8% and 2.9% for 2023. In addition, major developed international indices have a greater representation from Energy and Materials compared to the S&P 500®, which continues to be a key source of performance.

As we monitor the energy situation in Europe closely, we are mindful of elevated geopolitical risks and their potential influence on our oil market outlook. Despite the potential for continued market volatility, we are maintaining our current asset allocation views.

 

Accessible Version of Charts

 Figure 1: SPR Total Inventory, Barrels of Oil

SPR down to the lowest level in nearly 40 years

Date

DOE Strategic Petroleum Reserve (SPR) Total Inventory Data

10/1/1982

277633.00

8/15/1986

504191.00

8/10/1990

586678.00

8/12/1994

591672.00

8/14/1998

563429.00

8/9/2002

579095.00

8/11/2006

687845.00

8/13/2010

726586.00

8/8/2014

690972.00

8/10/2018

660013.00

8/12/2022

461156.00

As of 8/19/2022. Source: Bloomberg, L.P.

Figure 2: Oil Production, Consumption and Inventories
Not counting on spare capacity from OPEC+

Production (MBOE/d )

Avg
2018

Avg
2019

Avg
2020

Avg
2021

Avg 2022

2018-2022
Growth

Implied Spare Capacity

2018-2022
Max

   OECD

29.9

31.5

30.6

31.0

32.0

7%

1.1

33.1

      U.S. (50 States)

17.9

19.5

18.6

18.9

19.9

11%

0.6

20.5

      Canada

5.3

5.5

5.2

5.6

5.7

6%

0.2

5.9

      Mexico

2.1

1.9

1.9

1.9

1.9

-9%

0.3

2.2

      Other OECD

4.6

4.6

4.8

4.7

4.5

-2%

0.5

5.0

   Non-OECD

70.5

68.8

63.2

64.4

67.2

-5%

4.1

71.3

      OPEC

36.7

34.6

30.7

31.6

33.8

-8%

3.4

37.1

      Russia

11.4

11.5

10.5

10.8

11.0

-4%

0.7

11.7

      China

4.8

4.9

4.9

5.0

5.2

9%

-0.1

5.1

      Other Non-OECD

17.7

17.8

17.2

17.1

17.3

-2%

-2.0

15.3

   Total World Production

100.4

100.3

93.8

95.4

99.2

-1%

3.0

102.2

             

 

 

Producers with Highest Implied Spare Capacity

 

Saudi Arabia

10.4

9.8

9.2

9.1

10.2

-1%

1.4

11.6

U.S. (Crude Oil production)

10.9

12.3

11.3

11.2

11.6

6%

1.4

13.0

Iran

3.5

2.3

2.0

2.4

2.5

-28%

1.3

3.8

Venezuela

1.4

0.8

0.5

0.6

0.7

-51%

0.9

1.6

United Arab Emirates

2.9

3.1

2.8

2.7

3.0

2%

0.8

3.8

Brazil

3.4

3.7

3.8

3.7

3.7

7%

0.7

4.3

Nigeria

1.6

1.7

1.5

1.3

1.2

-27%

0.6

1.8

Iraq

4.6

4.7

4.1

4.1

4.4

-5%

0.5

4.9

Angola

1.6

1.4

1.2

1.1

1.2

-26%

0.4

1.6

Kuwait

2.8

2.7

2.4

2.4

2.7

-3%

0.3

3.0

Top Spare Capacity Producers

 

 

 

 

 

 

8.3

 

As of 7/31/2022. Source: U.S. Energy Information Administration (EIA), PNC

 Figure 3: Russian Oil Exports

Russian oil production has yet to be impacted by sanctions

Date

Baltic Sea Exports

Black Sea Exports

Pacific Exports

Arctic Sea Exports

Total

4 Week Average

Ukraine Invasion

1/23/2022

1356.00

313.00

1133.00

343.00

3144.00

2960.87

 

2/25/2022

1564.00

542.00

1242.00

400.00

3749.00

3000.13

4000.00

3/23/2022

1043.00

521.00

1138.00

314.00

3016.00

3299.00

 

4/23/2022

1669.00

850.00

1242.00

343.00

4104.00

3322.80

 

5/23/2022

1564.00

704.00

938.00

229.00

3435.00

3641.93

 

6/23/2022

1669.00

772.00

942.00

371.00

3754.00

3678.93

 

7/23/2022

1356.00

459.00

838.00

286.00

2938.00

3220.10

 

8/23/2022

1773.00

626.00

938.00

286.00

3622.00

336.43

 

As of 8/23/2022. Source: Bloomberg, L.P.

 

 Figure 4. WTI Crude Oil Intra-day Lows (per barrel)

Russian oil production has yet to be impacted by sanctions

Oil price support holding at $86

Date

Open

High

Low

Close

$86 Support Line

9/24/2021

71.92   

74.27

69.67

73.98

86

10/29/2021

83.98   

85.41

80.58

83.57

86

11/25/2021

75.75   

79.23

67.4

68.15

86

12/24/2021

70.07   

73.95

66.04

73.79

86

1/28/2022

84.91   

88.84

81.9

86.82

86

2/25/2022

91.75   

100.54

90.06

91.59

86

3/25/2022

105.13 

116.64

104.08

113.9

86

4/29/2022

101.38 

107.99

95.28

104.69

86

5/27/2022

110.56 

115.3

108.61

115.07

86

6/24/2022

110.58 

112.47

101.53

107.62

86

7/29/2022

95.1      

101.88

93.01

98.62

86

8/26/2022

89.65   

95.76

86.6

93.06

86

 

As of 8/19/2022. Source: Bloomberg, L.P.