Oil prices could average $135 in 2022 if Russia-Ukraine war continues, MUFG Bank says

Russia’s military aggression in Ukraine has introduced a risk premium in oil prices that is likely to remain embedded in markets for months, with average oil prices hitting $135 per barrel this year, MUFG Bank has said.

With little progress on the diplomatic front and Moscow facing the threat of more sanctions amid the protracting war, the price of Brent is expected to surge above $140 per barrel market in the second quarter of this year, Ehsan Khoman, director of emerging markets research for Europe, the Middle East and Africa at MUFG Bank, said in a research note on Monday.

Physical deliveries of Russian seaborne crude are set to collapse from the second quarter, which, combined with the simultaneous deficits of depleting inventories and thinning spare capacity, means oil prices will be materially higher in the near term.

“Barring a breakthrough in peace negotiations, we believe that the price-induced demand destruction — the only practical mechanism currently available in a world devoid of inventory buffers and supply elasticity — necessary to reduce consumption becomes widespread by the third quarter, with a corresponding Brent price above $140 per barrel,” Mr Khoman said.

“We believe this is the maximum pain level that could jolt corporate activity, squeeze private consumption and ultimately begin to ease the market’s severe tightness.”

Brent, the global benchmark for two thirds of the world’s oil, was 0.64 per cent higher at $105.1 per barrel at 1.07pm UAE time on Monday. West Texas Intermediate, the gauge that tracks US crude, rose 0.90 per cent to $102.2 a barrel.

Brent, which rose to just a notch under $140 per barrel in March, took a heavy beating last week dropping more than 13 per cent, after US President Joe Biden announced a record release of crude from the Strategic Petroleum Reserves. The US is releasing one million barrels of oil per day over the next six months, which equals about 180 million barrels.

International Energy Agency member countries have also agreed to a new emergency stock release to tame market volatility. The Paris-based agency said on Friday it will announce details of emergency reserves release this week, which is in addition to the 62.7 million barrels already committed to the market.

However, oil prices have dropped to levels that do not reflect the risk of disruptions to Russian exports or the ability of China to keep the coronavirus pandemic under control, the world’s biggest independent crude trader Vitol said.

MUFG Bank, Japan’s largest lender, has built three short-term oil price scenarios — easing, extending and escalating — reflecting the wide range of potential geopolitical outcomes stemming from Russia’s continued aggression in Ukraine.

The easing scenario, with 40 per cent probability of playing out, assumes ceasefire and de-escalation in the Russia-Ukraine conflict, laying the groundwork for withdrawal of Russian forces and sanctions relief. This could lead to crude flows returning to pre-crisis levels and averaging $96 per barrel in the second quarter, $90 per barrel in the whole of 2022 and $94 a barrel in 2023.

‘’Barring a breakthrough in peace negotiations, we believe that the price-induced demand destruction necessary to reduce consumption becomes widespread by the third quarter, with a corresponding Brent price above $140 per barrel’’
Ehsan Khoman, director, emerging markets research for EMEA, MUFG Bank

In its extending scenario, with 55 per cent probability, the conflict will go on with limited progress on the diplomatic front and sanctions on Russia remain or intensify.

“We believe this scenario has the highest likelihood of occurring, which includes a geopolitical risk premium in oil extending,” Mr Khoman said.

“In this scenario, we anticipate Brent oil to rise and average $142 per barrel in Q2 2022, $135 per barrel for 2022 as a whole and $112 a barrel for 2023.”

The escalating scenario, with a probability factor of 5 per cent, involves blanket sanctions with potential for explicit Nato involvement in the conflict. A worsening of the war in Ukraine will force a heavy-handed economic response from Nato allies to extort maximum costs, which will further isolate Russia with direct sanctions on energy exports.

MUFG expects Brent to hit $165 a barrel in the second quarter, average $180 per barrel for 2022 as a whole and reach $138 in 2023 in such a scenario.

“Given the unprecedented geopolitical landscape and high uncertainty of how Russia’s invasion of Ukraine will proceed and the resultant disruption to energy flows, we recognise that prices could rise beyond these levels in the escalating scenario,” Mr Khoman said.
Source: National News