Key Points
- It’s increasingly likely that this will be a multi-year conflict, with ongoing consequences for energy markets and the wider economy.
- OPEC is somewhat more optimistic as China reopens and demand there grows, but it’s still concerned about the path of rate hikes and will err on the side of caution on output increases.
- Most observers are looking to the Russia-Ukraine conflict as the major event in geopolitics right now, but attention should also be focused on the risks from Iran’s nuclear ambitions.
In February 2022, nearly 200,000 Russian troops invaded Ukraine in a conflict that most thought would last just a few days as the small country’s defenses collapsed. Instead, Russia has endured heavy losses in its invading force, and so far failed in its bid to weaponize its energy resources to undermine Western support for Ukraine.
One year on, it’s difficult to see how the conflict ends, but many see 2023 as a pivotal year. Both sides have seen heavy losses, militarily and economically, which could help inspire them to end the hostilities, but could equally spur an escalation.
“I think market participants have really derisked the idea of a wider war. But there could come a point where Vladimir Putin decides that the provision of certain types of weaponry, particularly weaponry that would allow Ukraine to target Russia, does constitute Western involvement in the war. And so I am not of the view that this is always going to be contained,” said Helima Croft, Head of Global Commodity Strategy and MENA Research at RBC Capital Markets.
“I think market participants have really derisked the idea of a wider war. But there could come a point where Vladimir Putin decides that the provision of certain types of weaponry, particularly weaponry that would allow Ukraine to target Russia, does constitute Western involvement in the war.”
HELIMA CROFT, HEAD OF GLOBAL COMMODITY STRATEGY AND MENA RESEARCH, RBC CAPITAL MARKETS
What is certain is that a multi-year war has serious implications, not only on a humanitarian basis, but also for the energy picture. Europe has been very lucky this year in that it built up storage heading into winter and then the winter itself was much warmer than expected. But a second year of war gives Europe no chance to build up further supplies.
“Europe faces a particular challenge if it has no Russian gas coming into the region, the question is, will it have sufficient storage for next winter? What if we have a colder winter? What if Asia has a colder winter and is competing with Europe for supplies of gas on the spot market? So by no means is Europe out of the woods,” said Croft.
OPEC unlikely to up output
Both the US and Europe have tried to put pressure on OPEC to help shore up energy supplies, but the oil-producing group is wary of interest rate hikes and the potential for global recession. Although China is reopening after its extended period of lockdowns amid the COVID pandemic, it’s unlikely to be enough to outweigh OPEC’s concerns about the global economy.
“I don’t think that OPEC is going to be quick to add barrels back to the market,” said Croft. “They will err on the side of caution when they think about increasing output.”
Why the market should be watching the Middle East
There’s an understandable focus on the Russia-Ukraine conflict in terms of energy and geopolitics, but for Croft, there’s a major underappreciated risk in Iran.
“Iran has reached basically the nuclear threshold state where it has amassed such a large quantity of highly-enriched uranium, that it could make a decision to develop a nuclear weapon in a very short period of time.”
HELIMA CROFT, HEAD OF GLOBAL COMMODITY STRATEGY AND MENA RESEARCH, RBC CAPITAL MARKETS
“Iran has reached basically the nuclear threshold state where it has amassed such a large quantity of highly-enriched uranium, that it could make a decision to develop a nuclear weapon in a very short period of time - that's what's termed nuclear breakout capability. And so with talks basically stalled on Iran’s re-entry into the JCPOA nuclear agreement, the question is, do we see a renewal of the shadow war in the region?” she asked.
It's important for market participants to be watching what Israel does next. President Benjamin Netanyahu has vowed to put Iran at the top of his agenda, which could spur action in Iran. There’s a real risk of a wider conflict around Iran’s nuclear ambitions if diplomacy in the region fails.
