The oil and gas markets were on edge before the Russian invasion of Ukraine and prices of both commodities were on the rise as supply growth was not matching stronger-than-expected global demand. This left the energy market vulnerable to any real or perceived disruption to supplies. So, when Russia invaded Ukraine February 24, those fears were magnified. There has been no serious disruption so far to Russian oil and gas flows to Europe and the rest of the world, but the stiff financial and banking sanctions imposed by the United States, the European Union, and other major economies are having an impact on trade with Russia.

As oil prices climbed to their highest level in eight years to trade above $100 per barrel and gas prices in Europe set new all-time highs, the 31 members of the International Energy Agency agreed at a March 1 extraordinary ministerial meeting to release 60 million barrels of oil from strategic stocks to stabilize a jittery market. In a statement, the IEA said the decision sends “a unified and strong message to global oil markets that there will be no shortfall in supplies as a result of Russia’s invasion of Ukraine.” But the announcement did little to calm the market and prices moved higher still.

Global benchmark Brent blend closed at $104.97/bbl March 1 and on March 2, traded above $114/bbl after producers in the OPEC+ alliance of OPEC and non-OPEC producers stuck to a scripted decision to increase output by just 400,000 b/d in April, saying in a statement that the decision was made on the basis of balanced fundamentals. Current volatility was caused by “current geopolitical developments,” the 23-member OPEC+ producers noted after meeting for less than 15 minutes. There was no mention of Ukraine or the IEA’s stock release. In failing to release more barrels onto the market, the OPEC+ producers added to bullish sentiment and provided further impetus to the price rally.

IEA members are obliged to hold emergency stocks equivalent to 90 days of net oil imports as insurance against supply disruptions; they are not meant to be used to manipulate prices. This is only the fourth time that the IEA has ordered the release of emergency stocks since its inception in 1974 as guarantor of energy security for OECD members after the 1973 Arab-led oil embargo. At present, IEA members hold 1.5 billion barrels of oil, and the 60 million barrels are equivalent to 2 million barrels per day for 30 days, according to the Paris-based agency. The IEA held out the possibility of further stock draws if warranted.

“The situation in energy markets is very serious and demands our full attention,” IEA Executive Director Fatih Birol said in a statement after the virtual meeting chaired by U.S. Secretary of Energy Jennifer Granholm. “Global energy security is under threat, putting the world economy at risk during a fragile stage of the recovery,” Birol added.

As one of the top three producers of oil along with the United States and Saudi Arabia, and the world’s largest producer of natural gas, Russia is an energy heavyweight; few other producers have the capacity to make up for the loss of Russian oil or gas. It currently produces just over 10 mb/d of crude oil and exports more than 5 mb/d, roughly 12% of global supply. More than half is exported to Europe with China accounting for 20%, according to IEA estimates. Russia has an even larger share of the refined oil product market, exporting 2.85 mb/d of various products, including diesel and fuel oil, the majority of which goes to satisfy European demand. When it comes to pipeline gas exports, Russia has no rival. It supplies roughly 35% of the European and United Kingdom markets, one-quarter of which goes through Ukraine.

The invasion of Ukraine heightened fears that Russia might withhold supplies in retaliation for the sanctions imposed on its banking and financial sectors and the exodus of multinational energy companies from joint ventures with Russian state-owned oil and gas businesses. BP, Shell, ExxonMobil, Norway’s Equinor, and Eni of Italy have all announced that they are selling their stakes in Russian joint ventures and halting further investment in Russia’s energy sector. France’s TotalEnergies has hedged its bets, announcing it would no longer provide capital for new projects in Russia rather than withdraw.

Although the sanctions against Moscow do not specifically target its energy sector, they have had an impact on transactions because of the complex layers of legal and financial restrictions on dealings with Russian banks. Reputational and legal risks have deterred buyers of Russian crude oil, though natural gas is still flowing through Ukraine and other pipelines to Europe. Russia’s main export grade, Urals, is now trading at a steep discount, and there have been reports that buyers are finding it difficult to open letters of credit despite exemptions granted by the United States for dealings with sanctioned Russian banks. Higher insurance rates are also making it more expensive to lift crude from Russian ports.

According to an Oxford Institute for Energy Studies paper assessing the implications of the crisis for global oil markets, despite the exemptions, the ban on access to the international SWIFT banking system had prompted some financial institutions to “self-sanction” and refuse to finance Russian-related transactions. There was also evidence that “some companies have been reluctant to purchase Russian crude as risks of exposure to Russian entities have increased,” while some shipping companies were unable to get vessels into Russian ports. Russia exports crude from terminals on the Baltic Sea, Black Sea, and Sea of Japan and is linked by pipeline to China.

Specialist publication Energy Intelligence reported March 3 that it estimated Russian oil flows had fallen by some 2.5 mb/d over the week as a result of shipping and financial sanctions “combined with a general reluctance among buyers to risk taking Russian cargoes.” It estimated that around 1.5 mb/d of crude oil as well as 1 mb/d of refined products are not making it to market.

Goldman Sachs Global Head of Commodities Research Jeffrey Currie said in a March 1 interview with Bloomberg television that there were “unintended consequent risks,” such as a pipeline outage, though the focal point was on seaborne trade in the event of increased hostilities, which would make it more difficult for the oil to get out. If seaborne trade is interrupted, this would potentially put at risk 7.3 mb/d of crude oil and product exports that cannot be easily replaced. The lifting of sanctions on Iran would offer some respite. However, nuclear talks in Vienna between world powers and Iran and indirect talks with the United States have not yet concluded. Even if a deal is agreed upon to restore the 2015 Joint Comprehensive Plan of Action nuclear agreement, it would only bring on 500,000 b/d of additional supply, and it would take months before it reaches the market. Given the magnitude of the potential disruption, Goldman Sachs had raised its price forecast to $150/bbl. “The volatility would be massive like we’ve seen over the course of the last several days,” he said. What was driving volatility was “the low level of inventories, lack of spare production capacity, and strong demand around the globe” that had resulted in a very tight market and exposed it to potential disruption.

On March 3, Brent rose to within a few cents of $120/bbl, its highest level since 2012, while U.S. benchmark West Texas Intermediate traded at its highest level since 2008, above $116/bbl.

The reference to the lack of spare production capacity has been a market feature since the OPEC+ alliance began unwinding steep cuts agreed to in April 2020 to steady the market at the height of the coronavirus pandemic. As quotas began to increase in April 2021, it became apparent that some producers were unable to meet their higher allocations, mainly because of insufficient investments made in new capacity during previous price downturns. The IEA’s February Oil Market Report, published before the Russian invasion of Ukraine, estimated the gap between OPEC+ output and target levels at 900,000 b/d in January. Should this gap persist, it would lead to more volatility and upward pressure on prices, according to the report, which added that these risks “could be reduced if producers in the Middle East with spare capacity were to compensate for those running out.”

There was no supply response from OPEC+, and Saudi Minister of Energy Prince Abdulaziz bin Salman has made clear that there would be no reallocation of quotas to make up for the shortfall. Any move to take a larger share of the market at Russia’s expense would jeopardize the relationship with Moscow, whose cooperation has been crucial since the alliance was formed in early 2016. Only Saudi Arabia and the United Arab Emirates have significant spare production capacity that can be brought online within 30 days and sustained for three months, the definition of sustainable production capacity. Birol, speaking at a March 3 news conference to present a 10-point plan that would help the EU reduce its dependence on Russian gas, said the OPEC+ decision was “disappointing.”

It’s too early to tell if the departure of the multinationals will have an impact on Russia’s oil and gas production capacity in the near future. But already Russia is nearing its capacity limits, and January production of 10.04 mb/d was below target for the second month in a row, the IEA noted in its February report. Under the July 2021 OPEC+ agreement, Russia’s OPEC+ baseline is set to rise to 11.5 mb/d in May, as is Saudi Arabia’s. But while the kingdom has the capacity to produce at that level, Moscow does not.

The IEA puts Russia’s sustainable production capacity at 10.2 mb/d and Saudi Arabia’s at 12.2 mb/d, leaving Russia with just 100,000 b/d of short-order spare capacity and 200,000 b/d of 90-day capacity compared with Saudi Arabia at 1.2 mb/d and 2.1 mb/d, respectively. The UAE could bring on an additional 1.2 mb/d within 90 days, Iraq 600,000 b/d and Kuwait 200,000 b/d, according to the IEA’s estimates.

The impact on Russia’s economy so far has been severe. The ruble has crashed to a record low against the dollar. The stock market remains closed, and foreign investors are withdrawing in droves all in just one week. Higher oil and natural gas prices may provide a temporary boost to producers but are likely to have implications for demand in the medium to long terms. An accelerated move to alternative sources of energy and a geographic shift in energy trade flows is likely to move up the political agenda of consuming countries. Germany has taken the lead in the effort to wean itself from overreliance on Russia for oil and gas supplies by freezing the certification of the controversial Nord Stream 2 pipeline across the Baltic Sea, which the United States and EU had long opposed because of its possible impact on the Ukrainian economy, and because it would have increased Europe’s reliance on Russian gas.

The IEA’s 10-point plan would reduce the EU’s dependence on Russian natural gas by one-third by next winter. The EU imported 155 billion cubic meters of natural gas from Russia, accounting for around 45% of EU gas imports and close to 40% of its total gas consumption in 2021, the IEA noted. The IEA’s recommendations included: not signing new gas contracts with Russia; maximizing gas supplies from other sources; applying gas-minimum storage requirements; accelerating the deployment of solar and wind; making the most of existing low-emission energy sources, such as nuclear and renewables; and ramping up energy efficiency measures in homes and businesses. In total, the IEA estimated this would reduce European imports of Russian gas by 50 bcm.

Around 30 bcm of natural gas and liquefied natural gas could be obtained from non-Russian sources over the next year, Birol said. He named the United States, Norway, Algeria, Azerbaijan, and Qatar as potential suppliers.

Barbara Pompili, minister for ecological transition of France, who joined Birol for the announcement, said the EU will be considering the measures because “more than ever, getting rid of Russian fossil fuels and of fossil fuels in general, is essential.” The European commissioner for energy, also speaking during the same presentation, described Russia’s invasion of Ukraine as “a watershed moment,” adding that the EU Commission will propose a pathway for Europe to become independent from Russian gas as soon as possible.”

Should more countries follow the EU’s lead and step up efforts to seek alternative supplies of oil and gas, Russia could find itself out in the cold, whether it wins or loses the war against Ukraine.