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Failure To Implement Russian Oil Ban Could Send Oil Crashing To $65
A key factor in the upper band of the benchmark crude oil trading ranges over the past weeks is market concern over a ban of Russian oil exports to the European Union (E.U.). Prior to the invasion of Ukraine, Europe was importing around 2.7 million barrels per day (bpd) of crude oil from Russia and another 1.5 million bpd of oil products, mostly diesel. This fear, though, is vastly overblown for several reasons analysed below. The removal of this particular fear factor in the oil price will allow oil prices to move back over the course of this year to the level they were before the Russia-Ukraine ‘war premium’ began to be priced in by the smart money in September 2021, which was around US$65 per barrel (pb) of Brent. The primary reason why a meaningful E.U. ban on Russian oil (or gas) will not occur is that it would require the unanimous backing of all of its 27 member countries. Even before the E.U.’s 27 member states met on 8 May to discuss pushing forward with the ban on Russian oil, Hungary and Slovakia had made it clear that they were not going to vote in favour of it. According to figures from the International Energy Agency (IEA), Hungary imported 70,000 bpd, or 58 percent, of its total oil imports in 2021 from Russia, while the figure for Slovakia was even higher, at 105,000 bpd, equating to 96 percent of all its oil imports last year. Other E.U. countries also heavily reliant on Russia’s Southern Druzhba pipeline running through Ukraine and Belarus have also made it clear that they are not willing to support the ban on Russian oil exports, the most vocal of which have been the Czech Republic (68,000 bpd, or 50 percent or its 2021 oil imports came from Russia) and Bulgaria (which is almost completely dependent on gas supplies from Russia’s state-owned oil giant Gapzrom, and its only refinery is owned by Russia’s state-owned oil giant, Lukoil, providing over 60 percent of its total fuel requirements). Other E.U. member states that are also especially dependent on Russian oil imports are Lithuania (185,000 bpd, or 83 percent of its 2021 total oil imports) and Finland (185,000 bpd, or 80 percent of its total oil imports). Even compromise proposals offered by the E.U. of allowing Hungary and Slovakia to continue to use Russian oil until the end of 2024 (and the Czech Republic until June 2024) were not enough to remove their opposition to the idea of the E.U. ban on Russian oil.
In fact, the only real flurry of activity in terms of a concerted effort by any group within the E.U. since Russia invaded Ukraine on 24 February has been to ensure that Russia did not stop supplying its member states with either oil or gas due to their not being able to pay in the way Moscow preferred. This followed the 31 March decree signed by Russian President Vladimir Putin requiring E.U. buyers to pay in roubles for Russian gas via a new currency conversion mechanism or risk having supplies suspended. According to an official guidance document sent out to all 27 E.U. member states on 21 April by its executive branch, the European Commission (E.C.): “It appears possible [to pay for Russian gas after the adoption of the new decree without being in conflict with E.U. law],… E.U. companies can ask their Russian counterparts to fulfill their contractual obligations in the same manner as before the adoption of the decree, i.e. by depositing the due amount in euros or dollars.” The E.C. added that existing E.U. sanctions against Russia do not prohibit engagement with Gazprom or Gazprombank, beyond the refinancing prohibitions relating to the bank.
Not only have several E.U. member states made it plain that they will veto any E.U. proposal to ban Russian oil (or gas) imports – and recall that all 27 E.U. member states must vote in favour of such a ban for it to come into effect – but also its own executive branch, the E.C., has been busy sending out crib notes on how best to continue to pay for Russian oil and gas imports, effectively to bypass any wider sanctions on them, including those from the U.S. Added to this is the lack of ideological surety emanating from the E.U.’s de facto leader, Germany, on the subject of the ban on Russian oil. There can be little doubt that the E.C.’s handy directive of 21 April on how to skirt sanctions on paying for Russian oil imports received the tacit approval of those responsible for such matters in Germany, otherwise, simply, it would not have been drafted or sent out. Germany is also set to be hit hard itself by any ban on Russian oil in the first instance, and gas later on, being the recipient in 2021 of the most crude oil from Russia of any country in the E.U. – an average of 555,000 bpd, or 34 percent of its total oil imports in that year, according to the IEA. Comments from German Economics Minister, Robert Habeck, that Berlin was prepared for a ban on Russian energy imports were overlaid with considerable detail about how Germany has still not been able to find alternative long-term fuel supplies for the Russian oil that comes by pipeline to a refinery in Schwedt operated by Russia’s state-owned oil giant Rosneft. He concluded that fuel prices could rise and that an embargo “in a few months” would give Germany time to organise itself in this regard.
The lack of clear leadership in the E.U. from Germany is not just another reason why there will be no meaningful E.U. ban on Russian oil (and gas) any time soon, if ever, but also opens up the probability that even if there were such a ban then it would have more holes in it than a fine Swiss cheese, just like the earlier bans and sanctions on Iran. As analysed in depth in my new book on the global oil markets, Germany was at the forefront in the E.U. of a range of measures designed to circumvent the mainly U.S.-led sanctions before 2011/2012. Shortly after the U.S. announcement of its unilateral withdrawal from the JCPOA deal in May 2018, the E.U. moved to impose its ‘Blocking Statute’ that made it illegal for E.U. companies to follow U.S. sanctions. At around the same time, Germany’s Foreign Minister, Sigmar Gabriel, warned: “We also have to tell the Americans that their behaviour on the Iran issue will drive us Europeans into a common position with Russia and China against the USA.” Shortly after that, Germany was a key mover in the E.U. introducing a special purpose vehicle – the ‘Instrument in Support of Trade Exchanges’ – that would act as a clearing house for payments made between Iran and E.U. companies doing work there.
All of this rhetorical flim-flam by Germany and the E.U. has resulted in an oil price that remains way above where it should be, given the confluence of multiple bearish factors currently at play. On the supply side there remain definite pledges from the U.S. Energy Secretary, Jennifer Granholm, to engineer a “significant increase” in domestic energy supply by the end of the year, with the U.S. also working to identify at least three million bpd of new global oil supply. There remains the prospect of further strategic petroleum releases as and when required both from the U.S. and from member countries of the IEA, and of a new ‘nuclear deal’ with Iran as the U.S. is still open to the idea. Additionally, the U.S.’s ability to pressure OPEC into increasing production has been increased by its resuscitating the threat of the ‘NOPEC’ Bill. On the demand side, there remains further likely destruction from the COVID-related lockdowns across China, and no prospect of its ‘zero-COVID’ policy being meaningfully relaxed, and of a series of U.S. interest rate hikes stifling economic growth elsewhere. It is apposite to note at this point that even without these bearish factors in play, Brent crude was trading at around US$65 pb before the real Russia-Ukraine war premium was kicked in by the smart money in September 2021 when U.S. intelligence officers started to notice highly unusual Russian military movements on the Ukraine border after the conclusion of the joint Russia-Belarus military exercises that had taken place.
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