Fear of price shock

style="float: right; margin-bottom: 10px; font-weight: 600;"Thu 7th Apr, 2022

A small group of demonstrators has gathered in front of the European Council, carrying Ukrainian flags and holding up a cardboard sign. "How does it feel to finance genocide?" it says in red paint. The question is directed at the EU ambassadors, who are discussing new economic penalties against Russia behind the facade of glass and light brown stone.

With every day of war and every atrocity committed by the Russian army, pressure grows on Europe to cut off the regime in Moscow from its main sources of foreign currency. But on Thursday, representatives of the 27 EU countries in Brussels balked at an import ban on oil from Russia for now. Hungary, where Putin confidant Viktor Orbán was re-elected as head of government last weekend, strongly opposes such a move. The German government, meanwhile, wants to buy time on the issue. Germany wants to curb imports from Russia only gradually. The German government continues to reject a short-term embargo on oil and gas.

Within the framework of the fifth sanctions package, a final agreement on the imminent import ban on coal from Russia was reached in Brussels on Thursday. According to EU diplomats, the point in time at which the halt in coal deliveries is to come into force was initially still disputed. Accordingly, Poland is pushing for the import ban to take effect in July, while Germany called for a longer deadline - until August.

Since the beginning of the war, Europe has transferred 35 billion euros to Russia for energy imports, calculates EU foreign affairs representative Josep Borrell. In contrast, Ukraine has received weapons and military equipment worth only one billion from the Europeans. EU Council President Charles Michel said he considered an import stop of Russian oil and gas inevitable to end the war. Commission chief Ursula von der Leyen announced Wednesday that her agency was preparing sanctions against Russian oil imports.

Despite the German government's current misgivings, oil would in principle be quite suitable as the next sanctions step because it is easier to replace on the world market than natural gas. However, Europe currently meets a quarter of its needs from Russia. Finding substitutes in these quantities in the short term is an enormous challenge.

Experts in the EU Commission are unsure how much an oil embargo would weaken Russia - and whether it could ultimately even be counterproductive. The fear: The Russians could divert exports to other countries and profit from the fact that the European import ban would unsettle the markets and drive up the price of oil. According to U.S. Treasury Secretary Janet Yellen, if Russian exports were completely blocked, oil prices would likely "go through the roof." And even as things stand, the German Institute for Economic Research (DIW) believes that the high oil price will continue to be a burden on consumers for years to come.

Russia, meanwhile, is having little trouble finding buyers for its oil. Ehsan Khoman, commodities expert at Japanese bank MUFG, says: "Russia's commodity exports, especially oil, are remarkably robust." This is despite the fact that the U.S. has already imposed an import ban and many Western importers no longer buy Russian crude oil, diesel or gasoline on the spot market.

This is because other commodity trading houses are sticking to their long-term purchase contracts with Russian oil companies. On the spot market, Russia has to accept high price discounts for its crude oil - but this attracts bargain traders, above all India and China. Thus, a three-digit million amount of petro-dollars probably flows into Moscow every day.

Oil revenues alone accounted for around 30 percent of the Russian state budget in 2021. This is significantly higher than gas, which contributes about six percent to the Russian budget.

About half of Russia's oil exports, totaling 3.7 million barrels per day, went to Europe before the war. Russia might have a hard time finding enough alternative buyers for its oil in the short term. "Russia is facing several bottlenecks at once," points out Simone Tagliapietra of the Brussels-based think tank Bruegel. "Russian oil fields in the west of the country are poorly connected to markets in the east. The Russians would have to find tankers, and that could be difficult."

In addition, not all oil is the same. "European refineries can process Russian crude," Tagliapietra explains, "but China's refineries are geared toward the lighter Middle Eastern oil."

Across the board, China plays a critical role: theoretically, the country could buy up all the crude Russia has so far exported by ship toward the U.S. and Europe, expert Khoman believes. Such a detour could take about two weeks. It remains to be seen whether China is prepared to do so.

Commission chief Ursula von der Leyen is already threatening, "We expect others to respect our measures or at least not to circumvent and undermine our sanctions." This was also the EU's message at the video summit with Chinese President Xi Jinping last Friday, she said.

After the coal embargo, the EU Commission is now considering imposing a punitive tariff on Russian oil. The idea is to make Russia pay to sell its oil on the European market. The revenue could be parked in a blocked account and even used to compensate European households for high energy prices.

For Germany, an embargo on Russian oil supplies would have serious consequences. For years, Germany has been buying around a third of its oil from Russia. Eastern Germany in particular would be affected by a cut in supplies. There are historical reasons for this: The "Druzhba" ("Friendship") pipeline was opened as early as the end of 1963. It still transports Russian oil to Schwedt in Brandenburg. Eastern Germany still resembles an island that is not connected to the remaining oil pipelines in Germany.

In Schwedt, the Russian oil is processed into gasoline, diesel, and kerosene. The refinery is majority-owned by the German subsidiary of the Russian oil company Rosneft. The refinery covers 95 percent of the market in large parts of eastern Germany.

A paper from the Federal Ministry of Economics states that "an immediate embargo of Russian crude oil could lead to market distortions and bottlenecks in the supply of petroleum products regionally in eastern and central Germany, at least temporarily."Industry insiders believe this assessment is glossed over. "If the refinery in Schwedt is no longer supplied with Russian oil, nothing will run in large parts of eastern Germany," said one insider. The capital's BER airport would also be directly affected: It is supplied 100 percent with kerosene from Schwedt.

It is unclear how oil from other sources was supposed to reach Schwedt in large quantities in the first place. It is true that there is a crude oil pipeline leading from Rostock to Schwedt. However, Rostock does not have an oil port where large tankers could be handled.Even if there is no oil embargo, the consumption of Russian oil in Germany should be greatly reduced as quickly as possible. German Economics Minister Robert Habeck (Greens) had recently said that oil imports from Russia would be halved as early as the middle of the year. The industry confirms that imports have already been "significantly reduced" since the start of the Ukraine war.

In the German government, people are already grappling with the scenario of the EU imposing an embargo on Russian oil, and in this context, they point to the national oil reserve that was set up at the time of the first oil crisis 50 years ago. "If all Russian supplies were to fail in the short term, the oil supply could be secured mathematically, i.e. without considering transport options and crude oil qualities, for more than 200 days with the oil reserve alone," the paper from the German Ministry of Economics states. This time could be used to procure replacements via the seaports.

Photo by Ehud Neuhaus


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