Stalling talks between EU members on the sixth round of sanctions on Russia and Vladimir Putin’s unexpectedly lukewarm Victory Day speech diverted attention from the developing supply tightness and the spotlight shifted back on economic considerations. The arduous task of getting landlocked EU countries sign up to the proposed sanctions on Russian oil sales progresses at a snail’s pace. The European Commission President, Ursula von der Leyen acknowledged that a breakthrough with Hungary on an EU-wide ban on oil imports is time-consuming, nonetheless she remained optimistic that a deal will be reached soon. Vladimir Putin’s speech to commemorate the defeat of Nazi Germany was also short of the usual sabre-rattling. He emphasized his long-held view of justified invasion of Ukraine, squarely put the blame for the war on the country he invaded and, of course, on NATO but did not go as far as to declare on all-out war on his western neighbour in the name of national security. Yet the arsonist still acts as the fireman.

The combination of Covid-related lockdowns in China and worldwide interest rate increases to battle inflation put equity investors on the backfoot, strengthened the dollar and significantly raised concerns of economic slowdown. An unmistakable sign of it is falling Chinese crude oil imports, which fell 4.8% in the January-April period of 2022 on an annual basis although it jumped 7% in April from the comparable month in 2021. Worries about the slowing Chinese economic expansion and the massive sell-off in global equity markets forced oil bulls to liquidate en masse yesterday. As disappointing as the performance was it is intriguing to note that the crude contracts fell harder than products, whose front-end structure actually strengthened yesterday, together with crack spreads. This might suggest that the price fall was speculative in nature and the underlying physical oil balance, in fact, remains tight.

Sanction/supply risk should trump demand concerns

The S&P 500 index has fallen 17% since January. So did the MSCI Global Equity index. The dollar scaled its 20-year peak yesterday. Inflation is running high, central banks are withdrawing monetary support and are raising interest rates. There is a real risk of stagflation and recession. The Chinese economy is suffering from lockdowns due to stubborn Covid-19 policy. Expectations from last year of the repeat of the “roaring twenties”, the economic prosperity and “annes folles” that followed World War I and the 1918-1921 influenza pandemic are now a thing of the past. Instead, Russia’s invasion of Ukraine has exacerbated fears caused by rising consumer and producer prices and focus has now shifted towards the fight against inflation. Genuine concerns are arising that instead of the repeat of the 1920s the memories of the 1970s will re-surface when the Arab oil embargo resulted in economic stagnation around the world.

Stagflation, the combination of continuously high prices and anaemic economic growth has no unequivocal monetary remedy. An increase in interest rates will put a break on aggregate demand growth but at the same time it will dampen economic expansion. Inflation has conspicuously jumped after the fateful February 24 date, but this should not come as a surprise- after all both Russia and Ukraine are significant suppliers of raw materials and agricultural commodities. On Wednesday the April US CPI data will be released. Consumer prices are expected to have risen 8.1% year-on-year last month. Albeit it is below the 8.5% jump registered in March it is almost double of the 4.2% seen a year ago. The current inflationary pressure has not matched that of the 1970s, but it is still migraine-type headache for policy makers and investors in general and oil market participants in particular.

The upcoming monthly projections on oil balance from the three main agencies are likely to stick with the recent narrative, which is one of deteriorating demand outlook due to economic hardship. In February the consensus figure for global oil demand stood at 100.65 mbpd, 3.61 mbpd above the 2021 projection. Fast forward two month and global consumption for this year was seen at 99.88 mbpd, a downward revision of 670,000 bpd with the year-on-year demand growth at 2.65 mbpd. Much of the same can be anticipated this week when the EIA releases its own findings this afternoon followed by the IEA and OPEC on Thursday.

Of course, the Ukrainian war has a profound impact on global oil production, supply and exports because Russia is one of the top crude oil producers in the world. Financial boycotts and self-sanctioning have led to a downward revision of 1.28 mbpd in non-OPEC supply between February and April. Energy Intelligence sees Russian oil production to have dropped by 900,000 bpd to 9.13 mbpd in April. The country’s OPEC+ quota was set at 10.44 mbpd last month, which will climb to 10.55 mpd this month, an impossible objective to achieve in war times. With the proposed EU sanctions on Russian oil sales the situation can potentially get worse.

There are numerous obstacles to overcome before the 27 EU members unanimously approve the plan. Landlocked countries are now being offered longer transition and financial help to upgrade their pipeline systems and refineries to be able to purchase and process non-Russian oil. Once these difficulties are tackled and sanctions are implemented genuine shortage of Russian products will be felt all over Europe and in the world. Despite a defiant Russian stance (the country’s Deputy Prime Minister said Russia’s oil production has risen in early May and the Russian leadership also believes that the proposed punitive measures will be weathered as the country’s breakeven price of $44/bbl is way below the current price level) its oil exports will inevitably suffer. According to the IEA, Russia’s crude oil and product exports to OECD Europe were 3.15 mbpd and 1.34 mbpd respectively prior to the invasion and this volume will not be easily replaced. Admittedly, ”friendly” nations will keep buying Russian crude and Russian products could still show up in Europe via third countries – unless secondary US sanctions are introduced, which is implausible at the moment. Refiners will not be able to fill the void left by the sanctions – chiefly due to significantly reduced global refining capacity. The recent market leaders, CME Heating Oil and ICE Gasoil, have become pariahs of the oil market lately, their differential to crude oil have tumbled, possibly because refiners have produced distillates and diesel flat out to counter Russian shortage. It is now gasoline and its crack spreads that started to rally with the summer driving season around the corner in the northern hemisphere. Projected product shortage should keep the oil market steady and resilient during the summer months. The market might just face a situation similar to the 2007-2008 financial crisis when oil followed the stock market meltdown with an 8-month lag.