Yesterday’s reaction to the US CPI release and the EIA stock report and this morning’s retreat is a true reflection of the paralyzed state of the oil market. What is the ultimate driving force? Fears of recession or supply shortage? The global economy is sputtering because of high inflation exacerbated by the Ukrainian crisis and the consequent interest rate increases. Stock markets, therefore, are struggling and inflated consumer (and retail oil) prices have a profound impact on global oil demand. In April the US CPI rose 8.3% on the year, more than the expected 8.1% increase. Stocks weakened once again. The MSCI Global Equity Index settled nearly 20% below the peak in January. The EIA revised global oil demand down on Tuesday and the IEA and OPEC will likely follow suit today.

Yet, the slump in equities went unnoticed in the oil market and prices started to recover from a two-day slump seen in the early part of the week. This change in sentiment was the function of worries about escalating tightness in the global product markets. The weekly statistics on US oil inventories mirrored this view. US crude oil stocks built by an unexpected 8.5 million bbls partly because 7 million bbls found their way from SPR to commercial inventories. The impact of the surprise build was also mitigated by the 3.4 million bbls growth in the US West Coast. Product inventories, on the other hand, keep dwindling. Gasoline stockpiles thinned by 3.6 million bbls and distillate stocks drew 913,00 bbls. The latter at 104 million bbls is the lowest since 2005 and it is probably only the question of time when it breaks below the 100 million bbls mark. After all, as preliminary export data suggests, refiners are keen to send products to the other side of the Atlantic to fill the void left by the diminishing availability of Russian barrels in Europe. Gasoline exports stood at 942,000 bpd last week whilst distillate shipments totalled 1.36 mbpd.

As the war rages in Ukraine the battle also intensifies between bears concentrating on negative demand developments and bulls emphasizing the impact of a supply crunch. Retracements are the part and parcel of oil trading; however, the view here is that fears of product shortage due to Russian sanctions and scarce global refining capacity should keep corrections brief and prices supported over the summer.

A spanner in the works

The proposed oil embargo, part of the sixth package of EU’s punitive measures on Russia, is expected to make the underlying oil balance even tighter than it already is, especially on the product front. Implementing these sanctions, however, is an arduous task for reasons well publicized. There are three landlocked countries, the Czech Republic, Hungary, and Slovakia that rely on Russian crude oil that is shipped to the region via the Druzhba pipeline. The only other alternative would be the Adria pipeline that connects the Omisalj oil terminal in Croatia to the southern leg of the Druzhba pipeline in Hungary, however, capacity constraints would make it impossible to use it to replace Russian crude oil volumes.

Because of these logistical limitations the landlocked EU members understandably raised reservations regarding the original proposal arguing that the planned Russian sanctions would have a disproportionate and unfair effect on their economies. To mitigate these concerns the EU has offered exemptions from the implementation until 2024 and is proposing financial help to upgrade pipelines and refineries in order to make the transition from Russian oil as smooth as possible.

The Czech Republic and Slovakia would probably support the measures against Russia in some form, but Hungary is expected to drag its feet over approving the boycott for reasons that go well beyond economic considerations. Ever since the current government grabbed power in 2010 it has always been the problem child of the EU because of the “illiberal democracy” (what an oxymoron) it represents. “Illiberal democracy” is seemingly a system that does not recognize the values of the wider group but at the same time expects and demands all the benefits that come with being a member. The complete lack of checks and balances, the absence of free press and strict government control of the judiciary makes the political elite unaccountable and last month’s election that provided a strong mandate for the government for at least another four years has clearly emboldened its leadership to continue its schismatic politics at home and in the international arena.

The current prime minister who publicly denies European values shares the view of other autocrats, including Vladimir Putin, notably that the west is in terminal decline, the world will soon be dominated by authoritarians and has been openly courting the Russian leader and his Chinese peer. When the EU proposal on the latest round of sanctions was announced Hungary immediately dismissed it (winning plaudits from Russia) and the same day it reaffirmed its intention of sticking with Rosatom to build new blocks in its nuclear plant. The details of a completely uneconomic railway project connecting Belgrade with Budapest and financed by China have been classified by the Hungarian Parliament – another sign of its commitment to build strong relations with the adversaries of the Western world.

Apart from the obvious opening towards the East, Hungary has well-founded financial reasons to oppose the impending Russian oil embargo. Its reluctance can be used as a leverage to negotiate the release of €7.2 billion of recovery funds that has been withheld by the EU over concerns of upholding the rule of law. Additionally, the planned sanctions on Russia will keep energy prices at an elevated level and will make the heavy government subsidies on household utility bills, a popular scheme amongst voters, unsustainable leading to ballooning and incontrollable budget deficit, and ultimately putting a break on economic growth.

It is not in the country’s economic and political interest to approve the proposed measures against Russia for now and the question is that under these circumstances what could be the way forward for the EU. The withheld recovery fund can be used in the ongoing negotiations together with offering an even longer transition. According to the country’s oil company, MOL, it would take around 2-4 years and $500-$700 million to wean the country off Russian oil (Reuters). And if everything else fails, exempting the country (and the Czech Republic and Slovakia, if needed), which accounts for around 0.2% of the global demand, from the sanctions will still deny Russia its main source of income. Even in a chiefly dysfunctional EU system where unanimous agreements are needed to implement plans and measures, a country of 10 million must not raise an insurmountable hurdle for the other 26 member states to ultimately make sanctions work.