The market had to deal with three of this week’s four defining events yesterday, the FOMC meeting, the Weekly Petroleum Status Report from the EIA and Brussel’s decision on banning oil imports from Russia. The fourth one, the OPEC+ consultation on output rise is taking place today with the scheduled 432,000 bpd increase being the most likely result. Judging by yesterday’s performance and the settlement prices the unfolding supply crisis is still the immediate concern. Both crude oil futures contracts gained more than $5/bbl on the day whilst CME RBOB rallied $6.34/bbl equivalent. Worries about inflation and its negative impact on economic growth are presently not in investors’ crosshair.
US interest rate hike
Red-hot US labour market, rising wages, pandemic-induced monetary and fiscal policies, and supply chain bottlenecks amplified by the Ukrainian war have increased inflationary pressure beyond a level where central banks, including the Fed, are forced to act. It has been widely anticipated that the US central bank will accelerate the tightening of its monetary policy and will raise its benchmark interest rates faster towards the “neutral level”, believed to be around 2.5%, than previously thought. The Fed did not disappoint as it decided to raise interest rates by 0.5% to a range of 0.75% to 1% and hinted at identical increases come the next two meetings. After a sigh of relief, the US stock market strengthened but make no mistake: the cost of borrowing will increase in the future hindering healthy economic growth.
US oil inventories
Compared to the API report the weekly EIA statistics were somewhat disappointing but it has not changed the underlying bullish outlook. Crude oil inventories showed a surprise build of 1.3 million bbls whilst both distillate and gasoline stocks declined by 2.3 million bbls – less than the API estimates. The supply gap created by the Ukrainian war and the consequent sanctions on Russia was on full display once again in the report. Product exports, on a 4-week average basis, were 6.27 mbpd compared to 5.13 mbpd a year ago. International gasoline shipments have risen from 625,000 bpd to 900,000 bbpd during the same period. The volume of distillate leaving US shores stood at 1.42 mpd, up from 989,000 bpd from the comparable week of 2021. On top of traditional Latin American destinations additional demand coming from Europe ensures that US exports will remain at an elevated level depleting domestic inventories and supporting prices.
Widening the boycott on Russia
It is not far-fetched to say that yesterday a new chapter started in the Ukrainian war. Brussels has proposed the latest round of sanctions on Russia, the sixth one, which includes, following the footsteps of the US and the UK, a phased-in embargo on Russian oil sales. The issue has always been contentious in the European Union and for a good reason. Some members are more reliant on Russian oil than others and the EU, as a whole is the biggest energy customer of Russia. A ban on oil imports would inevitably hurt the entire region but the economic and financial pain would not be proportionate.
The measures that need the unanimous approval of all 27 member countries would gradually end the reliance on Russian crude oil in the next six months and on products by the end of 2022. The proposed ban would cover both pipeline and seaborne purchases. Hungary and Slovakia, two landlocked member states, would be given until the end of 2023 to implement the boycott to its full extent. Slovakia would be willing to endorse the proposal in return for a longer transition, possibly 2 or 3 years. Hungary, however, dismissed the plan out of hand and said it would outright reject it unless pipeline imports would be exempted from the proposed measures. It is not the first nor the last time that the latter EU member goes against the EU. The Hungarian stumbling block, nonetheless, should be overcome shortly by using creative political techniques, like the threat of suspending support payments.
The impact of the proposed measures is ambiguous at this early stage, but yesterday’s market reaction suggests that it would ostensibly tighten the oil balance. Whilst Europe is less dependent on Russian oil than on natural gas it is the main source of income for the Kremlin. The move, if approved, will undoubtedly speed up Russia’s search for alternative buyers (just like Europe’s efforts to secure replacement supply) and there could potentially be quite a few of them. After all, four nations, Belarus, Eritrea, North Korea, and Syria voted against adopting the UN resolution condemning the Russian aggression against Ukraine whilst 35 nations, including large consumer countries such as China and India, abstained. The realignment of Russian crude and product flow will undoubtedly hasten as a consequence of the new punitive measure, but the questions are a.) how severely would Russian oil production be affected and b.) could exports be re-directed to “friendly” markets?
Firstly, turning crude oil faucets on an off in Russia is a much more complex task than in US shale producing regions or in Saudi Arabia. Once oil wells are forced to shut because of brimming domestic stockpiles, it might be impractical and even unworkable to reopen them. Secondly, diverting crude oil and product exports is costly and expensive at best or impossible at worst. Pipelines that chiefly ship Russian oil towards the West are time-consuming to build (the only eastward crude oil pipeline runs at full capacity). Seaborne trade logistics is also complicated as the availability of tankers could turn out to be scarce, partly due to sanctions. Additionally, long voyage time, say from the Baltic Sea to the Far East would add to the difficulties of re-directing exports. The introduction of the proposed new ban would likely hit Russia harder and longer than Europe and therein lies the biggest known unknown: could tightening the sanction screw force Vladimir Putin to make concessions or will his acrimonious relationship with the West deteriorate further as he will contemplate to retaliate by any means he deems necessary? The former is implausible, and the latter is a frightening prospect.