Home Commodities The oil market is bracing for further shocks as the EU prepares to freeze Russian diesel

The oil market is bracing for further shocks as the EU prepares to freeze Russian diesel

by SuperiorInvest

The EU is on the verge of effectively severing relations with its largest external diesel supplier when sanctions on imports of refined fuel from Russia come into force early next month.

The move, which will be coordinated with a G7-backed global price cap on Russia’s refined fuel sales from February 5 – similar to measures already in place for oil. oil from December – has the potential to trigger a new round of shocks in global oil markets.

Diesel supplies are already tight, contributing to pump prices significantly higher than gasoline in many regions. European countries are among the world’s largest users of diesel compared to other motor fuels, and Russia has been their main source of imports for decades.

One major oil trader at a European commodities house said a “crap” will develop in oil markets in the coming weeks due to logistical issues, with the reopening of China’s economy expected to boost demand.

“Any shortfall in exports of Russian products could coincide with higher demand in China, further tightening markets and raising the prospect of price spikes that will renew inflationary pressures,” said Eurasia Group analyst Henning Gloystein.

But the oil industry is deeply divided over whether the measures will lead to soaring prices and possibly even shortages, with many believing a sector accustomed to having trade flows under control — by pandemics, sanctions or war — could adapt quickly.

At stake is a rebound in oil prices that could offset some of the benefits the global economy is getting from cooling natural gas prices and dash hopes that fuel prices have peaked. Russia the all-out invasion of Ukraine is approaching its first anniversary.

The oil market has been restless in recent weeks. Brent crude prices started the year on the back foot, falling from $85 a barrel to just above $77 a barrel in the first two trading sessions of 2023, with diesel prices watching those moves closely. But since then, oil prices have turned around and recovered all those losses and more to trade above $87 a barrel at the end of last week.

Jorge Leon of consultancy Rystad thinks the markets are right to be nervous, but is reasonably confident that the sanctions will work as intended and hurt the Russian economy, rather than being too aggressive against Western economies.

“It will affect the price, but it won’t be a game changer,” Leon said. “European buyers have been stockpiling diesel over the past few months, including by increasing imports from Russia, so we’re in a pretty good position to start this potential shock to the system.”

Russian diesel and jet fuel exports to Europe increased by more than 25 percent in the last three months of 2022 compared to the previous quarter, according to ship tracking data. Analysts at Redburn said diesel stocks in the key Antwerp-Rotterdam-Amsterdam region are back at their highest level since October 2021.

But Benedict George, refined prices specialist at Argus, said he still expected diesel prices to rise after the ban was introduced.

“Importing from non-Russian sources means competing with other buyers who are physically closer to the source, such as Latin America in the case of US diesel or Singapore in the case of Indian diesel.”

Europe will rely heavily on new large refineries in India and the Middle East, as well as increased exports from China to replace Russian supplies. Chinese cargo has already arrived in Latvia, which shows the willingness of even Russia’s closest geographical neighbors to start providing alternatives from distant shores.

But Leon said that despite the concerns, it is Russia who should be most worried. The previous round of EU sanctions and G7 price caps targeting Russian crude sales in December allowed Asian buyers to demand big discounts on their oil. He expects this pattern to be replicated for refined fuels.

Russia’s primary export oil is attracting discounts of around 50 percent – trading at around $40-45 a barrel – and will hit Moscow’s revenues as Western measures intended.

“I suspect China and India will ask for even bigger discounts, potentially up to 60 percent,” Leon said, noting that shipping diesel is more complex than shipping oil.

Refined product tankers tend to be smaller and intended for short-haul routes, while Russian barrels, once intended for high-spec markets in Europe, are likely to have to compete with cheaper, high-sulphur diesel engines in markets such as West Africa and Asia .

Oil exports from Russia could actually rise in the coming weeks if the country struggles to find new buyers for its diesel and lets them ship crude instead.

For some traders and refiners, this could present an opportunity to bet on rising diesel margins if crude input prices fall under the weight of rising supplies while diesel is supported by tighter supplies.

Eurasia Group’s Gloystein warned that Russia may also be more willing to try to retaliate in refined fuel markets than it has been in oil, where any attempt to weaponize oil exports would risk alienating important allies such as China.

“The oil products market is probably the only place where Russia retains meaningful influence if it decides to export weapons,” Gloystein said.

If Russian diesel exports fell too sharply, China could curb its own exports of the fuel to insulate its economy from the impact — removing barrels from the market that European buyers had hoped would help replace Russian supplies.

While the outcome remains uncertain, the industry is undoubtedly concerned about renewed volatility in the oil market.

“It is clear that diesel supplies in Europe and globally will face shocks in the coming months,” said George of Argus.

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