LONDON, March 25 (Reuters) – EU leaders have refrained from imposing an immediate embargo on imports of Russian crude and oil products as the impracticability of the policy has become clear.
Imposing an immediate embargo on Russia’s fossil fuels “would mean plunging our country and all of Europe into a recession overnight,” Chancellor Olaf Scholz told German lawmakers this week.
Russia’s crude oil and oil product exports to Europe are the second largest bilateral flow of oil between two trading partners in the world, behind the United States and Canada, according to BP data.
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Russia supplied 29% of Europe’s crude oil imports and 51% of the continent’s oil product imports in 2019, the last year before the pandemic (“Statistical review of world energy”, BP, 2020).
No other trading partner came close to Russia’s participation, which would make it extremely difficult to replace in the short term.
(graphic book: https://tmsnrt.rs/3upVkI8)
So even speculation about a possible ban sent oil prices sharply higher this week as traders weighed the practical difficulties, before prices pulled back as it became clear EU politicians were backing away from the idea. .
NEW OIL ORDER?
Some proponents of the embargo have suggested that the EU could ban imports of Russian oil and then encourage the redirection of international flows to minimize the net loss of supply caused by a spike in prices.
In this scenario, sanctioned Russian crude would be left in the hands of buyers in China and India, freeing up crude from the Middle East for delivery to refiners in Europe.
On the products side, Russian fuel oil and distillates could be shipped to South America, Africa and Asia, while Europe receives more unauthorized products from the United States, China, India and the Middle East.
But there are multiple serious obstacles to making this work, so it’s probably been put on hold for now.
For producers and consumers, supply routes would be much longer, increasing the number of ton-miles of cargo, driving demand for tankers and significantly increasing transportation costs.
More importantly, crude oils are only semi-fungible. Most refineries are optimized to work with specific qualities of oil. Trading Russian and Middle Eastern crudes would reduce efficiency, driving up costs and prices.
Redirecting flows would disrupt long-standing contractual and customer relationships. Middle Eastern vendors have invested time and effort in building long-term relationships with refiners in China, India and the rest of Asia.
Asia is perceived as the growth market of the future, while Europe is the declining market of the past, especially with its plan for accelerated transmission to net zero emissions.
Breaking up long-term contracts and giving up the lucrative growth markets of Asia to supply refineries in declining Europe, possibly only for a few months or years, would make little strategic sense.
Similarly, North American refiners have lucrative and semi-captive markets in Central and South America that will be reluctant to trade for Russia’s markets in Europe.
For refiners in Asia, there is little incentive to sever long-term relationships with secure Middle Eastern suppliers to become dependent on Russian exporters if those exports may be subject to extraterritorial US and EU sanctions later on.
The flows of crude oil and products throughout the world form a dense interconnected network or matrix. The forced rescheduling of Russia’s exports through sanctions implies changes in all other relationships with suppliers and customers.
For commercial reasons, most crude exporters and refiners ship to the nearest available export market and purchase from the nearest suitable import source.
Russia has so far overwhelmingly supplied Europe, the closest major importer, although flows were slowly redirecting to Asia, the fastest growing market, even before Russia’s invasion of Ukraine.
For the same distance reasons, Europe has bought most of its crude and imported products from Russia and other countries of the former Soviet Union.
The political imperative to end these flows and codependency is now in conflict with the business and geographic reasons for maintaining them. Political imperatives may prevail, but they are unlikely to do so quickly.
In 2019, Russia’s exports to Europe accounted for more than 6% of all crude oil traded in the world and more than 8% of all its internationally traded products, according to BP data.
The rescheduling of such a huge part of world trade in the space of a few weeks or months would create a great deal of turmoil.
TIGHT LIKE A DRUM
Global oil markets were tight before the Russian invasion of Ukraine with inventories below the five-year pre-pandemic average and trending lower.
Even if the imposition of an embargo or other sanctions were to cause only a small reduction in Russia’s net exports, to deprive the country of revenue, it would still create a high risk of rising prices.
Previous embargoes imposed on Iraq in the 1990s and Iran and Venezuela in the 2010s were offset by additional supplies from other producers, reducing their overall impact on prices.
Currently, neither Saudi Arabia nor US shale companies appear willing to increase production to make up for lost Russian supplies, and the White House has yet to reach agreements to lift sanctions on Iran and Venezuela.
With little spare capacity, EU politicians have concluded that the price risks from an embargo on Russian oil exports are too high and have backed away from the idea for now.
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John Kemp is a market analyst for Reuters. The opinions expressed are yours.
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Written by John Kemp; Edited by Susan Fenton
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