FUEL DUEL

Situation in the oil and gas markets is getting worse amidst the Western sanctions against Russia and its retaliatory actions. The International Energy Agency (IEA) acknowledged that the world community was going through the first global energy crisis, which will most likely be resolved only after the end of Russia's military action in Ukraine, but gradually. Apparently, we should not expect a quick return to the period of lower oil and gas prices in the foreseeable future.

As of today, the EU has approved five sanction packages because of Russia's military actions in Ukraine. And with each new package, the approval process increasingly resembles a computer game, which becomes more difficult with each successive level. The sixth package was scheduled to be adopted back in April, but it is still under negotiations. The EU countries cannot reach a consensus on the key issue—an embargo on Russian oil imports. Hungary remains the main stumbling block to sanctions.

Meanwhile, Russia has started the implementation of its own action plan by disconnecting the so-called unfriendly countries from the gas supply for their refusal to pay in roubles. The first victims of these measures were Poland and Bulgaria.

Reaction of global fuel markets to such unusual hostilities between Russia and the EU was appropriate, with both gas and oil futures rising. While gas prices need a relevant containment mechanism, participants of the oil market are more lucky. Largely thanks to the efforts of OPEC+, quotations for elite grades of oil do not rise above $115 per barrel. However, even OPEC+ may become unable to curb a price surge, which will be inevitable with the introduction of embargo on Russian oil. The cartel has already warned the EU of its inability to completely substitute Russian oil. Organisation believes that sanctions against Russia could lead to the biggest upheaval in the world oil market in its history, and there is little exporters can do to change the situation.

Meanwhile, the US authorities announced their intention to start buying oil to replenish the strategic reserves (SPR). The US Energy Department is expected to start accepting bids from sellers as early as this autumn, although actual deliveries will start later.

Difficult compromise

President of the European Commission Ursula von der Leyen unveiled a sixth package of sanctions against Russia on May 4, saying the EU ‘simply has to’ stop buying oil from Russia. She did so in Strasbourg during debates in the European Parliament on the social and economic consequences of the Ukrainian war for the EU.

The new package includes an embargo on Russian oil, disconnecting Sberbank and several other Russian banks from SWIFT, banning Russian propaganda media in the EU and consultation or accounting services to Russian companies in the EU.

Additionally, sanctions will be imposed on Russian military leaders "who committed war crimes in Bucha and are responsible for the inhumane siege of Mariupol".

At the same time, the EU notes that the embargo on Russian oil should be imposed ‘carefully’ to allow time to find alternative suppliers and minimise the impact of sanctions on markets.

"Why does it take so long? This way we maximise pressure on Russia and, most importantly, minimise collateral damage for us and our partners around the world. To help Ukraine, we have to make sure that our economy remains strong," von der Leyen explained the delay with the new sanctions package.

She added that the complete abandonment of oil and refined oil products from Russia should take six months by the end of 2022.

After these statements about an imminent ban on all Russian oil imports as part of the sixth package of sanctions against Russia, Brent jumped 4.9% and WTI 5.3%.

A decision is expected in the coming days. All that remains is to persuade Hungary to change its position. Viktor Orban said during discussions on new EU sanctions on May 6 that Budapest would not accept the sixth package in its current form and compared the embargo on Russian oil deliveries to the EU to using a ‘nuclear bomb’ against the Hungarian economy. According to him, Hungary needs five years to abandon Russian oil.

However, the EC president's visit to Budapest on May 9 suggests that the embargo will be introduced anyway. "Discussions with Prime Minister Viktor Orban helped clarify issues related to sanctions and energy security. We have made progress, but we need to do more work," Ursula von der Leyen twitted.

To clarify Hungary's position, the Hungarian Foreign Minister Péter Szijjártó said after the talks that Budapest could support the embargo on Russian oil supplies only if the country was given hundreds of millions of dollars in economic aid. "We have made it clear to the European Commission that we could only vote for the proposal if Brussels also offers a solution. We expect an offer for hundreds of millions of dollars not only for the refurbishment of our oil refineries and increasing the capacity of the oil pipeline to Hungary via Croatia, but also for the future of the Hungarian economy," minister said.

However, the Hungarian government considers a realistic scenario if the embargo only applies to maritime transport routes, while the pipeline transit remains fully exempted.

Other countries also have questions about the proposed sanctions. President of Cyprus Nicos Anastasiades said the EU should consider the concerns of Cyprus, Greece and Malta when adopting decisions on banning the purchase and transportation of Russian oil. "Sanctions should be pinpointed. They should not benefit some members while leaving others under attack," he said.

Bulgaria, following Hungary, also threatened not to support the new EU sanctions package against Russia unless it was granted an exception to the proposed ban on the purchase of Russian oil. "Our position is very clear. If there is an exception for some countries, we also want to get it," Bulgarian Deputy Prime Minister Asen Vasilev told the national TV channel BNT on May 8.

Most likely, in order to achieve unity in the rejection of Russian oil, the EU will either have to accommodate the countries most vulnerable to Russian oil imports (Hungary, Slovakia and Bulgaria) or significantly soften the terms of the sixth package, as there is simply no other way. The practice of exemptions is not new and has been used successfully before in complex deals such as OPEC+ in April 2020.

Planned reduction

Incidentally, OPEC is by no means in favour of economic measures against Moscow. They believe that the current and planned sanctions on Russia could create one of the worst oil supply shocks in history.

OPEC Secretary General Mohammed Barkindo said the conflict between Russia and Ukraine had intensified uncertainties in the global market. "Both Russia and Ukraine are key global exporters, including essential agricultural commodities," he stressed.

The cartel estimates that losses from a possible oil embargo on Russian oil supplies could exceed 7 million barrels daily, and OPEC would not be able to recover these supplies due to a lack of "spare capacity". Barkindo added that markets are affected by "non-fundamental factors completely beyond OPEC’s control".

OPEC+ also ignored the calls of the G7 countries for a significant increase in oil production to avoid a surge in energy prices. Instead it has decided to follow its own course. After all, OPEC+ has not yet been able to reach the permitted production level despite systematic quota increases since August 2021. At the end of March, oil producers were 1.45mbpd behind the schedule.

At the 28th OPEC+ meeting on May 5, ministers voted to maintain the plan to increase the oil production quota by 432,000bpd in June. The decision was taken unanimously.

During the meeting they noted that "persistent oil market fundamentals and consensus on the outlook point to a balanced market". They also pointed out the impact of geopolitical factors and the challenges of the ongoing pandemic.

Meanwhile, oil traders have expected difficulties in selling Russian oil since mid-May.

Russian oil exports have fallen from 7.5mbpd to 1mbpd since the start of Russia's military operation in Ukraine, according to estimates by Mike Mueller, head of the Asian branch of Vitol. Supplies could fall further after May 15, expert added. "We are almost approaching the date after which the international banking system will not be able to carry out transactions involving Russian entities. The EU sanctions will prohibit a whole range of transactions from May 15," Muller said.

Meanwhile, even the companies that have so far traded Russian energy resources thanks to contractual obligations expect a completely "different reality", Mueller notes.

Gas blackmail

Considering the difficulty of negotiations on the new EU sanctions package against Russia, we can assume that the oil embargo is the limit Brussels has reached on fuel sanctions.

The EU member states admit that they do not even consider a gas embargo. At the same time, they do not rule out the likelihood of an emergency cut-off of gas supplies by Russia as Moscow’s countermeasure against the countries which refuse to pay for the gas in roubles. For example, since May 1, Gazprom has completely suspended gas deliveries to Bulgargaz (Bulgaria) and PGNiG (Poland) due to non-payment in Russian roubles.

Europe interpreted the move as blackmail and even prepared a package of measures in case of a sudden cut-off of Russian gas supplies.

Also on May 18, the European Commission will unveil a €195 billion plan to reduce the EU's dependence on Russian energy by 2027. According to the plan, Europe intends to make greater use of renewable energy sources, increase energy savings, diversify sources of energy imports and increase investments to replace coal, oil and natural gas supplies from Russia after the start of the conflict in Ukraine.

The strategy proposed by the EC is expected to save the EU €80 billion, €12 billion and €1.7 billion annually on gas, oil and coal purchases, respectively.

The plan also includes billions of euros in infrastructure investment to ensure sufficient imports of LNG and pipeline gas from new sources.

As for disconnections, the examples of Bulgaria and Poland, while demonstrating Moscow's seriousness towards those who refuse to comply with its gas payment conditions, look like sabre rattling.

Polish authorities viewed the cut-off as a retaliation measure for the sanctions Warsaw has imposed on Russia over its actions in Ukraine. At the same time, Polish Prime Minister Mateusz Morawiecki said that "cutting off supplies will not scare Poland" and that gas blackmailing would not harm it. According to him, Poland is not threatened by an energy crisis thanks to its long-term efforts to secure gas supplies from other countries.

Bulgarian Prime Minister Kirill Petkov said that this was a "gross violation of the contract" and "blackmail". At the same time, Bulgarian Energy Minister Alexander Nikolov said that at the moment Russian gas is still supplied and Bulgaria relies on alternative options for its delivery. The Bulgarian government noted that it has already agreed with the US to supply liquefied gas at prices lower than those of Gazprom.

In addition, the Bulgarian authorities expect the Azerbaijani gas through the Interconnector Greece-Bulgaria (IGB) in September 2022. Due to the ongoing construction of the interconnector, Azerbaijan supplies 250-300mcm of gas to Bulgaria, i. e., almost four times less than contracted volumes (1bcm per year).

"IGB will be commissioned at the end of June, with Uzbek natural gas flowing through it from September. This will mean lower prices and greater energy independence for our country", K. Petkov said.

The EU still refuses to pay in roubles, regarding it as a violation of sanctions against Russia and leaving freedom of choice only to private companies. Thus, the list of European countries cut off from Russian gas may soon be replenished, as some of them have deadlines due in May.

The fact that Gazprom might shut off the supplies is no surprise to anyone. This would be a major blow to Europe, as the utility bills will increase tremendously. However, on a flip side this move will destroy the whole gas market, as no one will trade with Russia, no matter how expensive the alternative is.