A carousel of consequences

The law of unintended consequences states that human — and especially government — actions never only have the consequences that have been intended from the beginning. They always have unintended consequences as well. These may be positive or negative but they are, again, always there. Yep, this is another post about those sanctions.

Last week, the EU celebrated what it considers a big win for European unity: the sixth package of anti-Russian sanctions that for the first time targeted the energy industry of Russia directly. The package sees EU reliance on Russian oil declining by some 90% by the end of the year, leaving just 10% of current volumes flowing to over-dependent countries.

Almost simultaneously, the EU and the UK agreed to introduce a ban on shipping insurance for tankers carrying Russian crude. Many saw this as a much more serious move on the part of the EU and the UK, a move that sought to prevent Russia from simply switching from Europe to Asia as its main export market. Let’s look at some consequences, shall we?

The purpose of both the EU embargo and the shipping insurance ban is to stifle Russia’s energy industry, which, in the minds of those making the decisions, seems to be Russia’s one and only lucrative industry. Leaving the difference between myth and reality aside, let’s focus on what the EU and the UK wanted specifically to happen, which was Russia seeing its export revenues plummet. This is the ultimate intended consequence of these two moves.

The unintended ones, on the other hand, are plentiful. For starters, the EU embargo, which also includes oil products, would mean higher fuel prices across the bloc. This, in turn, would likely lead to greater government help for consumers in one form or another, meaning higher government spending to cushion the blow caused by those same governments’ actions.

In addition to higher spending on subsidies for drivers and businesses suffering from higher energy costs (every business involving the transfer of goods from maker to user also involves diesel. Sorry.), governments would need to step up their efforts to tame inflation because, needless to say, higher energy prices are not exactly conducive to deflation.

EU governments will also need to boost their oil import budgets: nobody will be giving it to them for free and they won’t be making a lot of discounts, either. In fact, Saudi Arabia already hiked July prices. U.S. oil and fuels for Europe are also not getting cheaper and while there have been reports that Europe will soon start receiving crude from Venezuela and possibly Iran, the Venezuelan crude, for one, won’t be flowing into the EU in massive volumes.

So, higher government spending on energy subsidies and higher import bills are among the biggest unintended — but easy to guess — consequences of the EU’s decision to embargo Russian oil. And that’s not it at all.

It is with the shipping insurance ban that things get a lot more interesting. Per an FT report following the news of the ban, the insurance industry is in a state of discomfiture over the ban because it shipping insurance brokers would need to be very — and I mean very — careful what vessels they insure once the ban comes into effect. As is only logical, they have already indicated they would be erring on the side of caution. And this means a potentially major disruption on already quite distraught oil markets.

Per the FT:

Insurers worry about unintended consequences for the shipping industry and global commodity markets. As they try to make sure they are not falling foul of the underwriting ban, they could overcompensate and pull cover from a wider range of vessels.

This already paints an exciting picture but here’s a quote that adds all the shades:

“Because these cargoes are moving quite quickly and the insurance is contracted quite immediately, it’s quite hard to do a lot of homework on the provenance,” said one senior figure at Lloyd’s. If unclear, insurers would “tend to default to a slightly harder line”.

So, we have higher government spending for governments already burdened by a lot of pandemic spending, higher energy prices, higher oil import bills, and shrinking global oil supply, which means [FILL IN THE ADJECTIVE BECAUSE I’M EMBARRASSED OF REPEATING IT FOREVER] oil prices overall.

This in turn will lead to the need for even more government help for consumers and businesses, even higher oil import bills and so on. It’s a rather pretty vicious circle as far as vicious circles go.

Of course, none of this has to happen. As FGE noted in a recent oil market update, the crude oil embargo will only enter into effect after six months. The oil products embargo will enter into effect in eight months. The insurance ban will also enter into effect in six months. I may be wrong but that’s plenty of time for everyone involved to find a way around the bans.

Failing that, Saudi Arabia, the UAE, Kuwait, and Iraq together have some 4 million barrels in spare oil production capacity. The EU’s current rate of Russian oil imports stand at around 1 million bpd of crude and 1 million bpd of products, again per FGE.

U.S. drillers could probably be incentivised to boost production, if not this year, then next year. If prices rise much further they would really begin to hurt demand, which will contribute to downward price adjustments. Yet U.S. crude is predominantly light and sweet, so the more likely U.S. exports to Europe will be in the form of fuels. This in turn means the EU would be looking to the Middle East for crude oil.

The four OPEC members’ spare capacity will take between three and six months to put online, according to Reuters, although I’m not all that sure about Iraq. Also, there is still no certainty they would want to tap that capacity, not yet. And this is the conundrum for the EU.

The Middle Eastern majors probably will start boosting production at some point but they might wait for the situation with global supply to get much worse. Alternatively, they might want to see just how much worse that situation could become before they agree to act. Tapping your spare capacity is a risky move, after all, as one oil analyst told CNBC last week.

“Saudi has to make a choice — do we let the price go higher while maintaining a super emergency, super crisis level of spare capacity?” Paul Sankey of Sankey Research said. “Or do we add oil into the market and go to effectively almost zero spare capacity, and then what happens if Libya goes down?”

A U.S. production ramp-up is even less of a certainty because of, well, everything, from company business plans to federal energy policies to the fact that U.S. crude is predominantly light and sweet, which is not the kind of crude Europe needs the most to replace Russian imports.

Now for the really fun and mysterious part. According to some, the oil crisis sparked by EU sanctions would accelerate the energy transition. “People will say we don’t want to be dependent any more,” as Carlyle International Energy Partners managing director Marcel van Poecke told Politico in March. (I know some of you will laugh here. I can hear you!)

This seems to be an opinion shared by the decision-makers in Brussels. Indeed, it makes sense. In fact, it makes so much sense that I have had the growing suspicion — which I’ve shared previously here — that in their endless efforts to make the transition work, EU politicians may well choose a course of action that seeks to make fossil fuels prohibitively expensive in order to boost the competitiveness of wind and solar, and EVs.

To be perfectly honest, this still sounds a little too conspiratorial for my taste and I’d rather bet on incompetence driving decision-makers to the decisions that will put us all in the vicious circle. In other words, I’m inclined to believe that the acceleration of the energy transition as prompted by the oil crisis is more likely an unintended rather than an intended consequence.

The reason for this belief of mine is that this acceleration will also have major unintended consequences of the sort that simply cannot be intended. Unless, of course, one argues that blackouts and energy rationing are part of a plan to significantly reduce energy consumption in the most active consumers as part of another, bigger, plan to rearrange world order. And this is how we enter another vicious circle, this time a circle of speculation, that I’d rather not stay in. I’ll wait for evidence.

Image credit: Ken Mull