It's embargo time

The European Union has done it. It has overcome opposition from Central Europe and has managed to remain united in the face of adversity, that is, Russia making money from the export of its fossil fuels.

The President of the European Council, Charles Michel, tweeted proudly that “The sanctions will immediately impact 75% of Russian oil imports. And by the end of the year, 90% of the Russian oil imported in Europe will be banned.” The EU rejoiced. Or did it? (Sorry, I couldn’t help it.)

Where to begin… Let’s begin with the fact that the agreement reached by EU leaders is an agreement in principle. This is suspiciously similar to memoranda of understanding that sound just like hard contracts but are, in fact, nothing of the sort. An agreement in principle is basically an indication that you will do something but the how and the what exactly remain to be determined.

Let’s then continue with Michel’s assertion that “The sanctions will immediately impact 75% of Russian oil imports.” Really? How? The agreement appears to be on a gradual phase-out of imports to last until the end of the year. There is nothing immediate about a gradual phase-out and I apologise I had to put this blatant truism into words.

The 75% of Russian oil imports into the EU, according to Reuters, are the imports that come by tankers. In addition to suspending these imports — in principle and gradually — Germany and Poland intend to stop buying oil coming via the Druzhba pipeline by the end of the year, leaving, theoretically, only the Central European sucklings of the pipeline importing Russian oil come 2023.

All this sounds wonderful. In principle. In reality, things look a bit, shall we say, expensive. As Reuters’ Clyde Russell noted in an immediate column following the news of the embargo agreement, the EU will need to source its oil elsewhere once it stops letting tankers carrying Russian crude offload at EU ports. And they can’t just buy any oil because of the way many European refineries are configured, for oil with the characteristics of Urals.

“Some grades of crude from Angola and Nigeria, as well as some from the Middle East have similar qualities to Urals, which has an API gravity of 30.6 and a sulphur percentage of 1.48, making it a medium sour oil,” Russell wrote. Let’s have a look at prices, shall we?

As of Monday, May 30th, Urals was trading at a $35 discount to Brent crude per barrel. Saudi Arabia’s flagship Arab Light, categorised by S&P Global as medium sour as well, was trading at $116.31 per barrel as of Monday.

The UAE’s Upper Zakum, which has comparable medium sour chracteristics to Urals, was trading at $113.87 per barrel Monday.

Iraq’s Basrah Light is also relatively close to Urals in terms of API gravity and sulfur content to Urals but Iraq has excluded that grade from 2022 allocation options.

To cut a long and tedious story short, the OPEC basket was trading at close to $119 per barrel Monday before the EU embargo agreement was announced. After the announcement, it rose to $120.

I don’t think we need to guess where OPEC oil prices are headed for the rest of the week or the next few months, really. In other words, proud and moral EU will be paying a lot more for the oil that, disgusting as it may be, it still needs.

But it’s not just refinery configurations that will limit the choice of EU buyers in crude grades. Availability will play a significant role as well and availability is, not to put too fine a point on it, quite tight.

In April, OPEC produced a quite impressive 2.7 million bpd of crude less than it was supposed to under its own output recovery quotas. In the current price environment this could, and does, mean two things: first, some members cannot produce more than they are already producing and second, other members have done what they could for oil prices and couldn’t do any more.

What’s left? U.S. oil, of course. The United States exported 4.341 million barrels of crude daily in the week to May 20, the latest week there’s detailed data for. This compared with 3.52 million bpd a week earlier, so there’s a solid increase.

The U.S. exported even more refined products, at 6.235 million bpd during that most recent week with detailed data. A lot of that, though not all, went to Europe. And a lot of it will probably continue to go to Europe. If refiners can cope, that is.

Reuters earlier this week published a report that should cause concern, and a lot of it. The report suggests that global refining capacity is lower than it needs to be in order to satisfy demand for oil products. And the U.S., specifically, has slipped into something fascinatingly called a structural deficit of refining capacity, for the first time in decades. That capacity is down by 1 million bpd since 2019, according to official data cited in the report.

As a result, of course, the operating refineries have had to increase their utilisation rates, especially with exports booming, with rates reaching over 92%. The fun part is that "We've been at this 93% utilization; generally, you can't sustain it for long periods of time," according to Valero Energy’s chief commercial officer Gary Simmons.

Meanwhile, the White House is making inquiries into some of the refinery closures and apparently considering asking oil refiners to reopen some idled capacity. Because, as we can all imagine, it takes a week to restart an idled refinery and all will be well.

On a totally unrelated note, global refining capacity excluding the U.S. has shrunk by over 2 million bpd over the last two years. What a time to impose oil embargoes, right?

Right now, this means that should the EU stick to its in-principle agreement and transform it into a practical agreement, it would not only have a limited pool of crude for its refineries, it will also have a limited pool of ready oil products, neither of which will be more affordable than current oil and product imports are.

Then, of course, there is the question of whether the EU will not actually continue to import Russian crude and products but under a different name. Someone on Twitter joked that “If its 49% Russian, it’s good” and I think this is not too far-fetched.

If oil supply is as tight as the majority of analysts are saying, any oil would be better than no oil and it would be safe to speculate that a lot of blind eyes would be turned on oil blending here and there. After all, we’ve seen it happen with Iranian crude for years now.

So, what awaits us in most of Europe, is higher prices for energy and for everything that uses energy to reach its end consumer. Good times are ahead, especially for renewable energy developers and EV makers, with EC President Von der Leyen accurately, although convolutedly pointing out in that now notorious Brzezinski interview that the war in the Ukraine will push the EU further into the arms of wind and solar.

Meanwhile, down here, we, the poorest of the poor, are getting a temporary exemption from the oil import sanctions until the middle or the end of 2024. The EU, in other words, is confident that it can survive its own sanctions unscathed for another two years, at least. I have to give them top points for confidence.