EU nears oil embargo on Russia, but negotiations drag

Hungary has delayed a European-wide deal to ban Russian oil imports, but if a deal is reached, it could have a big impact on Russia.

Russian oil exports have taken a modest hit in recent months as global buyers have begun to avoid purchases, but all eyes are on the European Union as it continues to work on a new package that could result in a ban on Russian oil imports, a move that would ratchet up the pressure on Moscow.

The European Union’s decision to ban Russian oil has been held up by objections from Hungary, Slovakia, and the Czech Republic, who fear the economic fallout from turning off the taps and have a greater difficulty switching off Russian crude. The European Commission has proposed a full halt to Russian oil within six months and a ban on refined products by the end of the year.

The President of the European Commission, Ursula von der Leyen said that “this will be a complete import ban on all Russian oil, seaborne and pipeline, crude and refined.” Hungary reportedly wants an exemption for oil moved by pipeline. In addition, the EU is discussing a lengthier period reserved for some member states wary of an abrupt cutoff, giving them an additional year or two. But talks have dragged on with no agreement yet in sight.

“There’s a lot of diplomatic activity,” Christian Egenhofer, associate senior research fellow at the Centre for European Policy Studies, a Brussels-based think tank, told Gas Outlook. Despite the impasse, Egenhofer said back-and-forth negotiations are a “normal situation” for many EU-wide issues, and often talks are pushed to the brink before all sides settle on a compromise.

Phasing out Russian oil imports serves two purposes, Egenhofer said. “The symbolic part for the EU would be that the EU is not financing the Russian war. That is sort of the political point,” he said.

The second part is to ramp up the economic pressure on Russia. But “what it does to Russia is not so clear,” he added.

Although Russia has become an international pariah, it has still been able to sell the bulk of its oil on global markets by offering steep discounts, selling cargoes for as much as $30-per-barrel below prevailing market prices. The volume of Russian oil exports has dropped by roughly 20 percent to date, but oil revenues may actually balloon to more than $180 billion this year – a 45 percent jump over 2021 levels – due to the global spike in oil prices, according to Rystad Energy.

An EU ban could curtail Russian oil exports further, but again, the knock-on price spike could offset some of the damage.

“What will hurt more is if you get secondary sanctions. The secondary sanctions would be much more important,” Egenhofer said. The primary sanctions target Russian oil sales, but “secondary sanctions” could prohibit shipping and insurance companies from doing business with Russian oil, potentially extending the impact of the EU ban beyond Europe.

Egenhofer cited the example of U.S. secondary sanctions on Nord Stream 2, the highly contentious natural gas pipeline that would have doubled the existing system’s carrying capacity from Russia to Germany, but was suspended by the German government after Russia’s war in Ukraine. Before it was scrapped, U.S. sanctions severely delayed completion of the project.

“The Americans put a ban on Nord Stream 2 and basically said that any involvement of any company subject to U.S. law – which is basically everybody because of the payments system – any involvement is illegal,” Egenhofer said. “And the next day all the service providers dropped their tools and walked away. That’s the kind of model you think about.”

Already, there are signs that shippers and insurers are staying away from Russia, fearing legal and reputational risks.

EU oil embargo could be “damaging”

The global impact could be profound. Russia’s oil production has already declined by around 1 million barrels per day, but those losses could swell to 3 million barrels per day in the second half of this year, the International Energy Agency said in its May Oil Market Report. With the world already short on oil supply, an EU oil ban and stricter global sanctions could squeeze the market even further.

While crude supply remains tight, the markets for petroleum products, such as diesel and jet fuel, are even more strained.

“Limited spare capacity in the global refining system, together with reduced exports of Russian fuel oil, diesel and naphtha have aggravated the tightness in product markets, which have now seen seven consecutive quarters of stock draws,” the IEA warned.

However, demand destruction is starting to set in amid high prices, and lockdowns across large population centres in China are also cutting into global consumption.

At the same time, some exemptions and caveats within European sanctions could continue to allow Russia to sell a lot of oil. Hungarian Prime Minister Viktor Orbán is trying to “jam the process by raising ever-new and difficult requirements,” said Scott Montgomery, a professor at the Jackson School of International Studies at the University of Washington. The exemption on pipeline imports that Orbán is demanding would “essentially make the ban ineffective,” he said.

Carveouts for Hungary and other landlocked countries could keep some Russian petroleum products flowing. Greece, which plays an outsized role in the global maritime industry, has sought to weaken the provisions in the upcoming sanctions packaged related to shipping. “The feasibility of Europe eliminating its entire 1.5 million bpd of oil product imports to zero by the end of 2022 should be viewed with skepticism,” Bjørnar Tonhaugen, head of oil market research at Rystad Energy, said in a May 4 note.

Unlike natural gas, which would be trickier for Russia to reroute to other markets, some of Russia’s oil is fungible and can be sold to countries like China and India that are more willing to carry on a trading relationship despite the war.

However, despite these hurdles, the EU could yet strike a deal that has a substantial impact, and Russia cannot simply pivot its oil exports to Asia entirely. China and India could step up purchases, but could not make up for the loss of Europe. There isn’t enough infrastructure to redirect its oil destined for Europe to other parts of the world. Moscow’s pipeline system connecting it to Asia is “thin,” according to Montgomery, with many oil export terminals located in the west, including on the Black and Baltic Seas.

“A good deal of new infrastructure needs to be built before a full-scale shift to Asia can happen. This will not happen quickly, and in the meantime, Russian oil exports are likely to fall significantly,” Montgomery said.

“Russian storage capacity is practically exhausted,” so Russian oil production will have to be reduced to some degree after the EU ban, Tonhaugen of Rystad Energy said.

As a result, an EU oil embargo will “trigger a seismic shift in the European and global crude markets,” Tonhaugen added in a separate report on May 9. As much as 3 million barrels per day of Russian supply could be forced offline.

G7 countries have also pledged to ban Russian oil imports.

“One way or another, the EU embargo, should it be finalized, is likely to be damaging for the Kremlin,” Montgomery said.

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