🛢Oil nears 💲120 after partial EU embargo

Fake embargo or real hit at Russian oil business?

Paper-embargo on Russian oil

European Union announced that it has reached an agreement on the Russian oil embargo. Once again, the agreed measures seem to be a "paper embargo" that does not affect availability of the commodity but boosts uncertainty that fuels price increases on the oil market. Will new EU action have a real, negative impact on Russian oil business? Or will it just result in higher prices?

Sixth sanction package

Members of the European Union announced that they have agreed to impose an embargo on Russian oil. However, this will be only a partial embargo as it will not affect Russian oil imported via pipelines. Flows of Russian oil to the EU via pipelines amounted to around 750 thousand barrels per day in 2021 while slightly more than 1.5 million barrels per day were shipped via sea. Sixth sanction package from the EU will, in theory, ban around two-thirds of Russian oil imports. Previous sanctions package assumed that the EU would quit Russian oil and oil-derivatives at the end of this year or at the beginning of the next. Now this process is expected to accelerate. However, it should be noted that Russian oil will continue to flow to Europe via pipelines. Ursula von der Leyen, head of the European Commission, said that as much as 90% of all imports of Russian oil will cease by the end of this year. The remaining 10% will flow through pipelines to Slovakia, Czech Republic and Hungary, as well as to Hungary and Romania via sea due to agreed "exemptions". However, countries like Poland or Germany will still be able to import Russian oil via the Druzhba pipeline, which may amount to as much as 1 million barrels per day.

Are sanctions and embargo effective?

Apart from oil embargo, the sixth EU sanctions package will also include further sanctions on banks and individuals. However, exports of energy commodities is a key for Russia, especially oil exports. Even though some countries and companies decided to self-sanction and steer away from Russian energy commodities, Russia current account surplus skyrocketed to record levels, mostly due to high oil prices and artificially low USDRUB exchange rate.

Russia sends record amounts of crude to India and China. Revenues are record as well, even as crude sold to Asia is often sold at $30 per barrel discount. Of course, this data also includes exports to the EU as those were not halted yet. Russia current account surplus in Q1 2022 reached $58.2 billion! Source: Bloomberg, Zerohedge

It should also be noted that embargo may be only partially effective. Taking a look at tankers tracking data we can see that Russian exports to "unknown destinations" skyrocketed in April compared to March. This may increase further under the new embargo as some countries may try to circumvent it.

Russian oil is shipped to "unknown destinations" in Europe, pointing to a "hidden exports". Such shipments are likely to increase after embargo takes effect. Source: Twitter, TankerTrackers.com

A lot of uncertainty remains

EU was quick to announce that agreement was reached but a lot of technical details remain unknown and undecided. First of all, it is still unknown how long exemptions will last. On top of that, even though Poland and Germany said they aim to reduce imports of Russian oil to zero, it remains uncertain whether they actually will as they will be still allowed to import it via pipelines. Moreover, it is still uncertain whether any measures will be implemented to ban shipments of Russian oil to countries outside the EU. Around 1/4 of all tankers are registered in Greece. The EU wants to ban providing insurance to tankers with Russian crude but Greece and some other countries want "exemptions" in this case.

Is oil overvalued already?

In spite of a tense situation, oil market is more or less balanced. A lot of Russian oil is still being shipped to Europe and imports from Middle East, especially UAE or Saudi Arabia, is also one the rise. The biggest OPEC producers still have spare capacity due to lower demand from Asia, where an increasing amount of Russian oil is shipped. Moreover, EU oil embargo has already been priced in for some time therefore there is a risk of some profit taking as the risk materializes.

Backwardation (spot prices higher than forward price) on the Brent market exceeded $4 per barrel for the current and next-month contract. Such extreme situations were short-lived in the past, what suggests that oil may be overbought now. Source: Bloomberg

Such a strong backwardation points to a very high short-term demand on the oil market. That's why continuation of gains in the short-term cannot be ruled out. The nearest resistance zone on the Brent market can be found in the $123-125 area and this is a place where a supply-side reaction may occur. Prices are likely to drop in months-long horizon but may remain in the $100-110 range. Source: xStation5