Crude sentiment see-sawed last week between fresh demand worries on account of Covid flare-ups and restrictions in China and resurgent supply concerns as a festering Ukraine war and successive rounds of Western sanctions and company boycotts drive growing volumes of Russian oil out of the market.
Supply fears had regained the upper hand by the end of the week, with Brent futures settling at $109.34, up 7% from Monday, when prices were hammered by fears that Beijing may go into a lockdown similar to the one imposed in Shanghai for the past one month.
China rolled out mass testing in the capital and some other cities and implemented partial and localised curbs in a bid to control the spread of the virus, but averted more sweeping lockdowns.
As a result, the panic over Chinese oil demand at the start of the week gave way to renewed focus on the market losing more Russian oil supply and gas exports to the European Union being disrupted by a dispute over Moscow's demand to be paid in rubles.
Growing threats to Russian oil
Russian oil exports are now starting to get hit from multiple directions:
• Major traders such as Vitol, Trafigura, Glencore and Gunvor are backing off Russian oil purchases in view of an EU regulation that takes effect from May 15.
• State-owned Rosneft failed to find any takers for substantial amounts of May and June Urals crude cargoes offered on the conditions that buyers make full pre-payment and in rubles.
• Sokol crude loadings from the De-Kastri port in Russia’s far east have virtually ground to a halt as shipping and insurance companies stay away.
• BP and Shell last week tightened loopholes in their refined product purchases in Europe to ensure Russian oil does not sneak in to the cargoes.
Risks to Russian gas supply
Russia halted gas exports to Poland and Bulgaria from April 27 over their refusal to pay in rubles. Supply to other EU countries could be in jeopardy in the coming weeks, which could also inject a fear premium in oil.
EU energy ministers have scheduled a meeting on this issue on Monday, but discussions to hammer out a uniform response and establish clarity over whether their companies would be violating sanctions by opening ruble accounts with Gazprombank are likely to be tough and tedious.
Under the new payment mechanism, established by a decree signed by President Vladimir Putin on March 31, EU countries need to switch to rubles from euro and dollar payments for Russian gas delivered from April 1. Moscow requires the EU buyers to open and simultaneously maintain a euro account and a ruble account with Gazprombank. The euro transfers will be converted to rubles for payment to Gazprom.
Most EU governments have publicly rejected the idea. The payments for April gas supply are starting to become due, bringing the dispute to a head.
There are two major challenges for the EU. First, some EU buyers appear to have already broken ranks by agreeing to pay and making payments in rubles.
Second, there appears to be some confusion over whether European companies holding a ruble account constitutes a violation of EU sanctions against Russia.
Under the new payment mechanism, Russia will not deem the payment complete until the euros have been converted to rubles for payment to Gazprom.
The European Commission last week said the euro accounts would be in line with EU rules only as long as the buyer declares the payment complete after the euro funds clear.
The quarrel between Brussels and Moscow could escalate in the coming days, but a compromise will have to be found. Neither can the EU countries risk Russia halting all gas supplies, nor can Moscow afford the nuclear option of doing so.
Import ban may be watered down
The EU may agree a gradual phase-out of Russian oil imports after Germany last week said it was no longer opposed to such a move, as long as it gets enough time to secure alternative supplies. If adopted, this would be a considerably watered-down measure compared with an immediate import ban.
Other proposals that had cropped up in recent weeks, such as the EU imposing a heavy import duty on Russian oil to discourage buying, or “fixing” a low price that its members would pay for Russian oil, or locking away part of the oil payments owed to Moscow in a separate account, have been discarded. They would have either back-fired on the EU or were simply impractical.
Demand worries waiting in the wings
Meanwhile, storm clouds continue to gather over the global oil demand picture but the market is parking that worry into the second half of the year, while it remains squarely focused on supply fears.
The Russian offensive in Ukraine, now in its third month, has shifted to the east and south. Moscow’s latest strategy, to seize control of Donbas and the Mariupol port and consolidate a land bridge between Russia’s Rostov and Crimea, will likely lead to a drawn-out war.
As that sustains Western sanctions against Russia, it is hard to see a substantial retreat in the fear premium in crude. But the upward momentum may subside once the peak Russian oil loss comes into view and as the International Energy Agency member countries unleash 180 million barrels from their emergency oil reserves over the next six months.
That could pave the way for a decelerating global economy and softening oil demand to become the dominant force on prices in the second half.
The writer is Founder and CEO of Vanda Insights, which provides macro-analysis of the global oil markets.