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The Legislative Production Line: The European Union’s Next Attempt to Push Proposed Embargo Into Law

By: Harry Altham, Energy Analyst, Market Analysis EMEA & Asia

The Legislative Production Line: The European Union’s Next Attempt to Push Proposed Embargo Into Law
 
Harry Altham
Energy Analyst, EMEA & Asia

Brent has breached $120 for the first time since 25th March amid renewed attempts by the European Union to pass an oil embargo on Russia into law. As a result, Brent’s premium to WTI has widened to $4.38/bbl and is approaching May’s high of $4.56 (excluding the K22 ICE Gasoil contract expiry day). Meanwhile, the Brent/Dubai EFS has widened beyond $11.50 for the first time since March, as Europe’s demand recovery continues to show robust strength despite increasing concerns that deteriorating macroeconomic conditions could impact oil demand in Europe. Net bullish bets in Brent by Money Managers rose by 2.33% to 62.34% of total fund open interest on ICE, its second highest level since Russia invaded Ukraine (67.72% on March 1st) amid a further tightening of global inventories. Technical resistance on the front-month July contract is at late March’s $123.74 high, while support can be found on the five-day moving average at $116.90. For the first time on record, both Heating Oil and RBOB Gasoline closed above $4/gallon on Friday, causing the Cushing 3-2-1 crack to touch to $49.996/bbl – a ten-day high. Amid tightening inventories, there remains a strong possibility that NYM cracks will surge to new records, as JP Morgan forecasts retail gasoline prices to rise above $6/gallon in the coming weeks.

image 39005
Source: Bloomberg
what is the European union proposing to try and woo hungary into agreement?
The latest incarnation of the proposed embargo reportedly permits pipeline-transported crude to flow into Europe, a manoeuvre designed to appease a reluctant Hungary. Based on oil flows to Europe in 2021, this could see up to 750k bbd of oil imports from Russia – although the Druzhba pipeline system has as much as 1.3M bbd of capacity. However, in 2021, over 40% of those pipeline imports went to Germany and Poland, both of whom have signalled an unwillingness to continue purchasing Russian oil. On the basis that Hungary and Slovakia would be the only remaining importers (both countries are landlocked and heavily dependent on Russian oil), a seaborne embargo would mean a maximum of 400k bbd of Russian oil would reach European markets – a 90% drop versus January. Should an embargo beginning in 2023 materialise, we expect to see long-dated futures close the backwardation gap to front-month prices, as purchasers seek to secure ever scarcer supply further down the forward curve. 
image 39006
Source: CFTC
PRESSURE BUILDING AGAIN IN GLOBAL DIESEL MARKETS
ARA region gasoil stocks fell by 262k bbl last week, causing ICE Gasoil’s front-month crack to Brent to widen by 0.45% to $37.36/bbl - close to three-week highs above $40/bbl. Global diesel stockpiles are under scrutiny once again as Chinese refinery run rates are expected to fall by 8% to 75% in Q2, which is expected to place Asian refined products under increasing balance sheet strain and increase profitability for refiners; the Asia/Europe gasoil swap has narrowed from $3.32 to $1.49 in the last week on a fair-value basis as Asian spot prices surge. We expect the tightening supply/demand balance to exacerbate price pressure during peak demand over the summer, particularly in Europe and the United States where inventories remain low. One point of note in this week’s ARA inventory statistics was the rise in fuel oil and jet fuel inventory, which rose by a collective 682k bbl – far outpacing the fall in gasoil inventory. We believe the crack spreads could be due a minor correction on the basis that total middle distillate product inventory actually increased over the last week – a change which isn’t reflected in current price levels. 
 
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