Hungary and Slovakia challenge the status-quo

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

Thu, 05 May 2022, 10:17

Hungary and Slovakia Challenge the Status-quo

Harry Altham

Energy Analyst, EMEA & Asia

Brent is $0.10 higher again this morning ($110.23) after pushing $4 higher yesterday, with bullish factors stemming from multiple directions over the day. The key drivers were a proposed E.U. oil embargo on Russia as announced by E.U. Commission President Ursula von der Leyen, which was then followed by a net reduction in total oil and product inventories shown in DOE data (6.56M bbl total oil and product withdrawal including Strategic Petroleum Reserve [SPR] release). Finally, there was a general rise in risk assets following the FOMC meeting, which reduced fears of 75 basis-point interest rate hikes; the S&P 500 Index rose by 3% while the weakened U.S. dollar lent support across the commodities complex.

Hungary and slovakia take a stand

On the European Union’s proposed Russia embargo, Hungary has stated that it would not support an embargo unless an exemption could be made for pipeline-transported oil – the country’s 65% dependence on Russian oil imports makes a ban ‘too unstable for energy security’, according to government spokesman Zoltan Kovacs. Slovakia has agreed to the principle of an embargo but has requested a three-year transition period due to the nature of its Slovnaft Refinery, which requires oil with an API gravity close to 30 as its input; the refinery was specifically designed to handle the Urals blend (30.6 API). With West African oil suffering consistent outages that have reduced production by 1M bbd over the last 12 months - making it an unreliable source of oil, finding alternatives is indeed difficult for Slovakia. The best options in terms of density are Iranian Heavy (currently sanctioned -although could replace 1M bbd rapidly, should restrictions end), Mars (hotly demanded in Latin America) and Arab Medium (high sulphur content is suboptimal). The situation is compounded by red-hot demand for those grades in the context of global tightness in diesel markets; Slovakia would have to pay high premiums to procure the oil (e.g., $9.35 above Dubai benchmark for Arab Medium to Asia) and there are no guarantees it can secure enough supply in time.

5-year view. Source: Platts via Bloomberg

The European Union has provisioned for an extra year for both Hungary and Slovakia to wean themselves off Russian oil; a workaround appears probable for Slovakia, but Hungary remains an obstacle to European agreement. The market reaction we have seen suggests Russia will benefit in the near-term; the rouble rose by 7% yesterday against the dollar and has reached its strongest level since March 2020 – it has breached technical resistance levels and has a 14-day RSI above 78. Ms von der Leyen’s wording gave effective permission to European purchasers to buy from Russia for the next six months where there had been uncertainty before; Russian diesel was offered in the market-on-close last night in a sign that physical trading is anticipated – lending strength to the rouble. Should physical schedules recommence, we expect to see a tightening of the gasoil/brent crack and a short term reduction in the backwardation of oil product forward curves, as purchasers may seek to utilise the opportunity to replenish 14-year low ARA diesel stockpiles.

Rouble v USD, 14-day RSI. Source: Bloomberg

Brazil’s crude production growth provides relief to Latin America

Providing some much-needed supply relief to the market is Brazil, whose oil production rose by 2.2% in March to nearly 3.2M bbd, making it the ninth largest producer in the world at current levels. Simultaneously, refinery utilisation is rising close to capacity in the country as more oil is imported from the United States (SPR releases aiding supplies), and new regulations to ban high-sulphur diesel will likely have such a strong substitution effect that diesel imports will likely increase, according to Bloomberg. This is critically important for the regional market, which requires strong diesel supplies for harvesting and winter crop plantings – Argentina has experienced a major shortage over the last few weeks, threatening crop exports.

Energy

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