The biggest reshuffle of oil trade flows since the Arab oil embargo of the 1970s is underway—and things may never return to normal. The Russian invasion of Ukraine and the sanctions on Russian oil exports are changing global oil trade routes. Over the past nearly five decades, oil flowed more or less freely from any supplier to any customer in the world, except for sanctions on Iran and Venezuela in recent years.
This free energy trade is now over, after the Russian aggression and the Western sanctions that followed, plus Europe’s irreversible decision to cut off its dependence on Russian energy at any cost.
A New Cold War In The Oil Market
A new Iron Curtain is now upending oil flows as Europe turns to the U.S., the Middle East, and Africa (and basically everyone that’s not Russia) for oil supply. The EU adopted last week a sanctions package to stop importing Russian seaborne crude oil within six months and Russian oil products within eight months.
In a much farther-reaching measure in the sanctions package, the EU also bans EU operators from insuring and financing the shipment of Russian oil to third countries after a six-month wind-down period.
The UK is also set to join the insurance ban after the UK and the European Union have reportedly agreed to jointly shut off Russia’s access to oil cargo insurance. The UK is home to an insurers’ club that covers 95% of the global oil shipment insurance market.
This move is expected to make Russian oil shipments to countries willing to take its oil, mostly in Asia, more difficult to arrange in terms of liability coverage, and could prompt buyers in India and China to ask for even steeper discounts of the Russian crude to Dated Brent. The flagship Urals grade from Russia is selling at a more than $30 discount to Brent these days.
Trade Routes Shift
By the end of this year, Europe expects to have effectively banned 90% of all its imports of Russian oil before the war. The embargo and the self-sanctioning are already upending global oil tanker traffic. Instead of traveling two or three weeks from Russia’s Baltic ports to Hamburg or Rotterdam, tankers carrying Russian oil now travel two or three months to reach India and China.
For oil going to Europe, crude from the Middle East will now travel longer distances to European ports compared to the shorter routes to India and China.
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These changes in oil flows will result in higher insurance, shipping, and financing costs for cargoes, Zoltan Pozsar, Global Head of Short-Term Interest Rate Strategy at Credit Suisse and a former U.S. Treasury Department official, told The Wall Street Journal. More expensive energy trade—due to the end of the free trade that was based solely on market signals of supply, demand, and prices—could put commodities at the center of the next global economic crisis, Pozsar told the Journal.
Winners and Losers
Sure, Russia is increasingly using ship-to-ship transfers to load crude from smaller tankers onto supertankers. It is also expected to backchannel part of its crude shipments the way Iran has been doing since the U.S. sanctions on its oil exports were re-imposed in 2018. Still, Asia will not be able to absorb all the Russian oil that was previously going to Europe, which was Russia’s number-one oil customer before the war.
India, which has traditionally bought oil mostly from the Middle East, is boosting Russian oil purchases, taking advantage of the cheap Russian crude. Middle Eastern producers, for their part, are expected to supply more oil to Europe, as will African producers and the United States.
India and China are Russia’s chance to continue selling its oil. Although Russia publicly expresses confidence that it will have “new markets” for its energy, analysts doubt all the oil that would have gone to Europe could end up with buyers in Asia, also because of liability coverage issues and the changing oil trade routes which extend the period of crude traveling from seller to refiner.
For Europe, the choice of oil supply is now political, and it will be willing to pay a premium to procure non-Russian oil. This will tighten supply options and continue to support elevated oil prices for months to come.
Commenting on the EU’s embargo on Russian seaborne oil imports, Fitch Ratings said last week:
“This ban will have a significant impact on global oil trade flows, with about 30% of EU’s imports needing replacement from other regions, including the Middle East (Saudi Arabia and the UAE have sustained production spare capacity of about 2MMbpd and 1MMbpd, respectively), Africa and the US.”
“However, we believe that redirecting of all Russian oil and products volumes may not be possible due to infrastructural limitations, buyers’ self-restrictions and logistical complications, such as potential restrictions on providing insurance for cargos carrying Russian oil. As a result, we estimate that about 2MMbpd-3MMbpd of Russia’s oil exports, or about a quarter of the country’s oil production, may disappear from the global market by end-2022,” Fitch noted.
In this new world order for oil trade flows, there are two key issues that the market and policymakers in the United States and Europe will be looking at in the near term. These are whether the world has enough spare capacity to replace EU’s Russian imports, and how willing the holders of spare capacity—Saudi Arabia and the UAE—will be to tap into that capacity. Per OPEC+’s deal, Saudi Arabia’s target production for July is 10.833 million bpd, but the Kingdom has very rarely tested a sustained production of 11 million bpd despite claiming a capacity of 12 million bpd.