Oil traders braced for fresh turmoil as EU set to cut off Russian diesel

The EU is on the brink of effectively severing ties with its biggest external diesel supplier when sanctions on importsof refined fuel from Russia take effectearly next month. The move, which will be co-ordinated with a G7backed global price cap on Russia’s refined fuel sales from February 5 - similar to measures already applied to crude oil since December -hasthe potential tospark a renewed round of turmoil for global oil markets. Diesel supplies are already tight, contributingtopricesat the pumpbeing well above petrol inmanyregions. European countries are among the world'slargest usersof diesel relative to other motor fuels and Russia has been their main source of imports for decades. One senior oil trader at a European commodities house said there was the prospect of a “shit show” developing in oil marketsin the comingweeks — due to the logistical challenges involved when China’s reopening of its economy isexpected toboostdemand. “Any shortfall of Russian product exports could coincide with higher demand in China, tightening markets even further and raisingthe prospect of price spikes that renew inflationary pressure,” said Henning Gloystein, an analyst atEurasiaGroup. But the oil industry is deeply split over whether the measures will lead to soaring prices and possibly even shortages, with many believing that a sector that has grown accustomed to trade flows being upended - by pandemics, sanctions or war - can quickly adapt. At stake is a renewed rise in oil prices that could offset some of the benefits the world economy is getting from a cooling in natural gas prices and puncture hopes that fuel prices had peaked as Russia’s full-scale invasion of Ukraine approaches its first anniversary. The oil market has already been unsettled in recent weeks. Brent crude pricesstarted the year on the back foot, dropping from $85 a barrel to just above $77 a barre) in the first two trading sessions of 2023 with diesel prices trackingthemovesclosely. Butsince then, oil prices have turned round, regaining all of those losses and more to trade above $87 a barrel at the endof last week. Jorge Leon at consultancy Rystad thinks that markets are right to be nervous but is reasonably confident the sanctions will work as intended by harming Russia’s economy rather than backfiring too aggressively on western economies. “There is going to be a price impact but it won’t be a game-changer,” Leon said. “European buyers have been stockpiling diesel including by raising imports from Russia in the past few months,so we’re starting this potential shock to the system in a reasonably good position." Russian exports of diesel and jet fuel to Europe increased more than 25 per cent in the last three months of 2022 compared with the previous quarter, accordingtoshiptrackingdata. Analysts at Redburn said diesel inventories in the key AntwerpRotterdam-Amsterdam region were back totheir highest levelsinceOctober 2021. But Benedict George, refined products pricingspecialist at Argus,said he still expected diesel prices to rise once the ban was in place. “Importing from non Russian sources means com peting with otherbuyerswho are physi¬ cally closer to the source, like Latin America in the case of US diesel, or Singapore in thecaseof Indiandiesel.” Europe will rely heavily on new large scale refineries in India and the Middle East as well asa pick-up in exportsfrom China, toreplace Russiansupplies. A Chinese cargo has already made its way to Latvia, showing the willingness of even Russia’s closest geographic neighbours to start securing altema fivesfrom far flungshores. But Leon said that, despite the concerns, it was Russia that had most to fear. The previous round of EU sanctions and G7 price capsthat targeted Russian crude sales in December have allowed Asian buyers to demand big discounts ontheiroil.It isapattern that heexpects tobe replicated for refined fuels. Russia’s primary export grade crudes are attractingdiscounts of about 50 per cent — trading near $40-$45a barrel — hitting Moscow’s revenues as the westernmeasuresintended. “I suspect china and India are going to ask for even bigger discounts, potentially as much as 60 per cent,” Leon said, arguing that diesel is more complicated totransport longdistances thancrude oil. Refined product tankers tend to be smaller and designed for short-haul routes while Russian barrels once destined for high specification markets in Europe are likely going to have to compete with cheaper, high sulphur dieselsin markets such as west Africa and Asia. Crude oil exports from Russia could actually rise in the coming weeksif the countrystrugglestofind new buyersfor itsdiesel, leaving them to send out the unrefined crude instead. For some traders and refiners, that could present an opportunity - betting on diesel margins rising if crude input prices fall under the weight of rising supplies while diesel is supported by tighteningsupplies. Gloystein cautioned that Russia may alsobe more willingto try to retaliate in refined fuel markets than it has been in crude, where any attempt to weaponise oil exports would risk alienatingimportant allieslikeChina. “The oil product market is arguably the one place where Russia retains meaningful leverage if it chooses to weaponise exports,"Gloystein said. If Russian diesel exports fall too sharply, China could restrict its own exports of the fuel to insulate its economy from the impact — taking barrels off the market that European buyerswere hoping would help replace Russia’ssupplies. While the outcome remains uncertain, the industry is undoubtedly wary of renewed volatility in the oil market. “It’s clear that diesel supplies in Europe and globally face turmoil in themonthsahead,"said George. See Lex