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Why oil is back above $120 per barrel

In the 1970s Arab states used the “oil weapon” of embargoes to punish Western governments for supporting Israel. On May 30th the heads of the 27 eu member governments agreed to turn the weapon on themselves, as part of their latest round of sanctions against Russia following its invasion of Ukraine. As well as cutting off Sberbank, Russia’s largest bank, from the swift cross-border payment system, the package will also ban purchases of Russian crude oil and refined petroleum products, such as diesel, by the end of the year. There would, the eu said, be a “temporary” exemption for oil delivered through pipelines. The price of Brent crude oil surged above $120 per barrel on the news, its highest level since March.

In principle, the decision is highly significant. As well as being a demonstration of unity, and the bloc’s willingness to bear economic pain to punish Russia, it cuts one of the few remaining trade ties with the Kremlin. It also imperils one of Russia’s most lucrative sources of foreign-currency earnings. The eu is Russia’s biggest market for crude, buying about half the country’s oil exports.

There are reasons, however, to be sceptical that the move will deprive Kremlin of much foreign currency. For a start, the embargo applies only to seaborne oil, transported via tankers. That is the price of unity: excluding oil delivered by pipelines was necessary to find a compromise with Hungary, which is both more sympathetic to Russia than most eu countries and critically dependent on the Soviet-era Druzhba pipeline (a name meaning “friendship” in Russian). Hungary imports about 65% of its crude from Russia.

Seaborne oil makes up a similar proportion of Europe’s imports from Russia. But the ban is likely to have a limited impact on the oil market. Many tankers are already subject to so-called self-sanctioning in parts of the West. Dockworkers have refused to unload ships carrying Russian cargoes and oil majors have been worried about the hit to their reputations from accepting shipments. Western financiers are stepping back from writing insurance contracts. Although maritime insurers based in Russia’s allies could partly replace them, they have far shallower pockets.

A big question is whether Russian seaborne crude, once placed under sanctions, will go unsold. So far Russia’s oil exports have increased even as the country has come under sanctions. According to analysts at JPMorgan Chase, a bank, Russian crude exports have risen since the invasion of Ukraine. Much of it has gone to India, which has not issued sanctions of its own.

Another question is whether Europe does eventually ban piped Russian oil, which is harder to redirect to other countries. Poland and Germany have said that they will cease imports via the Druzhba pipeline. Yet it is hard to imagine Hungary dropping its opposition to a wider ban. Viktor Orban, the country’s populist prime minister, has demonstrated his willingness to block eu decisions before. Thanks to a hefty discount on Russian crude—the Urals benchmark is trading significantly below Brent—mol, a Hungarian oil group, reports “skyrocketing” margins.

Partial though the embargo may be, such is the tightness of the oil market that prices have still leapt. Demand for fuel is strong as the pandemic subsides and consumers start driving and flying again, and as governments take steps to shield voters from the impact of higher energy costs. China’s easing of coronavirus restrictions in recent days has also added to the thirst for oil. The prices of industrial metals, including iron ore and copper, have rallied, too.

Meanwhile, the Organisation of the Petroleum Exporting Countries (opec) and its allies, which include Russia, have shown little sign of increasing production just yet. At a meeting on June 2nd the group is not expected to announce any changes to its plans to gradually increase supply to levels seen before the pandemic (although it is reported to be mulling a plan to exclude Russia from its production targets, allowing Saudi Arabia and others to pump more to make up for any cutbacks in Russia).

Combine tight supply and increased demand, and the consequence for consumers at the pump is higher prices. To make matters worse, a shortage of refinery capacity in America has raised the prices for petrol and diesel even further than the cost of crude. Francisco Blanch of the Bank of America points out that the surging dollar adds to costs for Europe and emerging markets. None of this is welcome news in an already-inflationary environment. According to figures published on May 31st, for instance, inflation in the euro area rose to 8.1% in the year to May, higher than economists had expected.

The Arab embargoes of the 1970s caused short-term pain for the West, but also spurred a drive for fuel efficiency that ultimately reduced its reliance on oil. European governments today may also find themselves hoping that the short-term pain for consumers is worth the long-term gain of energy security.

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