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The Big Picture

Mideast Gulf to EU's Rescue?

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  • Russia's Ukraine war is reshaping global energy flows, severing Europe's oil and gas links to former major supplier Russia.
  • More disruption looms with the imposition of new controls on the trade in Russian products on Feb. 5.
  • With access to Russian supply emasculated, Europe will need to forge new energy relationships, especially with the oil and gas powerhouses of the Mideast Gulf.

Times of great upheaval can be deceptive: Stormy waters often recede to leave a landscape pretty much unchanged from before. But it is increasingly clear the Ukraine war will lead to some permanent changes. Most saliently, it is hard to see Russia ever recapturing its pre-February 2022 hegemony of European energy supply. This fact alone will require a major restructuring of the Eurasian political economy. Like no other region, the Mideast Gulf has the potential to meet EU needs.

Significantly, flows of Mideast crude and products to Europe (excluding Turkey) were up 620,000 barrels per day in the second half of 2022 versus the same period in 2021, according to data analytics firm Kpler. This isn’t just about quantity. Mideast sour crudes are the best fit for Europe’s refining system, especially as regards diesel production — and Saudi Arabia, after India, is the biggest potential source of available diesel supply.

Further, around 1 million b/d of new Gulf refining capacity should come on stream in the next 12-14 months, a potential counterbalance to the EU's loss of just over 1 million b/d of Russian products. This is comprised of: an additional 410,000 b/d from the second and third units of Kuwait’s new 615,000 b/d Al-Zour refinery; Oman’s 230,000 b/d Duqm refinery; Iraq’s 140,000 b/d Karbala refinery; the final ramp-up of Saudi Arabia’s 400,000 b/d Jizan refinery; and a 110,000 b/d expansion at Bahrain’s Sitra refinery.

Bans and Caps

But in the very near term, the mother of all market roller-coaster rides looms. The impacts of the Dec. 5 EU embargo on Russian crude, ban on the use of its shipping and insurance firms to trade Russian crude trade, and the G7 price cap (allowing G7-linked service providers to trade Russian crude provided it's priced below $60) are yet to fully play out. But it is clear they are bringing significant changes. Chinese state shipping giant Cosco, for example, has ceased transporting Russian crude since Dec. 5.

Physical Urals, which had been trading at steep discounts to Brent, dipped still further since December, with cargoes reportedly changing hands this month for under $40/bbl. Moscow, which needs $70/bbl to balance its budget, faces a revenue carpet-bombing if the situation doesn’t improve. “Public reports indicate that countries are using the price cap to drive steep bargains on the price of Russian oil imports,” US Treasury Secretary Janet Yellen noted this week.

Next month's products ban, however, will be exponentially more challenging for both Moscow and the EU. India and China have emerged as the saviors of Russian’s crude sales, even if at a discount. But as major products exporters themselves, neither will have the same appetite for Russian products. Meanwhile, Europe’s reliance on both Russian diesel and Russian vacuum gasoil imports to produce diesel at home mean Russian products will be hard to replace.

As Tim Gould, chief economist at the International Energy Agency, told Gulf Intelligence's virtual conference this week, the implications of the crisis, because of Russia’s standing in the energy world, have a breadth and a complexity not seen before: "And that’s why we’re calling this the world’s first global energy crisis.”

China Demand Wild Card

The key uncertainty surrounding Europe's success at replacing Russian flows is China. Europe might have had to pay a heavy price to secure the 55 billion cubic meters of LNG it bought as an alternative to Russian gas last year. But no doubt this price would have been a lot higher had China not been in lockdown. Similarly, the fall in Chinese crude imports last year sent arb grades from Latin America, West Africa and the North Sea to Europe’s aid. China's second-half 2022 imports from Brazil, Norway, the UK and Angola alone were around 550,000 b/d lower than the same period in 2021.

Beyond the spike in Mideast flows to Europe, the US also played a pivotal role, sending an additional 380,000 b/d of crude and nearly 3.6 Bcm/month of LNG in second-half 2022. But with China coming out of lockdown, Europe is going to have to pay up in order to repeat these flows. How much will depend on the pace and strength of the Chinese recovery.

Longer term, it is hard to escape the conclusion that the famed “Asia premium” for oil is going to going to morph into a Europe/Asia premium, at the risk of undermining Europe’s economic competitiveness. By contrast, India and China will at least benefit from ultra-cheap Russian oil for the foreseeable future, with China also likely to drive a hard bargain on any additional volumes of Russian piped gas.

EU-Gulf Twists and Turns

EU officials have been actively lobbying the Mideast Gulf region for more oil and gas since Russia's invasion. More supply is going west of Suez, but there are sound reasons why Mideast producers will continue to prioritize their core Asia-Pacific market. First, on the gas supply side, deeper ties have been hamstrung by EU reluctance to sign long-term contracts amid Europe's commitment to reducing fossil fuel usage.

Mounting producer-consumer tensions surrounding the energy transition also mean atmospherics are not positive at present. As Europe pushes for more supply, Mideast producers can see a vigorous internal EU debate over the wisdom of swapping overdependency on an autocratic Russia for one on the monarchies of the Gulf. The ongoing investigation into alleged Qatari bribery of EU officials over Doha’s World Cup could also taint the wider EU-Gulf relationship.

That said, the Gulf is one of the few places EU energy firms still want to invest, with the region's renewable resources also proving attractive to Europe. The Gulf remains a significant export market for Europe, including as a key arms customer.

For the Gulf, meanwhile, Europe is still largely the investment destination of choice for sovereign wealth funds. Whatever the talk of a fast-track EU transition, Gulf states clearly identify energy
opportunities in Europe, as seen in Saudi investments in Polish refining and Qatar's long-term leasing of regasification capacity in the UK and France. For all the challenges, this relationship is valuable to both sides — even if growing interdependency is accompanied by rising challenges and tensions.

For more coverage of the Ukraine crisis, visit Ukraine Crisis: Energy Impact >

Topics:
Military Conflict, Policy and Regulation, Oil Trade, LNG Trade, Oil Products, Ukraine Crisis
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