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Russian Oil Ban and China Recovering Could Increase Inflation in Europe

In: Finance, Forex

Europe’s planned ban on Russian oil imports and the easing of Covid-19 restrictions in China threaten to add a fresh jolt to surging consumer prices.

The move will continue a process of Europe buying less and less from Moscow and further redraw global flows of the commodity, just as inflation in the euro area hit an all-time high.

The European Commission has proposed to ban seaborne crude oil six months from adoption, while refined petroleum products would be halted in eight months. Shipments of oil through the giant Druzhba pipeline to central Europe will be spared until a technical solution is found that satisfies the energy needs of Hungary and other landlocked nations.

The EU’s measures would also prohibit services including insuring shipments to anywhere in the world. That matters because the vast majority of the world’s tankers are covered by the International Group of P&I Clubs. The organization ultimately buys reinsurance from European businesses, meaning it would have to comply with EU law.

The oil ban means Europe’s market will end up being structurally more expensive, as prices drift higher to incentivize local production and attract deliveries from elsewhere.

That’s already had an impact, with surging prices for Brent and West Texas Intermediate and a spike in Russian shipments to Asia as European refineries seek supplies elsewhere in anticipation of the sanctions. But more disruption is likely in store.

Tanker tracking information compiled shows that Europe is still taking about 770,000 barrels a day of Russian crude, large amounts of which are going to refineries run by Geneva-based Litasco SA, a unit of Russian producer Lukoil PJSC. That’s down from an average of 1.4 million barrels a day in January, the month before Russian troops invaded Ukraine.

Over time, Russian barrels will likely have a similar discount to grades from Iran and Venezuela and some production may be forced to halt as the ban eats into its potential market, according to oil traders.

The step comes as China shows signs of winning its battle to control Covid, which could revive the most important source of demand growth. The country brought new cases below 100 for the first time since early March, and authorities are loosening restrictions in Shanghai and tentatively easing curbs in Beijing.

China’s potential comeback is vitally important. Its recent Covid restrictions kept a lid on prices, which means the nation’s ability to find a balance between sustaining economic growth and fighting the virus may well prove pivotal for the crude market this year.

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