Brent hits 2-month high as potential EU Russian oil embargo tightens supply outlooks

ICE Brent futures settled at two-month highs May 26, breaking out of their recent trading range amid expectations of tighter European supply.

Front-month ICE July Brent finished $3.37 higher at $117.40/b and NYMEX July WTI settled up $3.76 at $114.09/b

Oil supply outlooks have come under pressure as the EU continues to debate an embargo on Russian oil imports in response to Moscow's invasion of Ukraine.

Holdouts Hungary and Slovakia have so far blocked the measure, but an agreement to ban Russian oil imports is still possible in the coming days, media reports quoted Germany's economy minister Robert Habeck as saying on May 26. Should the bloc be unable to reach consensus needed to pass an embargo, unspecified "other instruments" could be considered, Habeck said as per the reports.

NYMEX June RBOB settled up 4.57 cents at $3.8774/gal and June ULSD finished 10.16 cents higher at $3.9680/gal.

If the EU passes the ban on Russian oil, market analysts estimate that some 2.5 million b/d of oil will be displaced as a result, as Russia will struggle to find alternative buyers due to constraints on shipping and infrastructure.

Front-month ICE Brent was last higher on March 25, when the contract settled $120.65/b, but NYMEX WTI ended the session 11 cents shy of its most recent peak of $114.20/b reached May 16.

"OPEC is unlikely to fill the gap, with the group struggling to raise output in line with its higher quotas," ANZ Research analysts said in a May 26 note.

Even without an EU embargo, sanctions resulting from Russia's invasion of Ukraine could see Russian oil output drop 5%-8% in 2022, Russian Deputy Prime Minister Alexander Novak said May 26, according to the Prime news agency.

"The EU agreement is distraction, given individual member states and vital corporate buyers in Europe are already phasing out purchases of Russian oil," Stephen Innes, SPI Asset Management's managing partner, said in a May 26 note.

Backwardation in ICE Brent forward structure has also reached a two-month high, with the discount between year ahead and prompt-month futures opening to more than $20/b.

"Whether or not [an embargo] happens, there will be significantly less Russian oil flowing to Europe over the remainder of this year, which leaves the market in deficit with few immediate options to backfill that shortfall," Innes added.

Novak said that he estimates 2022 production will be 480 million mt to 500 million mt, equivalent to 9.64 million b/d to 10 million b/d. This would be a production decline of 4.6% to 8.4% on 2021 volumes of 524 million mt, or around 10.52 million b/d.

S&P Global forecasts peak Russian oil output disruptions of 2.8 million b/d by August, with the EU finalizing a phase out of its Russian crude imports.

UK announces "windfall" tax on oil profits

In a possible blow to longer-term European supply, UK Chancellor of the Exchequer Rishi Sunak on May 26 announced a 25% levy on oil and gas production earnings, raising the headline rate of tax to 65% from 40% while offsetting the hike with investment allowances he said would almost double total allowances for upstream spending.

Sunak estimated the levy would yield an extra GBP5 billion ($6.3 billion) in tax in the current year, helping pay for reliefs for energy consumers. The levy will be phased out "if oil and gas prices return to historically more normal levels," accompanying government documents said.

Offshore Energies UK CEO Deirdre Michie, the North Sea oil and gas sector's industry body, said tax levy on upstream oil and gas profits would "drive away" investors, in turn hitting production levels in the key basin and increasing the UK's import dependence.

"This is a disappointing and worrying development for industry, the shockwaves of which will be felt in offshore energy jobs and communities, and by consumers for years to come," OEUK Chief Executive Deirdre Michie said, adding the tax "will drive away investors and so reduce UK energy production. That means less oil, less gas, and less renewables."