Last Week in Oils

Another week, another flurry of activity in oil markets. Or rather, oils—crude and, we suspect perhaps less top of mind for most folks, palm. The EU revealed details of its plan to wean itself off Russian fossil fuels, Russia continued to find buyers for its discounted crude, and Indonesia lifted its ban on palm oil exports. What does it all mean for investors? Let us explore!

The EU’s Plan Appears to Be a Little … Lacking

For weeks now, observers we follow globally have eagerly anticipated Brussels’ explanation for how and when it will wean the EU off Russian energy. The concerns are at the fore today given Europe’s energy needs water down sanctions, ensure Europe continues funding Russia and raise the risk that Russian retaliation leaves the EU (to some extent literally) in the dark.^[i] But it has also been a long-running sore spot, especially with Russia occasionally throttling pipelines in order to exert political pressure and gain concessions from EU leaders.^[ii] So a long-term pivot away from Russia has been talked of for years.

The plan released last week seems like a strange way to get there, in our view. The EU billed it as a solution to both short- and long-term problems.^[iii] But the short-term solutions mostly amount to encouraging residents and businesses to be more energy-efficient, keeping coal-fired plants online a bit longer than initially planned and incentivising people to install electric heat pumps and reinsulate buildings.^[iv] That last bit has been part of the UK’s energy strategy for a while, and so far, it hasn’t worked well—heat pumps haven’t proven to be an efficient home heating source, and the upgrades have been uneconomical for the low-income and elderly people who would most need them.^[v] Keeping coal plants online might help with energy supply in the medium term, but it doesn’t increase supply in the here and now—it just doesn’t cut it. Whilst we think reducing consumption is an obvious help, we suspect the market is encouraging that already, as high prices are wont to do.^[vi] So overall, the near-term plans seem mostly like window dressing to us.

Longer term, the plan focuses on ramping up renewables, upgrading oil refineries to process non-Russian blends, and building new pipelines and liquefied natural gas import terminals to enable more imports of oil and gas from the Middle East and Africa—all in the name of ending Russian reliance by 2030.^[vii] We think the infrastructure buildouts should help. Whilst markets already appeared to be heading in that direction, we suspect having an EU plan should expedite permitting and construction—as well as give suppliers more confidence an investment is worth the risk. Ditto for reconfiguring refineries.

We think the same goes for expanding wind and solar power capability, as wind and solar farms face long permitting delays (though fixing this would require member states to make policy changes).^[viii] However, we would be remiss not to point out that wind and solar are intermittent electricity sources and can create other reliability problems. Several years ago in South Australia, poor weather made power costs soar through the roof in solar-reliant areas, requiring the state to import energy from coal- and gas-fired plants in neighbouring areas.^[ix] More recently, calm weather throughout Europe last autumn caused a run on natural gas, causing severe energy shortages and price spikes that rippled throughout Europe and Asia.^[x] We suspect this is why some member states have gone above and beyond the EU’s plans, pushing hydrogen development and next-gen mini nuclear reactors.^[xi]

Overall, this strikes us as a rather milquetoast endeavour that probably won’t have much cyclical economic or market impact. In our view, initiatives like this play out too slowly, over too many years, to have much effect on near-term economic results. As for the acute energy needs, whilst we don’t think this does much to address them in a meaningful way, we also don’t think it appears to create roadblocks to the efforts that are already ongoing. So, we guess it seems broadly fine, but we wouldn’t overstate the impact.

China Wants to Buy Some Oil

Whilst the EU wants to pivot away from Russia, other nations are still buying. India and China have both reportedly bought high volumes of Russian crude since the invasion, and maritime observers have also tracked heavy Russian tanker activity in Southeast Asia.^[xii] But as several industry analysts have noted, a lot of these purchases satisfied contracts that were signed before the invasion and Western sanctions took effect—creating questions about whether purchases would continue once new contracts were required.

We are starting to get preliminary evidence they will. Last Thursday, Bloomberg reported China was in talks with Russia to purchase huge stocks of Russian crude to refill its strategic reserves, which it tapped to tamp down energy prices during last autumn’s aforementioned electricity shortage.^[xiii] Interestingly, this comes after other reports from commentators we follow showed China cutting Tech-related exports to Russia after US sanctions on these categories took effect, suggesting Beijing was leery of contravening Western restrictions. But Beijing may see buying Russian oil as lower-risk and simply too good to pass up, given Urals oil continues trading at a deep discount and most of the sanctions included energy carveouts.^[xiv]

From a sociological standpoint, we think this illustrates why sanctions are unfortunately feckless at prompting rogue leaders to change their behaviour. But we think markets generally look beyond sociology and care more about economic effects over the next 3 – 30 months. From that standpoint, we think China’s continued purchases show why the acute oil shortage fears that accompanied Russia’s invasion of Ukraine were overblown—which in turn explains why oil prices remain down from early March’s spikes.^[xv]

Indonesia Is Ready to Export Palm Oil Again

Crude isn’t the only oil disrupted significantly by Russian President Vladimir Putin’s war. Cooking oil is also in short supply, contributing to global food concerns.^[xvi] Ukraine is a top producer of sunflowers, which are a key cooking oil feedstock.^[xvii] Whilst the crop season has largely gone uninterrupted, Ukrainian agricultural leaders are very pessimistic about the country’s ability to process and export the harvest, raising warnings from commentators we follow of a global cooking oil shortage. That sent prices higher globally, prompting Indonesia—the world’s largest producer of palm oil—to ban exports in late April.^[xviii] Predictably, that made global concerns amongst observers we follow even more acute, focused not only on continued inflation (broadly rising prices across the economy), but on food poverty in the developed world and severe hunger problems for low-income nations as well.   

Mercifully in our view, Indonesia changed tack last week, announcing that exports will resume from today onward, which should help ease one contributor to inflation.^[xix] Whilst people tend not to buy jugs of palm oil for cooking, it is used widely in industrial food production and is also a feedstock for soap, ink, certain types of diesel fuel and other household goods.^[xx] With exports resuming, food processors and other factories won’t have to scramble for alternatives, which we think will help ease the pressure on more traditional household cooking oils and other feedstocks. It may take time for these effects to materialise, given palm prices tumbled on the restrictions, discouraging production—and some exporters now say more clarity from the government is needed around local supply management rules it announced after lifting the export ban.^[xxi] But before long, we suspect this will provide some relief on cooking oil prices and other derivatives from palm oil. It isn’t a huge relief, perhaps, but every little bit helps, in our view.

More broadly, the U-turn cuts against warnings from commentators we follow of the war sparking a rise in global protectionism. In our view, that is another positive. Our research shows global markets tend to be most efficient when they are allowed to function freely, with global supply adjusting to meet global demand. We didn’t see this as a huge market risk, mind you, but perhaps it will help sentiment improve a tad.