Energy crisis: will the European ban on Russian diesel raise global fuel prices?

Europe is taking another major step towards cutting its energy ties with Russia by banning the import of diesel fuel and other products made from crude oil into Russian refineries.

The European Union’s ban will take effect on February 5 after the embargo on coal and most oil from Russia. The 27-nation bloc is trying to cut down on the last use of Russian energy and stop feeding the Kremlin’s war chest as the anniversary of Ukraine’s invasion approaches.

The latest ban carries risks: diesel prices have already risen since the war started on February 24 last year, and they could rise again for the fuel essential to the global economy.

“We leave money on the road to provide our services,” says Hans-Dieter Sedelmeier of the family-run German bus and travel company Rast Reisen.

Most of the things people buy or eat are transported by trucks, which usually run on diesel fuel, at some point. It also powers agricultural machinery, city buses and industrial equipment. The higher cost of diesel is built into the price of almost everything, driving up the inflation that has made life more difficult for people around the world.

Will the embargo drive up diesel prices?

It depends on. Diesel, like crude oil, is sold worldwide and Europe could look for new sources, such as the US, India or countries in the Middle East. If that goes smoothly, the impact on prices is likely to be temporary and modest.

Europe has already cut imports of Russian diesel almost in half, from 50% of total pre-war imports to 27%. According to S&P Global, U.S. suppliers have ramped up inventories to record levels, from 34,000 barrels per day in early 2022 to 237,000 barrels per day so far in January.

The EU’s top energy official, Kadri Samson, says markets have had time to adjust after the ban was announced in June. Europeans also appear to be stocking up on Russian diesel ahead of the deadline, with imports rising last month.

There is a complicating factor: the major democracies of the Group of Seven are talking about imposing a price cap on Russian diesel going to other countries, just as they did on Russian crude oil. As with oil, the idea is to allow Russian diesel to flow to world markets, but cut Moscow’s revenue.

If the cap works as advertised, global diesel flows should realign, with Europe finding new suppliers and Russian diesel finding new customers, without a major loss of supply.

But it’s hard to say how the limit will work without knowing where the price will be set and whether Russia will retaliate by withholding shipments.

“If Russian exports are restricted for any reason, that would obviously create problems in this whole realignment process,” said Hedi Grati, chief of fuels and refining research for Europe at S&P Global Commodity Insights.

“Europe would compete with other major importers and that would cause upward pressure on prices.”

If the cap doesn’t block large volumes of Russian diesel, there could be “a short-lived price spike” as the market adjusts. First, tankers would have a longer journey to Europe from the US, the Middle East or India than from Russia’s Baltic ports, putting pressure on shipping capacity.

But a massive new refining capacity will be launched later this year in Kuwait and Saudi Arabia and in Oman in 2024. That “could further ease all the pressure points of this separation from Russia,” Grati said.

What could a diesel price cap achieve?

The hope is to replicate the effect of the oil price cap, which has prevented Western companies that largely control shipping services from handling Russian crude priced above $60 a barrel.

Russia says it will not sell oil to countries that observe the price cap, but the cap and falling demand from a slowing global economy are allowing customers in China, India and elsewhere to buy Russian oil at deep discounts, hurting the revenues of attack the Kremlin.

Boosted by higher crude oil prices, diesel prices rose to more than €900 per tonne last week, from €735 per tonne in early December. Diesel costs more than $36 a barrel over the crude oil used to make it.

One reason for the price increase was a storm in the US in late December that disrupted refineries, said Barbara Lambrecht, an analyst at Commerzbank.

What happens if diesel becomes more expensive?

Fuel prices have been a major factor behind Europe’s painful inflation that has robbed consumers of purchasing power and slowed the economy.

The diesel price at the pump has risen in the course of a year from € 1.66 per liter to € 2.14 per litre.

“That’s a huge increase,” says Christopher Schuldes, the third generation of his family to run the German transport company Schuldes expedition.

The company has 27 diesel trucks and 50 employees in the small town of Alsbach-Haehnlein between Frankfurt and Heidelberg in southwest Germany. It has already reduced fuel costs by equipping trucks with efficient engines, ensuring trucks leave fully loaded and training employees in fuel-efficient driving.

“We all did that a long time ago, long before Russia invaded Ukraine,” Schuldes said. “There is no more room for optimization.”

To reduce the extra cost of diesel, the company tried to negotiate higher prices with customers on long-term contracts. Some agreed, others didn’t. Even if a contract allows prices to rise with diesel costs, there is a two-month delay.

As for the embargo, “I’m in two minds about it,” Schuldes said. “I have to see that the company is in good shape and that we purchase as economically as possible. On the other hand – on a personal level – I say that Russia should not be supported.”

In the meantime, Rast Reisen, the bus and travel company near Freiburg im Breisgau in southwest Germany, has seen diesel fuel rise from 12-15% of cost to 20-25%. Because 15 of the 25 buses are part of the regional public transport network, the company cannot raise fares automatically, and government increases so far are “a drop on a hot stone,” said Sedelmeier, general manager of public transport.

Rast Reisen had to charge a diesel surcharge of €10-15 for trips to popular destinations such as the northern German island of Sylt or the Croatian coast as prices soared after catalog printing.

Next year prices for travel will simply be higher.

What could go wrong?

Energy markets are looking to China and wondering when the world’s second-largest economy will recover after the end of drastic COVID-19 restrictions. With domestic demand for fuel low, the Chinese government allowed refiners to ramp up their exports.

But if travel picks up again in China, that diesel could disappear from the global market, driving up prices as competition for fuel intensifies.