Economy 1 August 2024, 12:22pm

Hungary Mol to make a crucial call that could affect local fuel prices

Portfolio

The Lukoil affair has put Hungarian energy group Mol in a tough spot, and the path to be chosen could also affect Hungarian fuel prices, no fewer than seven sources told Portfolio. Mol's choices are the following: 1) either to take over the ownership of the Russian or, on paper, Kazakh oil at the Russian-Ukrainian border and have it transported through Ukraine at its own risk, or 2) to divert the oil imports lost due to Ukraine's sanction on Lukoil to the Adriatic pipeline to Croatia, where there is plenty of capacity. For the time being, the first direction is the most likely one, which is also understandable for cost reasons, and we understand that Mol has already indicated this to the stakeholders behind the scenes. However, the group may go down the other path, because the Ukrainians are pushing it in the direction of decoupling as much as possible from Russian oil. That is why Hungarian motorists will also feel the tug of war.

The gist of the possible solutions

We have learned a lot of exclusive details about the complicated Lukoil affair, such as the fact that Russian suppliers did not make up for the oil lost in July due to Ukraine suspending Lukoil's oil transits to Hungary and Slovakia, because in fact the Russian side blocked the suppliers' capacity booking.

We have also learned that Mol has already indicated 'backstage' that it may be willing to take over ownership of oil from Russian suppliers on the Russian-Ukrainian border. In fact, the European Commission may well propose this to the company, after it has gathered information from all directions and established the real security of supply situation, in addition to the political statements that have been made about looming fuel shortages.

For the time being, there is no risk of security of supply or fuel shortages, all our sources have confirmed.

So one of the possible solutions is that Mol would transit the oil through Ukraine at its own risk, with the help of a supplier not subject to Ukrainian sanctions. This would be understandable, as the second option, increased shipments from Croatia, would entail much higher oil procurement and transport costs.

However, if the first course is chosen, it is in the cards, and remarks made by the Ukrainian Prime Minister on Wednesday only confirmed this: further sanctions could be imposed to make sure

Europe decouples from Russian oil as much as possible.

There may be a further twist in the story where Mol replaces Russian oil on paper with, for example, Kazakh oil, but at the molecular level it is still Russian oil, as we are seeing now on the northern branch of the Friendship pipeline to Poland and Germany. There, at the Schwedt refinery near Berlin, Kazakh crude is on paper coming in, which is in fact eerily similar to the properties of the Russian Urals crude (REB), as far as we know.

If the Ukrainians do not turn a blind eye to this arguably questionable / shady paperwork, they can divert Mol's non-Russian oil imports to the Adriatic pipeline, as far as the pipeline's capacity will allow, in order to force real diversification.

We also learned that a surprisingly large amount of oil could be brought up from there to Mol's refineries in Százhalombatta, Hungary, and Bratislava, Slovakia, although there would be risks.

Let's see the details!

It's worth going in order, because it makes the complex case more transparent. The most important information are as follows:

Because of the Ukrainian suspension of Lukoil's oil transit, 260,000 tonnes of Russian crude oil deliveries to Hungary and 105,000 tonnes to Slovakia were reportedly delayed in July. Thus, contrary to what we know so far, the deliveries lost due to the Lukoil sanction have not been replaced by other Russian suppliers through Ukraine.
This could be due to the discrepancy between Ukrainian communication and Russian actions. The backstory could be that after the Ukrainians sanctioned Lukoil's Russian parent company, Mol revealed to the Ukrainian pipeline operator Ukrtransnafta that the oil entering Ukraine from Russia was not owned by the Russian parent company, but by four other trading companies. (We will not name them now, but two companies are known in the industry, one is the Swiss trading company of Lukoil, and two are rather unknown, one is a Cypriot-based company with a trading branch in Hungary.)
After the four companies had been named, Ukrtransnafta indicated to Mol that there was no reason to suspend their supply, so Russian oil could have come through Ukraine. However, according to our information, what actually happened was that the Russian pipeline operator Transneft, which is linked to the traders, blocked the four companies from booking capacity on the Ukrainian section of the pipeline without giving any reason. Thus, the oil that Lukoil had planned to deliver could not be transported through Ukraine by the other four trading companies, thus the 365,000 tonnes mentioned above were lost, and that is why Lukoil diverted 340,000 tonnes of crude oil to Russian ports for July. The Kremlin's only response to all this was to say that the buyers of Russian oil are now in a crisis situation because of the Ukrainian decision, let them sort it out themselves, because there is nothing they can do.
This situation has been temporarily managed by Mol, partly through increased imports from Croatia and other assistance, so all our sources have stressed that there is no security of supply risk for the time being. However, Mol is stressing to the parties in the background that this is not a permanent solution, although it is not clear why. Indeed, it has also indicated behind the scenes that oil supplies from Ukraine could be 20% less than its needs in August. As far as we know this will not be a problem at the Százhalombatta refinery until the end of August, but that is why Gergely Gulyás, the Prime Minister's chief of staff, told journalists last Friday that a solution must be found by September, because this situation cannot be allowed to continue.
The solution would either be for Mol to take the Russian/Ukrainian oil at the Russian/Ukrainian border, or to increase non-Russian oil imports from the Adriatic. We understand that the actual annual capacity of the Croatian pipeline is currently around 10 million tonnes, but the Croatian pipeline operator JANAF could increase this to around 14 million tonnes per year without capacity expansion investments by "small tricks" such as reducing the viscosity of the oil transported. This can also have security of supply risks, as it is never a good idea to try to transport around the theoretical annual capacity of a pipeline on a sustained basis. It is also necessary to take into account the downtime for maintenance and the time needed to transport the different qualities of the oils purchased through the pipeline, since Mol does not have a blending plant at the Omišalj oil terminal (either).
We understand that there could be up to 8 million tonnes of annual spare capacity on the Croatian pipeline, while Hungary and Slovakia are to lose around 3.8-4.5 million tonnes of Lukoil oil transit via Ukraine per year. Therefore, the Adriatic pipeline would be able to take over the volume lost over the Lukoil sanctions and therefore there is no risk to security of supply for the time being.

Key considerations

So the big headache for Mol is, in layman's terms, the following: until now, the company has taken delivery of oil at the Hungarian-Ukrainian and Slovakian-Ukrainian borders, but from now on it would move this point of delivery to the Russian-Ukrainian border and entrust a supplier with the transit to Ukraine.

The risk of transit would this way be borne by Mol. it could try to take out an insurance on this, but it would have an extra cost, and on the other hand it would create a direct channel of pressure for Mol from the Ukrainians.

To put it very simply, the fuel prices of Hungarian motorists would also be affected if the Hungarian and Ukrainian governments were to clash over certain aid for Ukraine and other issues in the coming period.

Moreover, given the Ukrainian Prime Minister's words yesterday ("as much as possible, [EU countries] must give up Russian oil"), further Ukrainian sanctions against Russian oil producers and suppliers could easily be imposed to push the process in this direction. Thus it would be futile for Mol to take oil across the Russian-Ukrainian border if some further sanctions blocked its transit through Ukraine.

The alternative to this would be increased imports through the Adriatic pipeline, where there is plenty of spare capacity, but where Mol would have access to Western and Arabic oil, which is more expensive than Russian oil.

The cost of buying oil would therefore increase, as the transit fee per 100 km on the Croatian section is twice as high as on the Ukrainian section. Hungarian motorists would therefore feel the changes in local fuel prices as a result of these two effects.

Obviously, in the case of increased transport volumes, negotiations could be held with the Croatian JANAF to lower the transit fee, but this would also require better Hungarian-Croatian relations and a reduction of the tension in the Mol-INA issue.

Overall, the above points to the possibility that Mol may try to take over the ownership of Russian oil at the Russian-Ukrainian border, but

the Ukrainians may eventually push it to buy as much non-Russian oil through the Adriatic pipeline as the pipeline can handle.

This would give a further boost to diversifying away from Russian oil in Hungary and Slovakia, with no real security of supply risk, just an increase in procurement costs. In the latter case, the Hungarian and Slovak arguments would most likely be rebuffed by the European Commission, and the EU-Ukraine Consultative Forum would not be convened.

So far, there are clear indications that EC is reluctant to do so, and the Ukrainian Prime Minister has stated that Brussels is on their side in the Lukoil case.

An important reason for this is that, as the European Commission's country report on Hungary pointed out in June, Hungary "continues to rely heavily on Russia for fossil fuels and on nuclear energy, and its efforts to shift away from Russian dependence are slow."

The document also stated that

In 2022, Hungary depended on Russia for around 84% of its oil imports, the highest level since 2014.

The following impressive table on the extent of dependence on Russian energy and how diversification evolved up to 2022 was included with the massive document, from which we have highlighted the key points related to the above topic: