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Oil on troubled waters in Europe

Demand has perked up. But politics will weigh on consumers in 2017

Europe has been a global oil consumer laggard since the financial crisis. But, having established a low base, consumption posted solid gains in 2016, rising by around 2.4%. Lower prices helped, but the other reason was the strengthening economy. The outlook for 2017, though, is less positive.

"I see oil demand in Europe as stable rather than declining or growing," says Chris Weafer, head of Moscow-based consultancy Macro Advisory. He predicts an average oil price of $55 a barrel Brent for 2017, up from $45/b in 2016. "There is a small decline starting in Germany as more renewables enter the mix, but this is offset with demand growth in eastern Europe." Olivia Schorah, an analyst at consultancy Energy Aspects, expects European demand growth to ease, to 0.2% in 2017, led by a slowdown in gasoline demand. About two-thirds of EU oil is burned as gasoline and usage is not particularly sensitive to anything other than a major change in economic conditions.

"Fuel-oil demand should also decline after a solid performance this year, as ship scrappage is on the rise amidst growing environmental regulations, but diesel demand is expected to marginally accelerate by 1.3% this year, helped by a weak base in 2016," Schorah says. "The strength in distillate demand will be largely driven by a colder winter this year compared to 2016-one of the warmest northern hemisphere winters on record-but increased infrastructural investment and a lower base in 2016 as a result of slowing European dieselisation will also be supportive."

European "Heating Degree Days" (HDD), a proxy for the energy demand needed to heat a home or a business, have already risen by 15% so far this year, compared with the same period of 2016, with strength in the distillate market surfacing in the eastern Mediterranean, where cold weather and relatively low inventories have supported regional diesel values. Colder temperatures in the Mediterranean should help offset expected weakness in German heating oil demand this winter, which usually accounts for nearly a third of European heating oil requirements, after German consumers restocked domestic heating oil heavily last January amidst lower prices.

Overall, the risks to European oil demand, perhaps to a greater extent than that for gas, are tilted to the downside, say analysts. The fallout from the Brexit vote remains a key threat to the outlook for both UK and European growth in 2016, and the message of populist, anti-establishment parties appears to have resonated across the continent and could be reflected in the upcoming elections in Germany, France and the Netherlands.

"Further upsets to the European political establishment cannot be ruled out. While it is unlikely that the full effects would be felt in 2017, concerns over the macro outlook for the EU could quickly destabilise the region's financial markets," says Schorah.

While 2017 is unlikely to see a repeat of the periodic Ukrainian gas crises, where Russia has turned off the taps over disputes about unpaid bills by its traditional transit partner, there is a troubling dispute growing between Russia and Belarus over oil supplies.

In a statement published on 3 February, the Kremlin said that its budget had lost $22.3bn through oil subsidies for Belarus between 2011 and 2015. Russia shipped between 18m and 23m tonnes of oil to Belarus duty free during that period. "All of this is nothing if not direct and indirect support for Belarus," the statement read, while also demanding that Belarus repay around $0.55bn for gas already provided by Gazprom.

Since the start of July, Russian oil pipeline monopoly Transneft pumped about 40% less oil to Belarus than in the second quarter because of the claimed debt to Gazprom. In retaliation, Belarus hiked tariffs for Russian oil transit through its pipeline network and has also started looking for alternative supplies, such as from Azerbaijan and Iran.

On 31 October, several years after imports of non-Russian oil into Belarus ceased, the first cargo train carrying Azerbaijani oil reached a refinery in the Belarusian city of Mazyr, while President Alexander Lukashenko announced the same month that Belarus would resume construction of an oil pipeline to the Baltic Sea and demanded the modernisation of the Navapolatsk oil refinery, Belarus's north.

"Diversification efforts such as these are only viable in the long run if other neighbouring countries cooperate," says Siarhei Bohdan, an associate analyst at the Ostrogorski Centre, referring to the Baltics and Ukraine.

New trouble: Russia and Belarus are squabbling over oil supply

This article is part of a report series on European demand. Next article: Evergreen gas problem

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