25 June 2022

Saturday, 12:05

REDISTRIBUTING OIL SUPPLIES

Europe intends to give up on Russian oil, hesitating to do so without damaging its own economy

Author:

01.05.2022

We are going through the third month since Russia began its military action against Ukraine. Since then, the EU has introduced five sanction packages to stop Moscow. There are discussions in Brussels about the effectiveness of existing measures and preparations for the sixth sanctions package. This one is supposed to include certain measures to limit imports of Russian oil and disconnect a ‘larger number’ of Russian banks from SWIFT, Politico reported.

The previous sanctions package issued on April 7, in addition to banning Russian ships from accessing European ports and other measures, also included a ban on exports to the EU of Russian coal and other solid fuels. Even then, we predicted that oil was likely to be next in line for sanctions from among Russian energy carriers. However, it is not yet clear exactly how the EU plans to punish oil exports from Russia, i. e. how quick and comprehensive a future refusal of imports of Russian oil will be. Judging from serious disagreement among the EU members over Russian oil and gas supplies, it is hard to believe that measures will be as comprehensive as declared. The most likely scenario seems to be a gradual shift away from the Russian oil dependence.

 

Oil embargo

On April 17, President of European Commission, Ursula von der Leyen, said that a sixth package of sanctions was being prepared. She stated that Europe was "in the process of developing smart mechanisms" to help it cut off Russian oil supplies. According to Leyen, the new measures should affect Russia’s banking and energy sectors, including Sberbank.

It is no secret that energy revenues are the main source of funding for Russia's budget. The European think tank Bruegel estimates that the EU pays about 1 billion euros daily for Russian oil and gas due to rising energy prices. The EU therefore sees restrictions on Russian energy as a "vital step," clearly hinting that it could be vital for Europe itself. After all, European refineries are mainly designed to process Russian Urals crude.

Speaking about new possible bans, European Commission (EC) Executive Vice-President Valdis Dombrovskis explained that restrictions are still being developed and agreed upon in order to "minimise the damage to ourselves". He confirmed that EC is currently preparing another package of sanctions, which considers oil supplies - the possibility of a waiver or introduction of additional tariffs or fees.

According to Bloomberg, the US and the EU are currently discussing three options for measures to limit oil imports to the EU from Russia: a complete ban on supplies, setting a price threshold and using a settlement mechanism to retain Russian proceeds from the war in Ukraine.

At the same time, the US fears that a direct EU ban on Russian oil could lead to a surge in raw material prices bringing the Kremlin even more revenue. According to US Secretary of Treasury Janet Yellen, a total embargo could severely damage European economies without such an impact on Russia.

The world's leading media outlets expect the EU oil embargo on Russia to be differentiated, i. e. depending on the type of Russian oil and how it is delivered (by tanker or by pipeline).

US investment bank JP Morgan predicted that Brent crude could jump to $185 per barrel if the European Union imposes an embargo on Russian oil. They believe that the embargo will push more than 4m barrels of Russian oil from the market, which will not have time to be redirected to other markets. However, JP Morgan also considers a soft scenario, when the ban will be implemented gradually, so as not to provoke a sharp rise in prices.

Either way, any final decision will be taken by the EU member states. And it will be easiest and fastest for countries that are not heavily dependent on Russian oil, like for Germany. However, Annalena Baerbock, German foreign minister, said that oil imports from Russia to Germany "will be halved by the summer and reduced to zero by the end of the year". Apparently, this is Berlin's way of signalling to other EU countries that it is ready to consider giving up Russian oil supplies, but not gas.

 

Reputation is more valuable than oil

While the debate continues, some EU countries have decided to individually reduce their imports of Russian oil or even abandon them altogether.

Austria has refused to buy Russian oil since the start of Russia's military campaign in Ukraine, an unnamed OMV Group official said: "The volume of oil purchases from Russia has always been very low; with the start of the war we replaced it with other one from the market.”

Lithuanian oil refiner Orlen Lietuva (part of the Polish oil concern Orlen) is also rejecting Russian oil and switching to oil from Saudi Arabia, said Lithuanian Energy Minister Dainius Kreivys. In recent years, about two-thirds of the oil processed by Orlen Lietuva has been provided by Russia. The Polish company says that after the end of existing contracts, oil will no longer be purchased from Russia.

War and sanctions against Russia have already resulted in many major oil companies stopping new purchases of Russian oil, including BP, Eneos, ENI, Equinor, Galp, Neste, Preem, Repsol, Shell, etc.

Due to compliance with existing sanctions and in order to avoid reputational losses or possible legal problems, large trading companies such as Trafigura and Vitol have also refused to buy Russian oil.

Overall, this led to a 30% fall in the price of Russian Urals blend in Europe between early March and mid-April, to $78 a barrel from $111. Nevertheless, Russian crude has proved quite attractive for buyers, who have no fear of public scrutiny of their purchases.

 

Heading to Asia

The EU financial sanctions on Russia, European buyers' voluntary rejection of Russian oil, as well as the falling oil prices have played into the hands of Asian consumers.

According to Refinitiv, based on tracking oil tanker traffic, a total of 380 oil tankers left Russia from the start of Russia's military action in Ukraine (February 24 – April 18), an increase from 357 during the same period a year earlier.  Of this number, 115 vessels headed to Asian countries.  Shipments to India increased eightfold compared with the same period last year. Shipments to China increased by 33%, while shipments to other countries decreased by 16%.

Overall, analysts note that India and China will continue to buy Russian oil. "Although oil imports by these two countries did not increase significantly in March, we are likely to see an increase in purchases in the next two or three months," said Petro-Logistics manager Daniel Gerber.

In fact, the situation in China is not that favourable, with dropping fuel demand expected due to a sharp rise in new COVID-19 infections. For example, analysts expect dropping demand for petrol, diesel and jet fuel in the country to be around 20% in April compared to the same month last year, that is around 1.2 million barrels per day lower.

Incidentally, discounted oil sales have to some extent affected the Russian economy. According to Alfa-Bank, Russia lost $3bn of its oil revenues in March because of the Urals price discount to Brent, and this is not the limit.

"Russian Finance Ministry announced that Russian oil was selling at a 20% discount to the Brent price in March, meaning a monthly loss of $3bn in export revenues. Lower physical volumes of oil and metal exports are likely to result in additional losses in the coming months. We do not rule out that of the $45bn monthly export revenues in January 2022, Russia will receive only $30bn monthly in the coming months, especially if oil sales from the US strategic reserves lead to lower oil prices," the bank reported.

 

Israel refocuses on Azerbaijan

Threat of an oil embargo on Russia raises the issue of diversification of energy resources, especially for countries strongly linked to Russian hydrocarbons. In any case, being tied to a single supplier can create big problems for national economies of these countrie, even in peacetime. The EU learned this simple truth after the start of hostilities in Ukraine. It is clear that even with the end of hostilities, the energy partnership with Russia will no longer be at the same level. The EU will do everything it can to bring the moment for the rejection of Russian energy resources closer.

As noted above, amidst the Russian-Ukrainian war, the attractiveness of Azerbaijani gas and the importance of the Southern Gas Corridor (SGC) have increased manifold in Europe. The same can be safely applied to the Azeri oil.

The visit of Israeli Finance Minister Avigdor Lieberman to Azerbaijan on April 25 was particular important.

The Israeli media reported that the largest supplier of oil and oil products to Israel has so far been Russia. But the Israeli government intends to stop buying Russian oil as soon as possible, refocusing on other markets, in particular Azerbaijan.

Due to the Arab embargo on goods and any shipping connections with Israel, the latter has been unable to buy oil from the Middle East for decades. Tel Aviv currently buys most of its oil from Russia, Azerbaijan and Iraqi Kurdistan.

On the eve of Lieberman's arrival in Baku, the Israeli press reported that the main purpose of his visit was to obtain Azerbaijan's consent to supply large amounts of oil to Israel. In addition, Israel intends to buy urea from Azerbaijan, which has previously been imported from Russia. Urea is used to produce diesel fuel, a shortage of which can lead to disruption of public transportation.

According to the Azerbaijani State Customs Committee, Israel is among the top three importers of Azerbaijani oil. In January-March 2022, Israel bought 521,000 tons of oil from Azerbaijan ($328m). By the end of 2021, this indicator was more than 1.7 million tons ($887.5m). Statistical data of the remaining nine months will clearly demonstrate the growth rate of Azeri oil imports the two parties have agreed on. It seems that initially the annual level of 2-2.5 million tons is quite a manageable task.



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