SEMI-EMBARGO WITH FULL PRICE INCREASE

After two months of discussions, the EU adopted yet another (sixth) package of sanctions against Russia amid its military actions in Ukraine. As expected, Brussels' new sanctions affected both the imports and transit of crude oil and a number of oil products from Russia. The decision, as promised by the President of the European Commission, was a rather cautious one to mitigate the backlash of embargoes on the initiators.

Russia has estimated the potential damage to EU economies from the restrictions at more than $400b a year, while making very optimistic statements about the resilience of the Russian economy and its readiness to deal with any insidious blows from the West.

Obviously, the sanctions will not pass unnoticed in Europe, causing a record increase in energy prices and other negative effects. Nor will do any good for the Russian oil industry and the state budget in the long term.

Partial embargo

The sixth package of anti-Russian sanctions adopted by the EU Council affects the economic sector as well as individuals from Russia and Belarus.

The document prohibits the purchase, direct or indirect import or transfer of oil or petroleum products exported from Russia or of Russian origin. Related technical assistance, brokering, financing or financial assistance, and any other services also cannot be provided directly or indirectly.

President of the European Council Charles Michel explained that the ban concerns imports of crude oil and some petroleum products from Russia delivered to Europe by sea (!), which accounts for more than 2/3 of oil imports from Russia. The staged restriction measures will take about six and eight months for crude oil and petroleum products, respectively. These measures have already been called a semi-embargo, but even in this form they can cause considerable damage to the Russian economy. "In the long term, revenues from oil exports are three to four times more important to Russia than gas sales," Gunter Deuber, head of research at Raiffeisen Bank International said. Wintershall Dea estimates that oil exports account for about a third of Russia's budget, while the share of gas exports is 7% only.

Bulgaria was exempted from sanctions and is allowed to import oil from Russia by sea until 2024. The Czech Republic, Bulgaria and Croatia also received minor exemptions. Significant ones were granted to Hungary, which opposed the sanctions (it received Russian oil mainly through the Druzhba pipeline, and will continue to do so).

On top of that, Poland and Germany have also decided to voluntarily give up pipeline supplies of Russian oil. This means that they will not receive it through the Druzhba pipeline. As a result, by the end of the year the EU will block 90% of the oil coming from Russia and will soon discuss blocking the remaining 10%.

The package does not include a description of the banned petroleum products, only that it is prohibited to import any of them.

The ban does not apply to the purchase of marine oil and oil products from third countries if they are only loaded, shipped from or transit through Russia, provided that both the origin and the owner of these products are non-Russian. This clause is relevant, for example, for Kazakh, Turkmen or Azerbaijani oil shipped from the ports of Ust-Luga and Novorossiysk.

Budget hit

Bloomberg estimates that Russia will lose more than $22b a year from oil exports to Europe because of the new sanctions. In addition, there is also a high probability that Russia's oil production will fall already after the EU's semi-embargo enters into force.

The International Energy Agency has previously issued a forecast that Russian oil production will fall by 3m barrels daily (bpd) in 2022.

The Russian government expects the oil production to drop from 524m tonnes in 2021 to 480-500m tonnes (by roughly 8%). These figures were stated by the Russian Deputy Prime Minister Alexander Novak. But the Russian Finance Minister Anton Siluanov estimated a possible decline in oil production in 2022 at 17%.

At the same time, the Russian government sees no need in reducing oil production, as it may not increase the global prices, but the risk of losing markets and more. "Production decrease does not necessarily mean the price increase, because there will be a temptation and an opportunity for other countries to compensate the decreased volume. There will always be a balance of supply and demand, while the deficit is covered by new investments and production volumes. There may be a short-term effect, but in the medium term it will probably be even less profitable," Mr. Novak said.

Meanwhile, Leonid Fedun, co-owner and Vice President of LUKOil, proposes a decrease of the Russian oil production by 20-30%—from 10m bpd to 7-8m bpd. "Should we try to maintain pre-crisis export volumes by agreeing to 30% and sometimes 40% discounts?" Fedun wonders. According to him, the buyers will try to ‘institutionalise’ these discounts through tariff regulation tools disguised under the discussions on oil embargo.

However, since the ban on offshore deliveries of Russian oil to the EU will come into effect only by the end of this year, Russia's refusal to cut oil production and exports at this point sounds reasonable, given the high price margin. In April, for the first time Russia supplied more oil to the Asian market than to Europe, and this trend intensified in May.

As for the likelihood of decrease in Russian oil production in the long term, experts believe that it will depend on how much EU purchases of Russian oil decrease in relation to Russian supplies diverted to Asia. However, there are big doubts that the process of changing markets will go smoothly and painlessly. There is a strong competition for Asian markets, not to mention the infrastructure and logistics for both oil and oil products.

Mikhail Krutikhin, a Russian energy expert and partner at consulting company RusEnergy, believes that the EU embargo will have very strong consequences for Russia. "It is very strong. The West is the main market. Russia already supplies 80m tonnes of oil to the Chinese market. But increasing this volume to compensate for the loss will not work," the expert believes.

Oleg Buklemishev, president of Association of Independent Centres for Economic Analysis, is also skeptical about the supplies to China because Russia "simply does not have the necessary infrastructure like oil pipelines, logistics, railways and well-established storage reservoirs".

The idea of exporting 15m tonnes of Russian oil to India also sounds weak, given high transportation costs and strong competition from the Middle Eastern suppliers.

Updated forecasts

A ban on offshore imports of Russian crude has pushed Brent above $120 a barrel. Currently it is trading at $115 a barrel though.

There is no reason to push prices down yet. On the contrary, according to some estimates, they could rise to $150 per barrel during the year.

Barclays, pointing to EU sanctions, has updated its forecasts for the average price of Brent crude this year and next year to be no lower than $111 a barrel.

Goldman Sachs Group predicts that Brent crude will cost an average of $135 per barrel in the 2H2022-1H2023, up $10 from the bank's previous forecast.

The World Bank have also raised their expectations for oil prices in 2022 and 2023. For example, they believe that in 2022 in 2023 the average price of a barrel of oil will come close to $140 and $110 per barrel, respectively.

Jeremy Weir, CEO of Trafigura, a major oil trader in Singapore, said oil prices could reach $150 a barrel this year and warned of a possible drop in demand for the commodity as consumption becomes ‘very expensive’.

Azerbaijan supports balance of interests

"If some think that the oil and gas producing countries are happy with such high prices, they’re wrong. A balance of interests between producers and consumers, a stable market is what producers really need. This is the goal of our efforts in the OPEC+, where Azerbaijan is quite an active participant. These are new challenges. What I said today is quite different from what I said here six months ago. This shows that everything can change, everything is changing and nothing is stable," President of Azerbaijan Ilham Aliyev said on June 16 at the opening the 9th Global Baku Forum on Threats to the Global World Order.

Rising global oil and gas prices will increase Azerbaijan’s strategic foreign exchange reserves in and higher revenues for the State Oil Fund thanks to the sale of profitable oil and gas.

The current situation in the oil markets has prompted the Azerbaijani government to revise the parameters of this year's state budget and increase the benchmark oil price projected for 2022 from $50 to $85 per barrel, which would provide the state budget with additional revenue.

In his speech at the forum, President Aliyev also addressed the energy cooperation with the EU, noting that energy security is one of the urgent issues on the global agenda. "Azerbaijan's demand for energy resources is growing… We have started an energy dialogue with the European Commission. This includes not only gas, but also oil, electricity and hydrogen production. Azerbaijan has great potential related to renewable energy," Aliyev said.

EU Commissioner for Energy Kadri Simson, who attended the South Gas Corridor Advisory Council meeting on February 4, is expected to visit Azerbaijan again in July. It is not difficult to guess the range of issues to be discussed during her meetings with the Azerbaijani side, especially after President Aliyev outlined the topics included in the energy dialogue with Brussels. We just need to wait for the results of this process.