- Russian oil did not come off the market when sanctions were introduced
- In reality, demand for Russian oil increased
- Growing unwillingness in Europe to sacrifice economic growth for Ukraine
It has been almost five months since Western Europe first started to obstruct the movement of Russian energy resources in response to Russia’s actions in Ukraine. On Feb. 22, German Chancellor Olaf Scholz suspended the certification of the Nord Stream 2 pipeline, which was ready to start delivering natural gas to Germany.
Since that time, we have seen a declaration of sanctions that forced western oil and gas companies to exit projects in Russia; export controls on products that would support the Russian oil and gas industry; a U.S. ban on importing Russian oil, natural gas and coal; and commitments from Britain and the E.U. to phase out or ban the importation of Russian oil, petroleum products and coal delivered by sea at later dates.
So how have these actions impacted the market, and what we can expect with regards to Russian oil and gas in the future.
1. Re-routing of oil and gas flows
As I predicted, Russian oil did not come off the market when the west shunned it. After a brief period where Russia cut some production, Russian oil companies found new customers in India and China. They offered significant discounts to refiners that were willing to pay for, transport and insure the oil. As oil prices soared into the triple digits, these discounts made Russian oil even more attractive. Russia opened a huge new market for its oil in India and substantially increased its exports to China. In fact, Russia has overtaken Saudi Arabia as the top supplier to China. Meanwhile, Saudi Arabia’s sales to China have dipped. In May, Russia became India’s second largest supplier of oil, sending 819,000 bpd of oil to Indian refiners. This is up from just 75,000 bpd last year. Less Russian oil is heading to Europe and much more is heading to Asia.
India and China’s appetite for discounted Russian oil is likely to continue for as long as oil prices remain high (or at least higher than the discounts they get from Russia). There is some discussion that the U.S. may try to impose secondary sanctions on companies that import Russian oil, however this will be extremely difficult to implement. Expect the elevated oil flows from Russia to India and China to continue while displaced Saudi oil may end up in Europe.
2. Russian production and revenues are up
The point of the sanctions and bans was to cut Russia’s revenue from oil. However, these sanctions, most of which don’t actually go into effect until December, have actually done the opposite. As oil prices rose (in part due to these actions) discounted Russian oil became more attractive to non-western countries. They found ways to subvert sanctions on banking transactions and maritime insurance, and soon the demand for Russian oil was actually higher than supply. In response, Russian oil companies have increased production, pumping an average of 10.78 million bpd in July. This in an increase of nearly 1 million bpd compared to Russia’s production in June, which, according to Platts, averaged 9.75 million bpd. According to U.S. officials, Russia’s oil revenue has increased by 50% from the start of 2022. Expect Russian oil revenues to remain elevated for as long as the sanctions remain in place, barring a serious global recession. The G7 has been discussing plans to institute a “price cap” on Russian oil, but it is unclear how this price cap will be enforced, and it is extremely unlikely for any such mechanism to be implemented before December.
3. Europe’s need for Russian energy outweighs its politics
Despite its talk about cutting off Russian energy revenue to punish Russia for its military operations in Ukraine, Europe has continued to buy Russian oil and gas products. In July, 60% of Europe’s imports of diesel fuel came from Russia. However, the E.U. agreed in May to cut 90% of its petroleum imports from Russia by the end of 2022. The E.U. is also calling on all European nations to cut their natural gas use by 15% from August 2022 to March 2023. The idea is to reduce Europe’s dependency on Russian natural gas and cut Russian natural gas revenues. In the event of a supply emergency, the European Union could make the cut mandatory. Already, some European nations are pushing back. Spain, for example, which has other sources of natural gas, does not support the proposal, because it calls for an economic sacrifice that they believe is unwarranted. Traders should not assume that these cuts, bans and sanctions will all be implemented as written, given the growing unwillingness in Europe to sacrifice on behalf of Ukraine. Expect that Europe’s desire for energy will continue to outweigh politics.
DIsclaimer: I have no positions on any of the commodities mentioned in this article.