- Russian oil exports continue to make their way onto the global market.
- Buyers in China and India have found ways to circumvent Western sanctions.
- Russia continues to make a large profit per barrel, even with a $30 per barrel discount on its crude.
Despite the U.S.-led ban on importing Russian oil that some of Washington’s allies will also implement, Russian oil in significant volumes will continue to flow into various leading oil-importing countries, so adding to the overall global supply and affecting oil prices.
In oil trading terms, then, it is erroneous to assume that all circa-11 million barrels per day (bpd) of Russian oil supply has somehow been removed from the global supply/demand matrix and that this will tighten that oil pricing matrix in favor of further gains.
This was highlighted last week by Russian Deputy Prime Minister, and former Energy Minister, Alexander Novak, and supported by the current top global oil importer, China, and the country set to take over this mantle, India.
In comments reported by several Russian news agencies, Novak acknowledged that the new U.S.-led sanctions on Russian oil provide:
"New challenges linked to supply chain disruptions, the insurance of ships that transport our products, and with issues of financing and payment.” However, he added that: “These issues are being resolved at the moment…and customers are happy to buy it [Russian crude oil]."
It is apposite to note in this context that even with the US$30+ pb discount currently being applied to Russia’s benchmark Urals crude oil grade compared to Brent, Russia is still making more per barrel than it was before it invaded Ukraine.
Indeed, it is a lot more, if—as can reasonably be posited—the ‘war premium’ in oil pricing did not begin when Russian troops went in to Ukraine on 24 February 2022 when Brent stood at around US$95 pb. Rather, the real war premium may well have begun when the very smart money funds started to buy on the expectation of such an eventuality.
This dates back to September 2021 when U.S. intelligence officers started to notice unusual Russian military movements on the Ukraine border after the conclusion of the joint Russia-Belarus military exercises that had taken place.
At that point, Brent was trading at around US$65 pb. Therefore, it could well be argued that the real war premium for Russia’s invasion of Ukraine has been at least US$55 pb and not the US$25 pb that many still believe.
Three other factors are also apposite to note in terms of explaining Novak’s upbeat take on the prospects for Russia’s oil sector. First, Russia has long been able to make very good profits on all of its oil at US$40 per barrel of Brent.
This is a key reason why it was happy to allow Saudi Arabia to launch yet another doomed oil price war against the U.S. shale sector in 2020 by overproducing to drive prices down, as it could survive and prosper if oil averaged at least US$40 pb of Brent over the conflict period, and second, it could cheerily stand by and watch as one of its crude oil competitors, Saudi Arabia, destroyed its own economy (with a breakeven pb of Brent price of US$84 at that point), and caused disruption in another of its oil market competitors (and perennial geopolitical nemesis), the U.S.
The second reason is that despite the US dollar-centric sanctions on Russia, the country pays all of its domestic expenses in rubles, so the availability of US dollars or the US dollar-Russian ruble exchange rate is of no consequence in this regard.
That said, it is a very clever move to make importers of Russian gas from ‘unfriendly countries’ pay for Russian gas in rubles, as it does lend support to the Russian currency, which has a positive psychological effect on those receiving money in that currency.
And third, Russia will not be devoid of US dollars anyhow, or other hard currencies, given that it can certainly count on continued massive oil and gas and other trade with China and India.
China for one has a wide range of ways and means of getting around sanctions of any sort, with a basic factor working in its favor being the lack of exposure of China’s firms to the U.S. financial infrastructure, particularly to the U.S. dollar.
An adjunct advantage to this is the ease with which Chinese companies can set up new special purpose vehicles to handle ring-fenced areas of their businesses to allow for special situations, such as sanctions.
China made no secret at the time of the pre-2016 sanctions against Iran or the post-2018 sanctions against it that it was going to use its Bank of Kunlun as the main funding and clearing vehicle for its dealings with Iran.
The Bank of Kunlun has considerable operational experience in this regard, as it was used to settle tens of billions of dollars’ worth of oil imports during the U.N. sanctions against Tehran between 2012 and 2015. Most of the bank’s settlements during that time were in Euros and Chinese renminbi and in 2012 it was sanctioned by the U.S. Treasury for conducting business with Iran.
China’ skill and proven methodology at working around sanctions allowed Iran’s Foreign Minister, Mohammad Zarif, to state back in December 2018 at the Doha Forum, that: ‘If there is an art that we have perfected in Iran, [that] we can teach to others for a price, it is the art of evading sanctions.’
In the case of Russian oil and gas exports, though, there is no need for China to go through all the trouble it took to circumvent the sanctions on Iran. China has long seen increased internationalization of its renminbi currency as a fitting reflection of its growing status in the world and the chief executive officer of Russia’s Novatek, Leonid Mikhelson, said in September 2018 that Russia had been discussing switching way from US$-centric trading with its largest trading partners such as India and China, and that even Arab countries were thinking about it. "If they [the U.S.] do create difficulties for our Russian banks then all we have to do is replace dollars," he added.
At around the same time, China launched its now extremely successful Shanghai Futures Exchange with oil contracts denominated in yuan (the trading unit of the renminbi currency). Such a strategy was tested initially at scale in 2014 when Gazpromneft tried trading cargoes of crude oil in Chinese yuan and rubles with China and Europe. Additionally, the infrastructural development for oil and gas trading between China and Russia has also been extensive in recent years, as examined several times in depth by OilPrice.com.
The most recent examples of this was, in the oil sector, Rosneft (OTC:OJSCY) signing a US$80 billion 10-year deal to supply the China National Petroleum Corporation (CNPC) with 100 million metric tonnes of oil over the period (slightly over 200,000 barrels per day).
In the gas sector, at almost exactly the same time, Gazprom (MCX:GAZP) signed a 10 billion cubic meters per year (bcm/y) deal to supply gas to CNPC, adding to another supply contract between the two companies signed in 2014—a 30-year deal for 38 bcm/y to go from Russia to China.
This, in turn, is part of, and augments, the ‘Power of Siberia’ pipeline project—managed on the Russian side by Gazprom and on the China side by CNPC—that was launched in December 2019.
For the U.S., India had been envisioned at the time of the ‘relationship normalization deals’ drive in the Middle East as the global replacement buyer for oil and gas instead of China. There was every reason for optimism, as not only had India recently shown a new political resolve to combat China’s influence in the Asia Pacific but the International Energy Agency (IEA) had also released a report showing that India will make up the biggest share of energy demand growth at 25 percent over the next two decades, as it overtakes the European Union as the world’s third-biggest energy consumer by 2030.
These U.S. hopes were dashed, however, when Putin behind-the-scenes negotiated a huge, wide-ranging deal with India. This deal did not just include enormous oil and gas deals between the two countries, but also the intention to strengthen defense cooperation, including the joint development of production of military equipment.
Specifically, according to further official statements from one or both sides, India will produce at least 600,000 Kalashnikov assault rifles—the weapon of choice for terrorists and militias across the Middle East and elsewhere—and, even more disturbing for the U.S., India’s Foreign Secretary, Harsh Vardhan Shringla, said that a 2018 contract for Russia’s S-400 air defense missile systems is now being implemented.
Related: Sanctions Are Forcing Russian Companies To Consider Moving To Kazakhstan