Market Fears Over The Impact Of Russian Oil Sanctions Have Eased

Things are different now in the global energy markets to the way they were just after Russia invaded Ukraine on 24 February 2022. Back then, things from the oil markets’ perspective looked bleak, with Europe importing around 2.7 million bpd of crude oil from Russia and another 1.5 million bpd of oil products, mostly diesel. Europe’s reliance in considerable part on Russian oil imports meant that the European Union (EU) bloc of 27 countries was extremely reluctant to support any meaningful sanctions on Russia. This meant at that point that it looked likely that Russia would get away with its invasion of Ukraine without any significant repercussions from the rest of the world, just as it had when it annexed the Crimea region of Ukraine back in 2014. Things, though, are very different now, which is why the EU and G7 price caps imposed on 5 February on the imports of Russian oil products will have very limited effects on the global oil and products supply and demand matrix, just as the similar 5 December price cap on the import of Russian crude oil had.

In broad terms to begin with, back in the first half of 2022, even before the EU’s 27 member states met on 8 May to discuss pushing forward with the U.S.-proposed ban on Russian crude oil, Hungary and Slovakia had made it clear that they were not going to vote in favour of it. According to figures from the International Energy Agency (IEA), Hungary imported 43 percent of its total oil imports in 2021 from Russia, while the figure for Slovakia was even higher, at 74 percent of all its oil imports in the same year. Other EU countries also heavily reliant on Russia’s Southern Druzhba pipeline running through Ukraine and Belarus also made it clear that they were not willing to support the ban on Russian oil exports. The most vocal of these were the Czech Republic – 68,000 barrels per day (bpd) of its 2021 oil imports came from Russia – and Bulgaria (which was almost completely dependent on gas supplies from Russia’s state-owned oil giant Gazprom, and its only refinery is owned by Russia’s state-owned oil giant, Lukoil, providing over 60 percent of its total fuel requirements). Other EU member states that were also especially dependent on Russian oil imports were Lithuania (185,000 bpd, or 83 percent of its 2021 total oil imports) and Finland (185,000 bpd, or 80 percent of its total oil imports). Even compromise proposals offered by the EU of allowing Hungary and Slovakia to continue to use Russian oil until the end of 2024 (and the Czech Republic until June 2024) were not enough to remove their opposition to the idea of the proposed EU ban on Russian oil at that point. 

Related: U.S. Oil Drilling Activity Picks Up Amid Rising Crude Prices

Adding huge weight to this opposition to any ban whatsoever on Russian oil imports of any kind – either on crude oil or on oil products – was Germany, the de facto leader of the EU. Germany had been the recipient in 2021 of the most crude oil from Russia of any country in the EU – an average of 555,000 bpd, or 30 percent of its total oil imports in that year, according to the IEA. Comments from German Economics Minister, Robert Habeck, that Berlin was prepared for a ban on Russian energy imports were overlaid with considerable detail about how Germany had still not been able to find alternative long-term fuel supplies for the Russian oil that came by pipeline to a refinery in Schwedt operated by Russia’s state-owned oil giant Rosneft. He concluded that fuel prices could rise and that an embargo “in a few months” would give Germany time to organise itself in this regard.

It is apposite to note that Germany specifically had also been at the forefront of several EU initiatives designed to circumvent the mainly U.S.-led sanctions on Iran before 2011/2012. Shortly after the U.S. announcement of its unilateral withdrawal from the Joint Comprehensive Plan of Action deal between Iran and the ‘P5+1’ group of countries (comprising the U.S., U.K., France, China, and Russia, ‘plus’ Germany) in May 2018, the EU had moved to impose its ‘Blocking Statute’ that made it illegal for EU companies to follow U.S. sanctions, as analysed in depth in my last book on the global oil markets. At around the same time, Germany’s then-Foreign Minister, Sigmar Gabriel, had warned: “We also have to tell the Americans that their behaviour on the Iran issue will drive us Europeans into a common position with Russia and China against the USA.” Shortly after that, Germany was a key mover in the EU introducing a special purpose vehicle – the ‘Instrument in Support of Trade Exchanges’ – that would act as a clearing house for payments made between Iran and EU companies doing work there. 

The European Union’s view on the gas side of the Russian energy import equation was in the same vein and based on the same sort of reliance on these imports from Russia as it had for oil. As at the end of 2021, according to IEA figures, the European Union imported an average of over 380 million cubic metres (mcm) per day of gas by pipeline from Russia, or around 140 billion cubic metres (bcm) for the year. As well as that, around 15 bcm was delivered in liquefied natural gas (LNG) form. The total 155 bcm imported from Russia accounted for around 45 percent of the EU’s gas imports in 2021 and almost 40 percent of its total gas consumption. Germany itself was reliant on Russian gas for around 30-40 percent of its own commercial and domestic gas needs, depending on the time of year.

Consequently, back in the first half of 2022, the only real flurry of activity by the EU was aimed at ensuring that Russia did not stop supplying its member states with either oil or gas due to their not being able to pay in the way Moscow preferred. This followed the 31 March 2022 decree signed by Russian President Vladimir Putin that required EU buyers to pay in roubles for Russian gas via a new currency conversion mechanism or risk having supplies suspended. According to an official guidance document sent out to all 27 EU member states on 21 April by its executive branch, the European Commission (EC): “It appears possible [to pay for Russian gas after the adoption of the new decree without being in conflict with EU law],… EU companies can ask their Russian counterparts to fulfil their contractual obligations in the same manner as before the adoption of the decree, i.e. by depositing the due amount in euros or dollars.” The EC added that existing EU sanctions against Russia also did not prohibit engagement with Russia’s Gazprom or Gazprombank, beyond the refinancing prohibitions relating to the bank. 

Since then, however, three key things have happened that have calmed these fears. The first is a slew of deals engineered by the U.S. and EU that have secured new energy supplies into Europe. These include major LNG deals with Qatar, and other oil and/or gas deals with, among others, EgyptLibyaOman, and the UAE. Second, Russia’s oil and gas has continued to flow around the world at discounts of well over 30 percent, which has meant a plugging of specific demand centres (most notably China, and India), and this, in turn, has served to keep oil and gas prices dampened down from the immediate post-invasion high band of US$120-140 pb of Brent in oil’s case and EUR240-340 per megawatt hour band of the Dutch Title Transfer Facility benchmark. Third, because the omni-shambolic nature of Russia’s invasion of Ukraine has dramatically weakened its political, military, and economic position in the world, it looks likely that the stranglehold that Russia had over several other major oil and gas producers has been broken, and will lead to further opportunities for the EU to strike new oil and gas supply deals where needed. 

In addition, on a technical pricing point, the US$100 pb price cap on the imports of Russian oil products that usually trade at a premium to crude, such as diesel, kerosene and gasoline, is so high as to be redundant, and the US$45 pb price cap on Russia oil products that generally trade at a discount to crude, such as fuel oil, can be easily circumvented through the range of sanctions-busting techniques that Iran has been using for years, and which Russia has been using since the middle of 2022. Indeed, according to the latest OPEC+ figures for January 2023, Russia’s volumes fell just 10,000 bpd in the month to average 9.85 million bpd, despite the EU embargo on imports of Russian crude and an accompanying 5 December 2022 G7 price cap.