The EU’s oil embargo, contained in the sixth and eighth packages of sanctions, comes into effect on December 5 and is likely to severely disrupt Russia’s oil trade but not stop it.
“We think Russia’s oil output will fall steadily to 9.6mn barrels per day (bpd) by the end of next year, from an estimated 10.3mn bpd in the final quarter of this year,” Kieran Tompkins, a commodities economist with Capital Economics, said in a note.
So far while sanctions, and especially self-sanctioning by oil traders in the first months after the war started, have led to major changes in who buys Russian oil, they have not affected the overall production levels.
Oil production levels impact
After the start to of the war the Yale report presented one of the most pessimistic outlooks for Russian oil production, predicting it would fall from the summer’s level of 10.7mn bpd to 6mn bpd by the end of the decade – an extreme estimate that is shared by few analysts.
The government’s official forecast for oil production in August, when the Yale report came out, is that oil production could fall to 9mn bpd this year from the 11mn bpd produced in the first two months of this year.
Production did fall in the first two months of the war as international oil traders shunned Russian oil. But since then sanctions leakage to India, China, Kingdom of Saudi Arabia (KSA) and Egypt has seen exports recover and production rise again to 10.7mn bpd in June.
Since then, oil production has fallen again as European customers continue to reduce demand ahead of the embargo. Under the OPEC+ deal the Russian quota is 11mn bpd for October and 10.5mn bpd in November, but Russia’s output dropped below both those levels to 9.9mn bpd in October, according to Russian Deputy Prime Minister Alexander Novak.
And analysts say that production could fall further to as little as 9mn bpd in December after the embargo comes into force – which is still more than Russia was producing in the first months of the coronavirus (COVID-19) pandemic. (chart and chart)
“We expect that production in December will fall by 1.5-1.7mn bpd compared to the June-October average, or 14%,” according to a report from the Energy Development Centre cited by TASS.
Analysts have estimated that between 2-3mn bpd of Russian oil will have to find new customers after the ban comes into effect – a very large amount of oil that the market will struggle to absorb. The other problem is that Russia has added another 100 tankers to its own fleet of just under 100 ships, but these are very old tankers and they are not enough by themselves to transport 2mn bpd of oil to customers in the Global South who are willing to ignore Western sanctions.
On December 5 measures from the sixth and eighth package of sanctions will take effect. These include a tough flat ban on importing Russian oil in the sixth, but a softer oil price cap mechanism in the eight that is designed to allow the EU to import Russian oil, but cut the Kremlin off from making any real money from the trade.
The debate over where to set the price cap has been raging in the last week between those that want to set the level high enough so as not to meaningfully disrupt imports, which suggested a price of $65 – above what Russia currently sells its oil for. The other camp that is seeking to punish Russia, led by Poland and the Baltic States, wants to set the cap at a crushing $30, well below the estimated average production cost of lifting a barrel of oil in Russia of $40, that would almost certainly push Russia into a financial crisis.
On December 2 a compromise price of $60 was reached, but with an adjustment mechanism that will keep prices 5% below market rates and also a review of the cap every two months, allowing the price to be reduced.
In the first pass the emphasis appears on simply getting the legislation in place and thrashing out the mechanism to enforce it. Once the mechanics are set up, clearly the intention is to have created a tool that can be used to squeeze Russia’s oil business if the situation deteriorates further.
For its part, the Kremlin has said repeatedly that it will simply cut anyone off that attempts to use the oil price cap mechanism.
However, even after the embargo takes effect, Russia will continue to export significant amounts of oil to Europe, as the eighth package of sanctions only applies to seaborne oil deliveries, whereas two thirds of the oil Russia sends to Europe goes by pipeline (of which half goes through the Soviet-era Druzhba pipeline), which are not affected by the sanctions. (chart)
“Russia exported ~5.3mn bpd of crude in 2021. Pipeline export capacity stretches to around 3.4mn bpd, of which roughly 1.4mn bpd is from the Druzhba pipeline to Europe, where flows have fallen significantly as buyers have self-sanctioned. The remainder of Russia’s crude oil exports must be transported by sea and will be subject to sanctions,” says Tompkins.
However, the bulk of the piped oil goes to Germany and Poland, both of which have voluntarily promised to end the imports by the end of this year, although there is no requirement for them to do so under the sanction's regime.
EU traders have already reduced the amount of oil they import by ship in November ahead of the sanctions, but only slightly: according to available ship-tracking data, Russia still exported roughly 15mn barrels to EU countries in November, reports Capital Economics.
The plan is to enforce the embargo by targeting insurance; ships without insurance cannot enter ports or international sea lanes and some 95% of all maritime insurance is issued in London.
Russia has countered by beefing up its own marine insurance company, the Russian National Reinsurance Company (RNRC), which has been recapitalised and given a guarantee by the Central Bank of Russia (CBR), giving it in effect infinite coverage. The idea is to replace London-based policies with Moscow-based insurance to avoid the sanction measures.
So far Turkey and India have both said they will accept the Russian insurance, effectively breaking the sanctions, but China has remained more circumspect, afraid of bringing down sanctions on itself. China has become the biggest importer of Russian oil in recent months as Sino-Russian economic ties deepen.
Russian Deputy Minister of Transport Alexander Poshivay told reporters at a summit last week: "Yes," the official said, answering a question from reporters. "India and China recognise [Russian insurance] largely, but not completely."
China does not yet recognise protection and indemnity insurance, more commonly known as P&I insurance, and reinsurance certificates issued to shipowners by Russian insurers, according to Poshivay, which could prove a big problem for Moscow.
Russia oil exports have already largely reorientated from Europe to Asia. According to S&P Global Commodity Insights, Russia’s seaborne crude exports to Asia increased by around 31% year-on-year to an average 1.6m barrels per day in the first ten months of this year. India and China has seen the biggest increases in the inflow of Russian crude. China’s seaborne crude inflows surged by 36% year-on-year to an average of 780,000 barrels per day between January and October. India’s jumped to 450,000 barrels per day during the same period, compared with 90,000 barrels per day in the same period a year earlier, Splash reports.
Just how well the sanctions will work remains to be seen. As bne IntelliNews has already reported, there has been significant leakage with the existing oil sanctions. Dodges like ship-to-ship transfers of oil to hide its origin are already happening, and mixing “crude cocktails”, adding Russian crude to other blends to mask its origin, has also been reported. When Iranian oil was sanctioned it started cutting “compensation deals”, where it would take the sanction-enforced prices, but cut deals with buyer who would then overpay for other non-sanctioned commodities like wheat.
There is also the question Russia's growing fleet of “ghost tankers” and of preventing Greek tankers from carrying Russian oil. Under the sixth package of sanctions, Greek shipping was given an exemption. Greek ships accounted for 35% of Russian oil transported to Europe before the war, but that has since increased to 55%, according to Institute of International Finance (IIF). Theoretically as EU companies, Greek shipping would be included in the EU’s ban, but there have been reports that Greek shipping companies have been actively re-flagging their ships in order to dodge the ban.
The shipping journal TradeWinds said in an article on December 3 that an estimated 400 oil tankers have been sold to “unknown buyers or newcomers to the sector” since Russia’s invasion of Ukraine.
“The 393 sales represent 43% of the deals since the invasion on 24 February and the start of an upheaval in the oil trade that sent second-hand prices soaring and propelled tanker rates to 18-year highs, data from VesselsValue shows,” the publication reports.
That has led to reports that Russia is building up a “ghost fleet” of tankers that are nominally not Russian, but indirectly controlled by Russia to ship its oil under the sanctions radar. With its deep pockets Russia can afford to buy as many tankers as it can get its hands on.
At the same time, there has a been raft of tankers that have reflagged. TradeWinds reports that some 50 tankers have left Malta’s registry – Europe’s largest – since the start of the year, and the same is true for Greece and Cyprus, two of the world’s biggest shipping nations. The Cyprus registry has lost more than one-fifth of tankers, according to Greek daily Kathimerini.
Broker Barry Rogliano Salles has identified nearly 150 newly sold vessels, from small tankers to VLCCs, that could be put to work in the ‘dark’ fleet moving Russian oil, TradeWinds reports.
Altogether there are more than 1,000 vessels operating in the combined ghost fleets of Russia, and its allies Iran and Venezuela, against the total global tanker fleet of 11,716 vessels.
“Some disruption to Russian oil exports (and production) is almost inevitable,” says Tompkins. “Our base forecast is that Russia’s crude output will steadily fall to 9.6mn bpd by end-2023, compared with an estimated 10.3mn bpd in 4Q22. A drop in Russia’s production is one of the reasons why we forecast that oil prices will remain historically high next year, despite the global economy tipping into recession.”