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Over a Barrel: Russia has made it through a year of oil sanctions largely unscathed, but the West has more tricks up its sleeve

Russia has been under a tightening international sanctions regime since the start of its full-scale invasion of Ukraine on February 24, 2022. A Western oil embargo has been an element of that pressure for more than a year now. And yet, Russia has still not seen a notable drop in domestic oil production, nor a significant decline in budget revenues from its sale. In response, the United States and the European Union are shifting their approach in order to crack down on illegal Russian shipments and the financial networks that facilitate them. When coupled with a drop in global demand for raw materials, these measures may finally begin to make a real impact on Russia’s federal budget — and, by extension, on Moscow’s capacity to continue prosecuting its war in Ukraine at its current level of intensity.

  • Leaky ceiling

  • What has changed

  • Worse sanctions still ahead

In December 2022, the European Union prohibited its members from purchasing Russian crude oil transported by sea. In February 2023, an analogous embargo went into effect against Russian oil products, which include diesel fuel and kerosene. However, in order to ensure that Western economies did not experience energy shortages, price ceilings were introduced. Thus, the brokers, shipowners, and insurers involved in servicing the maritime transportation Russian oil and oil products could continue to conduct their business legally so long as the product in question had been purchased below a certain price: $60 per barrel for oil, $100 per barrel for diesel, gasoline and kerosene, and $45 for fuel oil. In coordination with the EU, five other major Western economies — Australia, Canada, Japan, the United Kingdom, and the United States — pledged to abide by the same restrictions.

The scheme aimed to reduce the revenues of the Russian budget by reducing the profits it could reap from each barrel of oil it sold, and to do so without precipitating the kind of drop in global supply that could have caused prices on the world market to skyrocket (and thus allow Russia to reap massive profits by selling its products to customers that had not adopted the embargo). The results have been underwhelming.

Leaky ceiling

Russia has largely managed to bypass the price ceiling. Consequently, the average price it reaped for Urals crude oil in 2023 was $63 per barrel, and in some months, according to the Ministry of Finance, it even exceeded $80.

China emerged as a key buyer of Russian oil, with customs data indicating an average cost of Urals at around $77 per barrel for local consumers. India and Turkey also successfully procured oil. Even the EU benefited, as neither the ceiling nor the embargo applies to oil shipped by pipeline. (In addition, Bulgaria was granted an exception to the ban on maritime deliveries from Russia through 2024, but the Black Sea nation has already begun shifting away from Russian crude oil in favor imports from Iraq, Kazakhstan, and Tunisia.)

Separate sanctions on technological inputs have had a similarly minimal effect. In 2023, Russia experienced only a 1% decrease in oil production, and the country’s Ministry of Energy expects output to remain steady in 2024. Moreover, drilling rates are increasing, leading some analysts to forecast medium term growth — not decline — for the Russian oil industry. Although it is true that Russian budget revenues resulting from its sale of oil and gas fell by almost a quarter last year, the primary reason for the decline was not sanctions, but the global dip in oil prices — a dip that occurred at least in part thanks to the Western price cap, the compromise that averted a potentially destabilizing shock to the global energy system.

What has changed

Behind seemingly stable figures lie significant shifts in Russia's oil industry, oil processing and exports.

The first notable change: Russian oil is now predominantly purchased on the spot, with each batch negotiated separately and no long-term commitments from companies for months-long purchases and deliveries. Long-term contracts for maritime deliveries, which previously accounted for more than half of all shipments, ceased as early as 2022. State oil giant Rosneft proved to be an exception, however, as the company reached an agreement in 2023 with the Indian Oil Corporation to increase shipments. (The Indian Oil Corporation owns shares in two Rosneft subsidiaries, and Rosneft itself is headed by long-time close Putin associate Igor Sechin.)

Russia's risk profile as a supplier stands out as a key catalyst for these shifts. “Reputational risks for companies trading Russian oil and oil products emerged immediately after February 24, 2022, but had a real impact six months later,” remarked an employee of a European trading firm. Despite the looming embargo, most of the world continued to actively trade Russian oil and oil products at very favorable prices (with discounts to the Brent benchmark of up to $35 per barrel). Nonetheless, major international oil and gas companies, along with trading firms, had been gradually scaling back their operations in Russia since the onset of the conflict in Ukraine. Some major multinational companies, including Trafigura (headquartered in Singapore) and Glencore (headquartered in Switzerland), relocated offices and staff to new jurisdictions, often in the UAE, and openly condemned Russian aggression.

Consequently, a second notable change ensued: a plethora of new trading companies emerged to fill the void left by former intermediaries that refused to engage in deals.

“At first, it felt like a time of change or the discovery of an oil Klondike: new companies, offices everywhere,” recalls a market player. “But just two months later, it became clear that behind the new names were the old, successful traders, many of whom had left large companies to keep their profits to themselves and continued to purchase oil from the same Russian oil producers they had worked with for years. They have simply replaced Vitol, Trafigura, and Glencore, which have almost stopped working with toxic Russian oil.”

It's practically impossible to determine the extent of the connection between these new entities and Russian companies, let alone understand how trader premiums are distributed. Some trade oil from various producers, while others are tied to a single supplier. Despite this complexity, there are over a hundred new players in the market, the majority of which operate within a sort of legal gray area.

As for transportation and insurance services, they now need to be found in jurisdictions outside the “ceiling coalition” of countries. If this trend persists and trading volumes remain stable, as is expected, a new market will emerge in Asia — with its own set of institutions, actors, and regulators. Quite possibly, it will even quote its prices in Chinese yuan, rather than in the customary U.S. dollar.

The third change involves new trade routes, which have shifted towards the East. Despite the expectation that Western sanctions on Russia will tighten and that third-country banks could face increased scrutiny, India, China, and Turkey are likely to remain key buyers of Russian oil in 2024. Russian Urals crude is a competitive medium-sour grade, and the risk discount for customers still willing to do business with the toxic Russian state makes it an attractive product for those who remain more concerned with profits than with the fate of civilians in Ukraine.

The fourth change concerns the shadow fleet. Thanks to hastily acquired tankers registered under the flag of Liberia or the Marshall Islands, Russia effectively circumvents the price ceiling. The owners and insurers of these vessels are not obligated to adhere to restrictions, and regulators from North America and Europe have thus far proven unable to hold them accountable. According to the analytical agency Vortexa, in 2023 the shadow fleet accounted for up to 20% of Russia’s oil and oil product exports by sea. It remains to be seen whether the strict EU restrictions introduced in late 2023 as part of the 12th sanctions package will make any appreciable impact on the shadow fleet’s share of exports in 2024.

The U.S. is already pinpointing sanctions on vessels. 50 tankers have been targeted, with only 18 of these still managing to load oil, according to Bloomberg, which tracks vessel movements. Nine of these ships are shuttle tankers that load oil from platforms or vessels, and one tanker is carrying raw materials that were loaded prior to the imposition of the sanctions. According to Craig Kennedy, a researcher at the Davis Center at Harvard University and an expert on the Russian oil industry, the U.S. could potentially extend sanctions to over 100 tankers in the shadow fleet using this approach.

Currently, experts estimate the size of the global shadow fleet to be approximately 1600 vessels, representing almost 20% of all major trading vessels worldwide. Of these, around 1100 vessels were used for transporting Russian oil.

The fifth change involves the increasing pressure Russian oil companies face in the European market. Lukoil, for example, sold its Sicilian refinery, ISAB, after prolonged negotiations. Furthermore, in response to Bulgaria's decision to transition away from Russian crude, Lukoil has also expressed a readiness to sell its Burgas refinery, which it had owned since 1999. After the start of Russia’s full-scale invasion of Ukraine, Lukoil essentially shifted its entire trading operation from Geneva to Dubai, maintaining only representative functions and a small volume of non-Russian oil deals at its Swiss office.

The sixth change concerns the risk of fuel shortages within Russia itself. Due to a fuel crisis, in late September 2023 the government imposed a two-month ban on exports of gasoline and diesel fuel. Although the situation was resolved, market participants fear a recurrence with the onset of the new agricultural sowing season, especially amidst attacks on oil processing facilities. One of the initial sanctions against the Russian oil industry involved prohibiting the supply of equipment and technologies related to deep (secondary) oil refining, which produces light petroleum products like diesel fuel, gasoline, and kerosene. Consequently, Russian refineries that are forced to shut down their largely Western-made production equipment following explosions and fires — whether the result of Ukrainian drone strikes, simple wear and tear, or “employees smoking where they should not have been” — may find it difficult to repair critical machinery.

Worse sanctions still ahead

Last year, many experts believed that more time was needed before the true impact of sanctions would become visible. Once the picture became clearer, it would be possible to adapt less effective measures while strengthening those that were already demonstrating results. Now that 2024 has arrived, it appears both Europe and America have thoroughly studied the mechanisms and concluded that targeted sanctions and enhanced regulation in banking and logistics will yield the most serious results.

As a result, the number of banks from Global South countries participating in financing deals that involve Russian oil will almost certainly decrease in 2024. Banks in the UAE have declined to open accounts for Rosneft in their national currency, the dirham. Turkish banks are also refusing to work with Russian entities, and a similar stance has been taken by a Chinese bank. In 2023, if transactions were not conducted in dollars or euros, the impact of sanctions was limited. Consequently, when oil was sold above the price ceiling, parties aimed to conduct transactions in yuan, rupees, or dirhams, significantly increasing the influence of these currencies in the global oil trade. However, this year the list of sanctioned Russian banks is likely to expand, and the U.S. will more meticulously monitor the cooperation between international banks and Russian entities. In such a scenario, Asian and Arab banks may introduce their own stringent restrictions in order to maintain the trust of their Western partners.

The second area where restrictions will be strengthened is in logistics. Since late last year, the US has been imposing sanctions on companies transporting Russian oil, leading to the freezing of any assets these companies may have on American soil. Until recently, the U.S. had pursued a much softer policy in such matters. Additionally, pressure on shipowners will continue — both for those transporting Russian oil and for those selling vessels to entities involved in the shadow trade.

To avoid sanctions, shipowners have been steering clear from compromised flags of Liberia and Panama in recent months, opting instead for registration in Gabon. The number of vessels flying its flag this past January was five times larger than the monthly average for 2023.

The third area where sanctions may be intensified relates to ship insurance. Reports surfaced in November suggesting that Denmark might begin inspecting tankers carrying Russian oil without Western insurance. However, a few days later, the local Maritime Authority stated it had “very limited capabilities” to inspect such tankers passing through its territorial waters. Nevertheless, if such measures or similar ones are implemented, transporting Russian oil at prices above the ceiling and without Western insurance will become more complicated. In 2023, according to calculations by the Financial Times, nearly three-quarters of all maritime shipments of Russian crude oil were made without Western insurance.

The fourth avenue involves lowering the price ceiling. This could be done if the cost of crude oil decreases, global demand diminishes, and supply outside Russia and its partners continues to grow steadily. Currently, there is no clarity on whether this constellation of conditions will form in 2024. At the time of writing, the price of Brent crude futures for April was fluctuating at around $80 per barrel, lower than the figures for the past few months. According to the latest forecast by the International Energy Agency, a Paris-based intergovernmental organization that provides policy recommendations in the energy sphere, this year there could be a significant surplus of oil in the global market, as unstable economic growth is expected to put downward pressure on demand, and non-OPEC countries continue to ramp up oil production despite the impending glut. That group of non-OPEC producers includes the United States, which has significantly increased its crude oil deliveries to Europe over the past two years — another effect of the partial embargo on Russian oil.

Amidst this backdrop, the tightening of sanctions against the Russian oil industry appears almost inevitable. The prospect of an oil shortage in global markets — and the price increases that would inevitably follow — no longer intimidates American and European policymakers.

If the oil ceiling were lowered to $35 per barrel, it would still surpass Russian companies’ production cost. However, selling its energy resources for $35 per barrel would significantly diminish Russian budget revenues, a fact noted by an international group of economists. Moreover, if circumstances would allow for the a price cap of $30 per barrel to be enforced, and if measures could be taken to block the entire shadow fleet, the income reduction could amount to 4.7 trillion rubles — a decline so significant that a group of scholars from Stanford University has suggested it could prompt Russia to seek a swift resolution to its conflict in Ukraine.

As with last year’s efforts, however, only time will tell. With oil prices still hovering around $80 per barrel, and with a robust demand remaining for medium-sour grades like Urals, the prospects for $30 oil appear slim. Effective enforcement of truly crippling restrictions would necessitate extensive, coordinated efforts endorsed by a multitude of nations — well beyond just the coalition of democratic states currently implementing the price cap. However, a failed attempt to compel states such as China, India, and Turkey to comply with the Western sanctions regime could prove more costly than the price of continued inaction. Under any circumstances, Russia will persist in making every available effort at getting its oil to market at the highest possible price it can receive. Under an enhanced sanctions regime that proves incapable of achieving its full ambitions, the market advantages enjoyed by China as a broker of semi-legal Russian petroleum products would only grow — a very real possibility that evokes considerable apprehension in the West.

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