Russian Oil and Gas: One Year of War Reverses Decades of Energy Diplomacy

Climate Strategies Insights Report, 2023, 27 p.

The Russian OIL SECTOR has been targeted by significant Western sanctions. Serious impacts of sanctions on oil exports are approaching as the EU, the G7 and Australia banned seaborne imports of Russian crude oil from December 2022 and oil products from February 2023. The most important market is the EU, which accounted for 47% of Russian crude oil and 52% of Russian oil product exports in 2021. Also the price cap on Russian oil delivered by sea to other markets will have a significant impact, as the EU countries and the UK used to insure 85–90% of seaborne Russian oil. The sanctions against exports of Russian crude oil have been mitigated mostly by soaring demand from India, which increased its imports of crude oil from Russia by seventeen times in 2022; total crude-oil exports dropped significantly only in December 2022, when the EU embargo kicked in. Oil products are less likely to be saved by the Asian markets; both China and India prefer to use their own refinery capacity rather than paying higher prices for readily available oil products. A lower price for Russian oil will weaken the revenues accruing to the Russian federal budget, with potential negative social effects and instability. The Ministry of Finance of the Russian Federation plans not to replenish the National Welfare Fund in 2023 if the oil price falls below $70 per barrel. The price for Urals grade of crude oil (price benchmark for Russian oil) dropped to $50 in December 2022. Various approaches have been applied to circumvent oil sanctions: these include operating a ‘shadow fleet’ of unmarked oil tankers which do not indicate the oil’s destination or origin, and mixing Russian oil with oil from other countries for re-packaging. The prevalent official position is that the sanctions will gradually lose effect as Russian oil cargos find their way to markets, particularly in Asia, not involved in sanctions. However, longer distances and higher transportation costs, together with the price cap, reduce the commercial outlook.

The Russian GAS SECTOR was hit already in 2022 due to Russia’s decision to cut supplies to the EU. Gas production fell by 11.8% largely because pipeline supplies to the EU and the UK were cut by 56%; Russia has very limited options of redirecting these pipeline gas volumes to other markets. No sanctions have been imposed on Russian LNG exports, but this technology cannot replace pipeline gas deliveries, due to limited production and transport capacities. Planned expansion of LNG production is halted by Western sanctions on investments and technology exports to Russia. Reduced exports leave Russia with a gas surplus. The Russian authorities aim at increasing domestic gas use; however, this is not necessarily commercially attractive for gas producers. Some 70% of Russia’s heat and power is already generated by gas. As many of the remaining coal-fired plants are located in Eastern Russia, near large coalfields, redirecting gas supplies to these regions would be very costly. Gas that was intended to be delivered through the Nordstream 2 pipeline may be redirected to Northwest Russia. However, new pipeline infrastructure is costly. Without revenues from gas exports, this will be almost impossible for Gazprom to finance – which could lead to more openings for other domestic gas suppliers, threatening Gazprom’s semi-monopoly. Also in the case of gas, radically increased supplies to China are seen as a solution. China is currently served from fields in Eastern Siberia not connected to the integrated pipeline network, and receiving some LNG. However, Chinese interest in a new pipeline from West Siberia, which Russia has been advocating for years, has been very limited. The new geopolitical situation may eventually favour such a pipeline, but only if China obtains highly beneficial terms – which would reduce the economic value of this option in comparison to the revenues from lucrative European markets.