06.12.2022.

The West’s oil war with Russia gets real

The European Union is finally trying to hit Russia where it hurts — Moscow's oil revenues. But it needs to take care not to hurt itself, and a fragile global economy, in the process.

On Monday, a ban on the import of seaborne Russian crude oil comes into force. It's one of the EU’s toughest sanctions yet, designed to drive down the fossil fuel revenues that Vladimir Putin uses to finance his invasion of Ukraine.

Russia’s oil exports matter enormously to the world. It is the world’s second-biggest crude exporter, after Saudi Arabia. In 2021, around half of those exports went to Europe.

The war hasn't changed much in terms of Russia's ability to make cash from oil: So far, Moscow’s overall oil exports have held up, running at 7.7 million barrels per day in October, according to the International Energy Agency. That's only 400,000 barrels per day lower than pre-war levels. Moscow has been taking in tens of billions of dollars of fossil fuel revenues since the war began.

The U.S. and its European allies want to change that.

Here’s what you need to know as Europe and the wider world enter a new and uncertain phase of the West’s energy war with Russia.

What's the plan?

Earlier this year, the EU agreed sanctions banning imports of Putin's oil by sea. G7 countries and Australia have also banned crude imports. The ban coincides with the introduction of a $60 price cap on Russian oil shipped to the rest of the world, which will — in theory — be enforced by the EU and the G7. Then in February 2023, a fresh EU ban on imports of Russian oil products — like gasoline, diesel and jet fuel — comes into force.

The three measures all have different potential impacts for Europe, for Russia and for the global oil price — and all carry significant risks in an already volatile economic and geopolitical environment.

What does Monday's EU oil ban mean?

From Monday, EU countries will not be able to import Russian crude oil by ship, with the exception of Bulgaria, which has been given longer to comply.

Brussels has said that around 90 percent of Russian oil imports to the EU will be covered by the ban by the end of this year. Crude oil, or petroleum, is oil in its original state — before it’s been converted, or refined, into the products most people encounter in their day-to-day lives, like gasoline.

Already this year, Russian exports to the EU have fallen dramatically, reducing by 1.5 million barrels per day, to a total of 3.95 million barrels per day by October, according to the IEA. Most of that European supply has been rerouted to China and India.  

The effect of Monday’s ban would be to complete this “reshuffle” of global oil flows, said Claudio Galimberti, senior vice president of analysis at the energy research firm Rystad. “There is capacity to redirect almost all the crude that is going into Europe,” he said.

 

Finally, the EU seaborne crude ban does not apply to oil that comes into Europe from Russia via pipelines. That means that Hungary, the Czech Republic and Slovakia will continue to receive Russian oil through the Druzhba pipeline.

Germany and Poland also receive supplies by pipeline but have unilaterally pledged to stop these imports by the end of this year. Due to its particular reliance, Bulgaria also has a special temporary exemption from the Russian seaborne oil ban until the end of 2024.

How does the oil price cap work?

In September, G7 countries and the EU announced plans to cap the price at which Russian oil can trade on the global market — a plan due to apply at the same time as the EU ban, on Monday.

The cap will be enforced by G7 countries. They will do this by banning their shipping and insurance firms from working on Russian oil shipments that are sold above the cap price. The level of the cap was subject to lengthy debate — particularly within the EU — which finally agreed a price of $60 per barrel on Friday. The cap level will be reviewed, based on changes in the oil market.

But at the level of $60 per barrel, the cap may not actually affect Moscow’s oil revenues, for now. Russian oil currently trades at a lower price on the global market — last week it was around $52 per barrel. That's why Ukrainian President Volodymyr Zelenskyy described the measure as "weak."

“A price cap around $60 per barrel, it will not harm Russia,” said Tagliapietra. “This is not optimal from a geopolitical perspective, but it might make sense if we introduce this firstly, then increase pressure over time by lowering the cap.”

Non-EU vessels that violate the cap will also face a fairly soft sanction: EU operators won't be allowed to insure, finance or service them for the transport of Russian oil for 90 days. Penalties for EU vessels will be determined by each country's national laws.

So what's the point?

In truth, the G7 cap was always intended as a means of trimming Russia’s oil income without causing major disruption to the global market by effectively blocking the export of huge quantities of Russian oil to the world.

Without the cap, the EU’s sanctions coming into force on Monday would have hindered Russia’s ability to redirect its European oil exports to India and China, which rely on tanker shipping facilitated by EU and British insurers and other services.

That would have risked removing millions of barrels per day of Russian oil from the global market and would have been “an extremely big deal” for the oil price, said Galimberti.

To an extent then, the oil price cap as it stands has become an inflation-controlling measure to counteract the impact of the EU’s sanctions, as much as it is a way to cut Russia’s oil revenue.

How will Russia react?

Only one man really knows — and he doesn’t have a strong record for caution.

While Russia will likely find new buyers for its crude, no one is underestimating the risk that Putin will lash out in response.

In recent weeks, Russian ministers have repeatedly threatened to stop selling oil to countries that cooperate with the G7’s price cap. How the cap at the higher-than-market price will influence Moscow's response remains to be seen. But Russia has already amassed a so-called shadow fleet of aging tankers — and made in-roads in setting up its own marine insurance providers — in order to circumvent the cap, said Tatiana Mitrova from Columbia University's Center on Global Energy Policy.

Mitrova said Russia could "reduce its exports and production” in a bid to drive up the global oil price and hurt the economies of its adversaries.

“People assume there should be rational economic behavior from Russia … But frankly looking at everything that is happening in Russia, I wouldn’t call it rational behavior. Economic interests can be sacrificed in favor of political and military goals,” she said.

Speaking on Sunday, Russian Deputy Prime Minister Alexander Novak said the Kremlin would seek to “ban” oil sales under the price cap — even if that meant cutting oil production. “We will sell oil and oil products to those countries which will work with us on market conditions, even if we have to somewhat cut production,” Novak said, according to Russian news agency TASS.

Kremlin spokesman Dmitry Peskov said on Monday the cap would destabilize global energy markets, but not harm Moscow’s ability to sustain its war on Ukraine, Reuters reported.  

The reaction of other oil-producing countries will also be watched closely. “OPEC understand that if this mechanism is successful, it could be applied to other cases — OPEC countries could themselves become the next target,” said Mitrova. “They are not happy with this mechanism. They want it to fail.”

The OPEC+ group — which includes Saudi Arabia, other major oil-producing Middle Eastern, African, Latin American, Central Asian countries plus Russia — met virtually on Sunday, and agreed not to change policy for now, Reuters reported.

Galimberti said he expected the core OPEC group, spearheaded by Saudi Arabia, to take a watching brief for now. “There is too much uncertainty. We don’t know exactly what is happening in China with lockdowns. We don’t know how many barrels Russia is going to lose."

What about the diesel ban?

Even if the world gets through the coming weeks without major volatility on oil markets, the EU’s next big sanctions blast could deliver a significant shock — both for Europe’s energy supply and for global prices.

The EU ban on “refined petroleum products” from Russia, coming into force on February 5, 2023, is “the most important one,” said Galimberti — particularly when it comes to one product: diesel fuel.

“Europe depends on Russia for its diesel imports: 60 percent comes from Russia. There are no easy alternatives,” he said. “There is going to be a potential shortage of diesel for Europe in the middle of winter. Diesel is used almost everywhere in Europe from cars, to industry and heating purposes.”

Unlike crude, China and India will not hoover up Europe’s former share of Russian exports when it comes to refined products, Galimberti added, as they have their own refining sectors. “They would much rather buy crude and refine it. That has always been the strategy of China and India. No matter what the price is, they refine themselves.”

What happens to Russian diesel?

Russia may be able to sell some of its former European exports of refined products to North Africa and Turkey, but not in the same volumes. “That means they will reduce their own crude production," Galimberti said. "Crude needs to be refined into oil products. If you don’t find a market for oil products, either you consume it yourself or you store it.” But Russia lacks the capacity for significant storage, Galimberti added.

“If out of the market you take out around 1 million barrels per day, which is what we think Russia is going to lose as a result of the product export ban, this is going to be a big deal. That’s about 1 percent of the total market. It doesn’t sound a big deal, but everything in the oil market is based on marginal economics. It takes a little amount to tip the balance and have much higher prices — which is what we expect is going to happen in February.”

The IEA has also projected in its monthly oil report for November that Russian oil output could fall by 1.4 million barrels per day in 2023 — potentially pushing up global prices. “The range of uncertainty has never been so large,” the report said.