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5 May 2022

EU ban stands to end Russian oil for good

The European Commission has proposed an outright ban on Russian oil imports, as part of its latest sanctions in response to the invasion of Ukraine. As Russia struggles to reroute its oil to the East, a loss of European sales will choke off up to one-third of its government’s funding, sending its oil sector into terminal decline.

“This will be a complete import ban on all Russian oil, seaborne and pipeline, crude and refined,” said Commissioner President Ursula von der Leyen, as she addressed the European Parliament.

“We will make sure that we phase out Russian oil in an orderly fashion, so in a way that allows us and our partners to secure alternative supply routes and, at the same time, be very careful that we minimize the impact on the global market. And this is why we will phase out Russian supply of crude oil within six months and refined products by the end of the year,” von der Leyen said.

The move aims to maximize pressure on Russia, while minimizing disruption within the bloc itself. It also includes sanctions on military officers involved in alleged war crimes in the Ukrainian cities of Bucha and Mariupol.

The plan will now be debated by EU member states, with hopes for it to be signed off in the next few days. While many countries will be in firm support, others such as Slovakia will be reluctant. Hungary, unsurprisingly, has already threatened to block the ban unless pipeline imports are excluded. So far Germany, one of the bigger buyers of Russian oil, appears onboard with an end-of-2022 cut-off, although Austria and Italy are among others with reservations. Other alternatives such as punitive tariffs or a price cap will also be discussed.

Russia makes up a leading 25% share of the bloc’s total oil demand, although the figure is over 75% in countries like Lithuania, Hungary, Slovakia, Finland and Bulgaria, and is particularly high for certain oil types including diesel and jet fuel.

Europe’s bid to eliminate Russia’s decades-long dominance of the bloc’s energy market hopes to choke the Russian economy. With President Putin continuing to wage war in Ukraine, cutting off his largest export earner could be vital to thwarting the sustainability of his efforts. It’s estimated that Russia’s oil sales to Europe are worth $310 million per day, and nearly 70% of its overall oil exports.

While Europe has a greater dependency on natural gas than it does on oil, Moscow earns far more through oil and oil products. Rystad Energy believes that elevated oil prices mean the country is set to generate $180 billion in oil tax revenues this year – equating to 60% of the country’s 2022 federal budget – even despite many traders refusing to touch Russian crude. In fact, since the start of the invasion of Ukraine, Russia has received around €62 billion from energy exports to the EU due to the higher prices – double the usual figure over this time period. Oil prices rose after the announcement. Brent crude was up more than 3.7% on Wednesday.

It also comes in direct response to Russia turning off the taps for natural gas in Poland and Bulgaria last week – showing Putin that both sides are able to weaponize their energy sectors. The plan to embargo Russian oil was the inevitable next step in the escalation of the EU’s sanctions, following similar announcements from the UK and the USA.

Russia’s oil sector is an easier target than gas as arranging alternative supplies is much less troublesome – the USA and Qatar being key contenders – although the shift will have to be handled carefully to ensure that costs can be contained. It’s worth noting that the EU has already pledged to reduce Russian gas imports by two-thirds by the end of this year.

Saudi Arabia and the UAE are estimated to have enough capacity to replace nearly all the crude the EU buys from Russia, but it is not clear OPEC and US shale producers are physically capable of ramping up output as fast as will be needed, with OPEC+ output still falling short of agreed quotas.

Moreover, Saudi Arabia’s Crown Prince is on better terms with President Putin than with President Biden, and OPEC+ counts Russia itself as a member. Back in 2020 Saudi Arabia initiated an oil price war with Russia, but it ended in failure which threatened the Crown Prince’s authority at home. Since then, the two countries have co-operated on maintaining high prices.

EU members are racing to implement new energy security strategies, ramping up renewable energy targets and efficiency measures. Terminals to import LNG took in a record amount of the super-chilled fuel for the time of year in April, while oil imports from non-Russian suppliers have hit their highest level since the start of the pandemic. Shortages and higher prices, however, can be expected for gasoline, diesel and jet fuel among others.

Even prior to its invasion, Russia pointed to its recent dealings with China as an alternative outlet for its abundance of oil and gas. But this itself has limitations. The vast majority of Russia’s oil infrastructure points to the west, with its one pipeline to China already operating at full capacity. Russia’s gas supply to China went up by 60% in Q1, but that was mostly from more intensive use of an existing pipeline, with  further increases to be smaller and more difficult. More oil supply will require supertankers taking week-long journeys from Russia’s ports; many shipping companies are also reluctant to risk the possible sanctions associated with doing so.

China also only accounts for one-fifth of Russia’s total oil and oil product exports, so is unlikely to provide a suitable replacement to Europe. Russia also has to offload its oil somehow; the geology of the county’s oilfields means that turning off supplies at many sites would be irreversible. Because of this, China’s independent refiners have already been buying Russian oil at a huge discount, with Chinese buyers facing scrutiny for their own dealings with Russia.

Once Europe sorts out its own Russia-free oil landscape, then Russian oil will never return at scale. That’s unless a trade deal is offered in exchange for a ceasefire in Ukraine, or a punitive tax is imposed with proceeds going to the rebuilding of the war-torn country.