What an escalation in Russian sanctions would mean for shipping
Against the backdrop of the tightest inventory levels in decades, low spare capacity and a much less elastic shale sector, any escalation in Russian sanctions would all but guarantee increasing oil prices, but it would also spark a surge in rates as long-haul replacement cargoes increase demand
While industry consensus assumes Russia’s energy infrastructure will not be targeted, any wider escalation in the Russia-Ukraine conflict could yet see market disruption scenarios play out. The implications for shipping are mixed
WHILE the first tranche of economic sanctions on Russia have left shipping markets relatively unscathed, what follows could yet disrupt commodity flows and re-route energy trading.
Officially, the administration of US President Joe Biden has said all options are on the table for taking action against Russia, including sanctioning entities that could affect energy.
But behind the scenes officials from the US, the European Union and Britain have been coordinating sanctions discussions with Opec states and energy market officials, briefing that oil and gas flows will not be targeted.
The extreme scenario of Russia’s energy infrastructure being cut off by Western sanctions are widely deemed to be unlikely given European reliance on oil and gas trades being maintained amid already tight market supply.
A complete shutdown of piped gas from Russia, which makes up roughly a third of the gas burned in Europe, would hurt European interests more than Russia, at least in the short to mid-term.
Nevertheless, escalation of sanctions remains a credible outlier and a lot yet depends on whether Russia’s recognition of Donetsk and Luhansk is an end in itself, or a step to a wider war.
There are also a myriad of possible scenarios that would see Russian retaliation cut oil and gas exports, either overtly or via putative excuses that could include maintenance outages, damage from military attack or a cyber attack by the West.
The risk assessment necessary for shipping therefore requires context.
Russia energy sanctions: the competing scenarios
The potential expansion of sanctions against Russia could induce a change in trade patterns of crude trade and benefit crude tankers, especially aframaxes and suzemaxes, according to one senior Shanghai-based oil shipping executive.
The EU was the destination for more than half of Russian crude oil exports last year, but that trade, if hit by sanctions, is not irreplaceable, he said.
“Moscow could shift the exports to Asia, primarily China, via pipelines and ships.”
Ports in European Russia, big enough to accommodate suezmax vessels have enough capacity to handle the volume, with the additional support from smaller ports, such as Kozmino, in its far east territory, the executive added.
While sanctions from the US and its allies could deter mainstream tanker owners from participating in such new routes, the restrictions will give rise to shadow voyages performed by vintage tonnage with ambiguous ownership.
The practice has already been used to move regular volumes of Iranian and Venezuelan sanctioned crude outside of the compliant tanker market via an increasingly sophisticated logistical network of ship-to-ship transfers and subterfuge operations.
Accordingly, the EU will need to turn to the Middle East for more crude supplies, which are mainly carried by suezmaxes and aframaxes.
The shifting trade is feasible, but only “technically”, according to Banchero Costa head of research Ralph Leszczynski.
Russia’s crude exports to EU amounted to 114m tonnes in 2021, compared to 107m in 2020 and 129m in 2019.
“Volume-wise, it’s quite a lot, about 5% of global seaborne crude oil trade.”
Countries such Saudi Arabia should have the spare capacity to increase output to fill that gap, as they were holding back exports in the previous years, he said.
And if Middle Eastern crude diverted to Europe and Russian oil diverted to China, tonne miles would increase significantly.
“To send a cargo from the Baltic Sea to China would be like 20 times the distance to places such as Rotterdam. It would be a boon for tanker rates,” said Mr Leszczynski.
However, the altered trade flows will go hand in hand with surging oil prices.
In addition to the contribution from elevated freight rates, the Middle East ramping up production would reduce global spare capacity to virtually zero, considering the depleting of reserves and the limited investment in new fields worldwide in recent years, said Mr Leszczynski.
“One solution would also be of course to ease up the sanctions on Iran, and replace Russian crude with Iranian crude, although from a geopolitical point of view this would be quite a curious move.”
As a result, substituting Russian crude would be extremely difficult and expensive for Western European countries, he added.
“The direct ‘Iran-style’ sanctions are not really viable as they would hurt countries like Germany and France almost as much as they would hurt Russia.”
As broker BRS explained, China is likely to support Russia by taking increased volumes in the event of sanctions and may not even need to risk a confrontation with the US over financial embargoes.
A significant volume of the Russian crude shipped to China has been pre-paid under long-term oil for loans deals (another $80bn deal was signed earlier this month). Therefore, most Russia-China crude sales already bypass the US banking system, which should help to support flows under any sanctions.
“Against this backdrop, it seems unlikely that there would be a halt to the [600,000 barrels per day] flow of Russian crude shipped via the ESPO pipeline to the Chinese refining hub of Daqing,” BRS said in a recent tanker analysis. “This leaves the [720,000 barrels per day] shipped via port of Kozmino on Russia’s Pacific coast, largely by aframax, as being the only eastern volumes potentially under threat and much depends on whether third party tanker owners will carry such oil.”
Russian energy exports overview and data analysis
Russia is the second-largest crude producer and crude and clean petroleum products exporter in the world. Last year it exported 4.2m barrels of crude a day as seaborne trade (it produced 10.8m barrels a day).
Any disruption to Russian oil flows would primarily hurt Europe, which takes two-thirds of Russian crude exports.
Europe took 2.7m barrels a day of crude from Russia in 2021. These were almost all medium and light sour varieties. A like for like replacement would effectively mean a draw down in strategic reserves, and higher European imports of US, Norwegian and Middle East crude.
This comes against the backdrop of the tightest inventory levels in decades, low spare capacity and a much less elastic shale sector that would all but guarantee increasing oil prices.
Output growth from Opec+ countries has slowed in recent month. Despite agreements to continue to increase production by 400,000 barrels a day, crude trade flows from the Middle East have declined so far this year, prompting questions over the ability of Middle East producers including Saudi Arabia to ramp up production sufficiently to meet any potential extra demand.
While Russia accounts for a tenth of China’s crude imports China is widely assumed to be unlikely to cut back on its Russian imports in the event of sanctions. Currently around 600,000 barrels flow daily from Russia to the Chinese refining hub of Daqing and 720,000 barrels are shipped via port of Kozmino on Russia’s Pacific coast, largely by aframax.
Based on 2021 figures monthly Russian crude liftings globally accounted for 80 aframaxes (a quarter of all global loadings) and 23 suezmaxes (one tenth of global loadings).
Europe draws about 1.2m barrels a day of overland crude from Russia through the Druzhba pipeline. That pipeline supplies 10 refineries in Eastern Europe, Italy and Germany and some of these plants are jointly owned by Russian oil majors in joint ventures with Western oil majors.
The International Energy Agency warned this week that the energy supplies most immediately at risk were the roughly 250,000 barrels a day of Russian oil exports transiting Ukraine via the southern branch of the Druzhba pipeline to supply Hungary, Slovakia and the Czech Republic.
The agency stated that these countries had ample government-held emergency stocks to draw upon in case of need.
IEA net-oil-importing countries have an obligation to hold emergency oil stocks equivalent to at least 90 days of their net oil imports.
Assuming a continuation of normal weather this winter that would leave enough gas in storage by spring to make up for two months of lost Russian gas exports. However, a cold snap would quickly reduce this theoretical buffer.
Recent precedents in Russian sanctions suggests a limited approach
Whether the current sanctions against Russia can deter military escalation remains an open political question, but the recent 2014 precedent of responses to the annexation of Crimea by Russia bears revision in light of the current stand-off.
The response dealt by the US and Europe in 2014 was not disruptive for oil trades and Russian access to the SWIFT system for international payments was not sanctioned. Despite political debate at the time, blocking access to SWIFT was considered an “all out war” scenario and international financial transactions therefore carried as usual.
Instead, sanctions very similar those imposed on Tuesday were handed down. Russia was barred access to US and EU capital markets on a limited basis, key individuals and companies, including banks, were blacklisted and technology to extract oil in the Arctic was blocked.
As broker Braemar pointed out in a recent analysis, sanctions imposed by the administration of former US President Barack Obama caused limited damage to Russia’s economy. Crude and product flowed and continues to flow into Europe, largely unaffected by US sanctions on Moscow.
Russia still holds Crimea and has ignored most of its diplomatic commitments made at the time of annexation. Meanwhile, Russia has developed the Arctic oil fields with domestic technology.