Oil and gas in the capitals: Casualties of war
The consequences of the war between Ukraine and Russia will be considerable for the energy and oil markets. Given the extent of damages produced by the war and the sanctions taken by NATO countries and their allies (Australia, Japan, South Korea), a ceasefire will not imply a return to normal. The Ukrainian oil industry is in shambles, and the future of Russian oil production is uncertain. If Russia can find substitute customers, the question of the sustainability of production levels achieved so far arises.
Ukraine was traditionally the processing location for most Soviet oil. However, its refining level declined dramatically after 2010, even before the 2013-2014 Maïdan insurgency and problems with Russia. Oil refinery throughput declined from 369,000 bpd in 2005 to 108,000 bpd in 2012 and 68,000 bpd in 2020. As most industrial facilities were emplaced around Odessa and Mariupol, all the output is now stopped. Damage is probably extensive.
Ukraine possesses some conventional and unconventional hydrocarbon reserves. These resources are concentrated in three regions: Carpathian in the west (13% of proven reserves); Dnieper-Donetsk in the east (80%); and Black Sea-Sea of Azov in the south (around 7%). Territorial conditions for a war termination are here of the utmost importance.
Russia is the third-largest oil producer behind the U.S. and Saudi Arabia. But Russia is the largest exporter of petroleum and products in the world. Europe depends on these exports, whether for crude oil or products—such as diesel—for its supplies. In January 2022, Russia’s total oil and product production reached 11.3 MMbpd, practically recovering its pre-Covid level, of which about 8 MMbpd, or 70%, were exported. IEA forecasts indicate that 2.5 MMbpd to 3.0 MMbpd of exports are at risk, corresponding to 35% to 37%. However, the Ruble-USD exchange rate, after plummeting during the invasion’s first days, is now recovering, with the ruble stabilizing at 10% under its early February value.
The U.S. and Canada have banned imports of Russian oil, while the UK has said it will phase out purchases. French firm TotalEnergies, which owns a major part of NOVATEK, the main exporter of Russian LNG, has said that it will stop its purchases of Russian oil by next December. But other European nations have not followed suit, given their energy dependence on Russia. The IEA said that major oil companies, as well as trading houses, shipping companies and banks, were backing down from doing business with Russia.
However, in the short term, Russia could find substitute customers, mainly in India and China. Purchases made by Indian companies, which have obtained significant discounts from Russian firms, are up very sharply. Given that the Russian budget was calculated on the basis of a $42/bbl oil price (Brent), and that the price today is above $100, this leaves a significant margin for future discounts. The fact that India, with Russia’s help, is studying the construction of tankers suitable for the Arctic route, is a good indication of the economic and strategic importance of the ties between the two countries.
The question is more complex, when we look at sanctions relating to production, itself. Many companies from countries that imposed sanctions against Russia worked as subcontractors for large Russian companies (Rosneft, Lukoïl, etc.) and for Western firms operating in Russia. Is the withdrawal of these subcontractors likely to compromise Russian production capacity?
Probably no, in the short term. Similar, albeit less extensive, sanctions were imposed in 2014 and 2015 against Russia, and they had no significant impact. If Russia had to permanently do without the contribution of these companies, the impact could be more severe. But today’s world is no longer that of the late 1970s, when high-tech sanctions were imposed on the USSR following the invasion of Afghanistan. Dissemination of techniques and know-how in several countries is now a reality.
Moreover, the weight of the NATO countries and their allies is much less than it was in the 1970s. It is, therefore, more than likely today that the new sanctions will bring about a change in subcontractors, favoring Chinese or Indian companies, rather than blocking production. In addition, some of the NATO bloc or allied countries could transfer part of the know-how to Chinese companies, to maintain an indirect presence in Russia.
Finally, the de facto prohibition for Russian companies to finance themselves on Western financial markets should not represent a significant obstacle to investments. Already, part of the investments in Russia’s hydrocarbon sector are made in yuan. This should accelerate in the coming period. Moreover, the Central Bank of Russia has changed its policy significantly since the war between Russia and Ukraine began. It is not impossible that it will put in place specific refinancing conditions for large Russian companies in the hydrocarbon sector.
Russian production is not likely to be affected severely in the medium term. The experience of the sanctions taken in 2014 and 2015 shows that their impact is limited. The question of short-term impact, paradoxically, seems more important. The extent of additional Chinese and Indian demand for Russian oil, and the ability of Russian companies to deliver this oil by sea, is a real uncertainty. We can, however, consider that Russian companies will find ways to circumvent both the effects of the sanctions and that of the implicit withdrawal of many Western companies from operating with Russia. The world is no longer “West”-centered. This could be one lesson rammed home by this ugly war.
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