ED: This is the first in series of articles exploring the leakages to the Western sanctions regime imposed on Russia.

Not only have the extreme sanctions imposed on Russia following its invasion of Ukraine in February not crushed the economy, but Russia is making a killing from the war thanks to the abundant leaks in the sanction regime.

The ban on exporting technology and machines to Russia has been highly effective but the attempt to cut the Kremlin off from its energy revenue has backfired.

Russia racked up around $97bn in revenues from its exports of oil, gas and coal in the first 100 days of the conflict, according to Finland’s Centre for Research on Energy and Clean Air. Some two-thirds of those revenues were derived from oil, and the balance mainly from natural gas.

In the first two months of the war oil exports and production dipped due to self-sanctioning by traders; Russian oil exports have not been sanctioned but traders avoided buying Russian oil if they could. But by the summer the market did its thing and both exports and production recovered as Russia found new markets for its hydrocarbons.

The unprecedented revenue is due to a combination of the rapidly recovering export volumes and the high prices for all commodities caused by the uncertainty of Russia’s ability to deliver as it remains a key player in almost all the commodity markets. The Finnish research body reported that Russia’s fossil fuel export prices were 60% higher than last year after three months of war, even though Russian oil is priced about 30% below international market prices.

As Russia’s neighbour and leading trading partner, the EU has been left to foot a large part of the bill. In the first half of 2022 the EU paid Russia $52bn for oil, $24bn for natural gas and $5bn for coal.

And spending is likely to more than double this winter. Italy’s economy minister said on September 3 that its net energy import costs will more than double to €100bn this year, warning that Rome could not spend indefinitely to cushion the blow.

"To keep offsetting, at least in part, rising energy prices through public finances is very costly and we could never do enough," Italy’s Economy Minister Daniele Franco said at the weekend.

Italy is one of the most exposed countries in the EU, relying on imports for three quarters of its energy, but costs have been soaring across the continent and the total cost of the war to Europe is an estimated €278bn so far, according to the IMF. And that is before the cold weather sets in. On top of that Germany announced a new €65bn energy crisis relief package on September 2, double the total €30bn spent in the previous two packages.

Oil exports have given Russian President Vladimir Putin the wiggle room to use natural gas exports as an economic weapon against Europe. Before the war, Russia supplied Europe with 40% of its gas, but has since throttled flows through the Nord Stream pipeline to Germany and other conduits, driving prices higher and putting more pressure on European households and businesses.

Those pressures are starting to bite. On September 2 Czechia saw a mass demonstration of more than 70,000 protesting against the rising cost of living and calling for sanctions to be lifted to restore cheap gas. Similar protests have already happened in Albania in March and German Foreign Minister Annalena Baerbock has warned that Germany could also see protests this winter if household food and utility costs keep rising.

Gazprom cut off gas deliveries via Nord Stream 1 completely on September 2 after finding another “technical problem” and said no date has been set for them to resume. Oil revenue more than makes up the difference from the loss of gas revenues.

“Russia is swimming in cash,” said Elina Ribakova, deputy chief economist at the Institute of International Finance. “Moscow earned $97bn from oil and gas sales through July this year, about $74bn of that from oil,” she said.

The country exported 7.4mn barrels of crude and products each day in July, of which about 2mn go to Europe, according to the International Energy Agency (IEA), down only about 600,000 barrels per day (bpd) since the start of the year.

“There came a realisation that the world needs oil, and nobody’s brave enough to embargo 7.5mn bpd of Russian oil and oil products,” said Sergey Vakulenko, an analyst and former Russian energy executive.

It is the willing participation of Russia’s “friendly” countries that is facilitating this boom in trade and sky-high export revenues. The most serious leakage is with oil exports, but Russia has also already found some backdoors to ensure it can continue to sell gas to Europe even if the EU eventually bans imports.

Hungary leakage

Within the EU Russia can count on “friendly” Hungary to ignore the sanctions. Gazprom agreed to deliver extra gas to Hungary on September 5 that it doesn’t need so that Budapest will simply sell on to its neighbours, allowing them to import more Russian gas without having to admit to it.

Hungary and Russia’s gas giant Gazprom signed an agreement that will guarantee the delivery of up to 5.8mn cubic metres gas per day to Hungary in September and October above the volume stipulated in the country's long-term contract signed in October that was already a significant source of gas leakage into Europe, according to Hungary’s Foreign Minister Peter Szijjarto. Gas imports from Russia are not banned, but it is already clear that if they were, Hungary will not participate and will continue to import Russian gas.

Gazprom delivered an extra 2.6 mcm of gas per day in August on top of its 15-year contract obligations, which guarantees the annual supply of 4.5 bcm of gas through Serbia and Austria, bypassing Ukraine. Hungary has been in talk with Moscow in the summer to obtain an additional 700 mcm of gas above the 4.5 bcm level.

Hungary has opposed proposals for EU sanctions on Russian gas as well as calls for a voluntary 15% cuts in member states’ gas demand until the end of March next year. The government has blamed EU sanctions for the soaring energy prices in Europe.

Due to Hungary’s geography, being a landlocked country, "it is physically impossible to ensure Hungary's energy supply without using and taking into account Russian gas sources", Szijjarto said.

LNG leakage

While it will take as long as a decade for Russia to reorient its gas business to Asia, China is already facilitating some leakage of Russia’s LNG exports, which already account for about 7% of Europe’s imports.

In the last decade Russia has invested heavily into LNG and has two major processing plants on the island of Sakhalin in the east and Novatek’s plant Yamal in the northwest. The energy crisis in Europe has driven LNG prices to record highs and this has become a hugely profitable business.

Reports have emerged that China has been cashing in by increasing its imports of Russian LNG and then re-exporting them to Europe, in the same way that India has imported Russian crude, refined it, and then sold the products on to the US market and elsewhere. The LNG is not actually physically shipped to China and back but traded using swap deals that effectively re-flags the Russian LNG as Chinese.

China’s LNG imports have surged in the first half of this year. It has then been selling “surplus LNG" cargoes because of "weak power demand at residences.” Europe's imports of LNG from China are up by 60% year to date to June, analysis agency Kpler figures show.

China bought 2.35mn tonnes of LNG in July, reports local media, valued at $2.16bn, bypassing the US and Indonesia, to make Russia China's fourth-largest LNG supplier. China's giant oil refiner, Sinopec Group, has acknowledged channelling extra LNG into the worldwide market, offering 45 cargoes of LNG to bidders this year. Overall, analysts estimate that more than 4mn tonnes of Chinese LNG has been resold this year, equivalent to 7% of Europe's imports in the first half of this year.

Geopolitically Europe has partially swapped reliance on Russian gas for reliance on Chinese gas that is actually still Russian gas, only a lot more expensive.

Gas pivot to Asia

The coming European ban on gas imports will hurt, but it will only temporarily stymie Russia’s gas business. bne IntelliNews already covered the gas trade in its assessment of the Yale report, which concluded that Russia’s economy is already wrecked. Gas has not been sanctioned and Russia has little option other than to sell its gas to Europe for the moment as the gas pipeline infrastructure cannot be switched from its overwhelming western direction to service Europe since the 1970s to the east. But the process of making that switch has already begun and will take about eight years to complete.

The Power of Siberia 1 gas pipeline that connects the gas fields in Siberia with China went online in December 2019 and gas deliveries have already grown from 10bn cubic metres to 16 bcm now and are due to reach their maximum of 38 bcm in 2024, as James Henderson of Oxford Energy commented for bne IntelliNews.

A second Power of Siberia is planned and a new pipeline via Mongolia (Soyuz-Vostok) will together bring the total capacity of eastward-bound pipelines up to 160 bcm in the next 5-10 years and entirely replace the 155 bcm that was sent to Europe last year.

“Can Russia replace lost European sales in Asia? In the short term this is unlikely, although it depends how fast and how far exports to Europe fall,” Henderson wrote. “However, by the late 2020s the current Power of Siberia contract could have expanded by 6 bcm and we could see the Far East pipeline on stream with a further 10 bcm, and if contracts can be signed quickly for Power of Siberia 2 / Soyuz-Vostok then initial sales from a 50 bcm contract could also have started. Extra LNG projects could also have started, albeit more slowly than hoped, adding another possible 15-25 bcm, meaning that by the early 2030 Russia could be sending an extra 116-126 bcm of gas to non-European markets. If some gas is still flowing to Europe at that stage, then a re-balancing could have occurred, after a likely dip in export volumes in the 2020s,” Henderson concluded.

Oil leakage 

The biggest leakage of all is in the oil business. Oil is not yet sanctioned, but restrictions on shipping oil were introduced as part of the  sixth package in July, but those sanctions have been almost completely ineffective. India and China have become two of the biggest buyers.

China and India have between them bought almost all the oil that the EU has rebuffed and now together the two Asian countries account for more than two fifths of Russia’s total export volumes.

In January 54.5% of Russia’s oil exports went to Europe, which accounted for 80% of the oil and gas revenues, according to the IEA, but by June exports were down by a third due to self-sanctioning.

Including Turkey as part of Europe, Russia’s exports there were 2.15mn bpd in July, slightly down from 2.19mn bpd in June, and down from 2.99mn bpd in February just before the war started. The European imports are bolstered by Turkey, which has refused to join the sanctions regime and imports around 312,000 bpd in July, up from 222,500 bpd in the same month in 2021.

India and China accounted for 1.85mn bpd of Russia’s total exports of 4.47mn bpd in July, according to data from commodity analysts Kpler, reports the Wall Street Journal. This gives the two Asian giants a share of 41.4% of Russia’s total crude shipments in July, which is almost double the 21.7% India and China had in July last year.

India has been the most active of the “friendly” country paid. From nothing before the war, India has become the world’s biggest buyer of Russia’s Urals crude blend and will likely be importing even greater quantities following the opening of a new, shorter route from St Petersburg to Iran’s Nhava Sheva port in the first week of August. The route traverses Iran and slashes the transportation time to just over three weeks from more than 10 weeks via the Suez Canal, also significantly reducing the costs.

Russia now makes up 20% of Indian oil imports, up from 2% before the Ukraine war. India imported 1mn bpd of Russian crude in June, up from 840,645 bpd in May, 388,666 bpd in April and the 136,774 bpd it bought from Russia in May 2021. Back in 2020, Russian Urals crude exports to India were just 16,000 bpd.

Imports have ebbed recently because of refinery maintenance work, said an executive at state-owned Indian Oil Corp., but the company signed a contract with Russian oil giant Rosneft to lock in supplies until 2028. Rosneft also has a 49% stake in India’s Nayara refinery, which formerly belonged to the Essar group.

“Importing Ural crude is just too good a business not to go into. The profit India can make on buying Russian crude and then selling the product that it refines at market prices creates a situation in which Indian refiners are the most profitable refineries globally,” BCS GM analysts said in a note.

Part of India’s reluctance to play ball is the country has become addicted to cheap Russian oil that is helping it deal with soaring inflation and a record trade deficit. India is the world’s third-largest buyer of oil, importing 85% of its oil needs, and its refineries are making money hand over fist at the moment – money it can’t do without.

For the US, which has banned Russian oil imports, this is particularly embarrassing after it was found that some plastic products made at an Indian refinery using Russian crude had ended up in New York.

Exports of oil to China have also been soaring, but the state-owned companies have been shy of buying Russian crude, afraid of bringing down sanctions on themselves. Most of the imports to China have been bought by privately owned refineries.

Another unexpected buyer of Russian crude has been the Kingdom of Saudi Arabia (KSA) and the Middle East. Exports of Russian fuel oil, a lightly refined version of crude, now go to Saudi Arabia and the United Arab Emirates, often stopping in Egypt en route.

The Russian oil is either burned in Saudi power stations or exported from Fujairah, a UAE port and hot spot for blending Russian and Iranian oils to conceal their provenance. This is oil that before the war was shipped to US refiners.

The Russian imports, purchased at a discount, free up state giant Saudi Arabian Oil Co. to export more of its own crude at market prices and so increase profits, as they are freed of their domestic duties to provide fuel for the home market. “The Saudis are happy to take their oil and sell it rather than burning it,” said Carole Nakhle, chief executive at consulting firm Crystol Energy.

China has been more hesitant to import Russian oil, as it is much more exposed to sanctions than India as its biggest export markets are the US and EU worth $1 trillion a year. Almost all the growth in Russia’s maritime oil exports to Asia in 2022, up 43% from late January to late June, is down to India. The state-owned oil refineries have avoided buying Russian crude, but the privately owned refineries have been less reticent. Russian crude oil exports to China were up just 4%, according to Marcel Salikhov, director of economics at the HSE Institute of Energy and Finance.

China imported 843,000 bpd of Russian crude in July, down from 1.33mn bpd in both June and May, according to Kpler’s shipping data, while Refinitiv Oil Research estimated total seaborne and pipeline imports at 1.78mn bpd and May’s at 1.99mn bpd. China imports about 880,000 bpd per via three pipelines – one Kazakh and two Russian – that have been operating all summer at full capacity.

Analysts speculate that China import appetite has probably reached saturation even though Urals crude remains at a discount of at least $10 a barrel to grades from Middle Eastern suppliers such as Saudi Arabia.

Elsewhere in Asia, Russia crude is struggling to find buyers, with exports to Japan falling to zero in June and July, from a 2022 high of 112,200 bpd in March. Russia’s shipments to South Korea have also been declining, with 115,400 bpd assessed in July, down from 131,000 bpd in June and a 2022 high of 307,000 bpd in March, reports the Wall Street Journal.