The EU embargo on Russia’s oil products will drive down prices – but not yet

The EU embargo on Russia’s oil products will drive down prices – but not yet
The EU embargo on Russia’s oil products will drive down prices – but not yet #Russia #Ukraine #bne #EmergingMarkets #sanctions #RussiaUkraineWar / bne IntelliNews
By Ben Aris in Berlin February 27, 2023

EU sanctions on Russia’s oil products went into effect on February 5 and will take several months to make themselves felt. The products market is very different to the crude oil market. Crude is sold to a few big players that have built up domestic refining capacity, but oil products are much more widely distributed to many more smaller markets that haven’t invested in their own refineries.

The EU was Russia’s biggest buyer of oil products, which accounted for half of all Russia’s products exports, and while the volumes it imports have been declining, the products market has been much less affected by the promise of the bans that were part of the sixth package in June that was introduced last summer.

“Oil product market is much more fragmented, with China, India and Turkey the most important buyers of Russian crude oil after lower European demand playing a much smaller role, and many smaller export partners making up the remaining share,” a team of leading economists at the Social Science Research Network (SSRN) found in a paper assessing the impact of international sanctions on Russian oil exports.

The February product sanctions has led to Russia ending exports to some markets like the US and the UK, but that has been offset by a limited growth in other markets, including China, India and Turkey. Russia’s problem is that while it has massively increased its exports to Asia, those countries have a lot of refining capacity, so the demand for Russian products is greatly diminished.

And SSRN reports that the exports of Russian products to Europe have not shrunk as far or as fast as those of crude. That is partly due to the fact that the embargo was phased in later than that of crude. It is also due to the surge in demand for fuels, especially diesel, ahead of the ban as European countries built up stockpiles as a precaution against shortages caused by the embargo. And it was partly due to the fact that Russian refineries doubled the import of Russian crude to their own refineries in Europe, which had become massively profitable as a result of the price distortions that are a result of the threat of sanctions, as bne IntelliNews recently reported.

Finally, the main effect of the sanctions on both crude and products has not been to prevent Russia from selling its oil, but it has forced it to find new customers in Asia, which continues to ignore the price cap regime. That means oil that used to travel the short distance from Primorsk in the Gulf of Finland to Rotterdam in the Netherlands now has to travel for a month to the Pacific Ocean. As the embargo only came into effect at the start of February and it takes two months for tankers to travel to Asia and back, the first cycle of product deliveries will only be complete at the end of March, when the shape of the new market will become apparent.

How the sanctions will affect the products market is also made more complicated, as unlike the relatively homogenous crude market, each of the products have markets of their own with their own quirks.

“When we talk about the oil products market, we are effectively discussing several separate markets for individual types of refined oil,” SSRN reports. “Diesel is, by far, the most important item for Russian exports, accounting for roughly 50% of total product exports in 2022, but fuel oils (25%), gasoline (10%) and naphtha(10%) also play an economically meaningful role. Importantly, different countries import these products to varying degrees; therefore a comprehensive analysis of product exports requires looking at them individually.”

EU imports of Russian oil products from Russia’s Baltic ports have fallen by roughly one-third in the final weeks of last year compared to the pre-invasion period. And Russia appears to be using the freed-up capacity for shipments to destinations located father away such as India, reports SSRN. That probably means that Russia has offered discounts on its products going to Asia for them to be able to compete with the locally produced products.

“We find much larger divergence between prices of different oil products compared to the pre-invasion period. Aside from fuel oils, key Russian products such as diesel, gasoline, kerosene and naphtha had displayed relatively stable and small price differences. This is no longer the case," SSRN reports.

"Diesel has been the case in point as the disruptions in the traditional delivery routes have led to concerns about possible shortages of this essential fuel and prices have risen. On the supply side, several European countries have been closing refineries due to rising energy costs. On the demand side, the post-coronavirus bounce-back has pushed up demand.

"In addition, the production of diesel (and kerosene, for that matter) requires natural gas, the prices for which soared for extended periods in 2022,” SSRN reports. On the other end of the price spectrum, naphtha, which is largely used in the petrochemical industry, tends to reflect overall economic conditions and cheapened as the global outlook weakened.

“Russia appears to be providing discounts to keep up export volumes. As neither the EU’s embargo on oil products nor the price caps took full effect during the period covered by our data, we cannot analyse detailed price dynamics in the same way we did for crude. However, we find that Russia appears to be providing “new” customers such as India with substantial discounts, especially on diesel and fuel oils, to keep export volumes from dropping too much,” SSRN says.

Russia has its own infrastructure bottlenecks. In the course of refining oil for the domestic market, it produces several other products for which there is little demand at home and which have to be exported. However, if the export volumes fall off too far then Russia will start to run out of storage space and be forced to reduce its refining throughput, which will lead to fuel shortages in Russia.

Exporting crude around the world is not a problem as the main obstacles are the cost and availability of tankers, but the products market is more complicated.

“As the full redirection of oil product exports to alternative markets away from the EU is unlikely to be possible to the same extent that Russia realised for crude, the problem will grow now that the EU embargo on oil products is in force. We expect to see both an overall reduction in volumes and downward pressure on prices,” SSRN concludes.