The European Union’s pledge to ban most Russian oil is forcing it to rewire an economy that is geared to run on cheap Russian fuel—and threatens to deprive Moscow of revenue from its most valuable export.
Senior EU officials are expected to sign off on the oil embargo in the coming days, raising the intensity of the bloc’s economic retaliation against Russia for the war in Ukraine. Leaders of EU member states said late Monday they had agreed in principle to ban Russian crude and refined fuels that arrive on ships, which accounts for at least two-thirds of imports from Russia.
Fuel imported via pipeline was exempted from the deal to get holdout Hungary to agree. The ban will be phased in over several months. By the end of the year, the embargo would cover 90% of previous Russian oil imports, EU officials said.
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The deal drove oil prices higher Tuesday as traders braced for a loss of Russian oil supplies to international markets. Brent, the global benchmark, rose 1.9% to $119.84 a barrel Tuesday, trading at close to its highest level in more than two months. U.S. marker West Texas Intermediate rose 3.5% to $119.06 a barrel, playing catchup after trading was closed for the Memorial Day holiday.
The ban would end Europe’s decadeslong reliance on Russian oil to power its economy and force the bloc to find new sources of crude and refined fuels. It could fan global inflation, already running at its highest rate in decades in major economies, and exacerbate a shortage of fuels in poorer regions that will compete with Europe to import oil. The eurozone’s annual rate of inflation rose to a new high in May, hitting 8.1%, the EU said Tuesday.
In 2020, 29% of the EU’s crude-oil imports came from Russia, with the U.S., the second-biggest supplier, providing 9%. Russia is also a major exporter of refined fuels to Europe, supplying 10% of the region’s diesel demand in 2021, according to the International Energy Agency.
The stakes are high for Russia, which depends on its energy exports to fund government spending as international sanctions have cut off much of its economy from the West. The EU currently pays around $10 billion a month to Russia for crude oil and oil products, according to Brussels-based think tank Bruegel.
The pipeline exemption won’t provide much respite for Moscow. Before the war, the EU imported about 2.5 million barrels of Russian crude each day of which 800,000 barrels was via the Druzhba pipeline, the world’s longest pipeline network at 5,500-kilometers-long.
By year end, Russian crude oil flows into the EU will be 500,000 barrels a day, 20% of prewar levels, said Amrita Sen, founder of Energy Aspects, a consulting firm. That equals roughly $170 million a day in lost revenue for Russia, at the current discounted prices for Russian crude.
Europe has already shifted away from Russian oil in recent months, dialing down purchases from Moscow and sourcing crude from West Africa, the U.S. and elsewhere. Germany, which imports Russian oil through the northern branch of the Druzhba pipeline, rapidly reduced its purchases of Russian oil after the war broke out, reducing its reliance on Moscow to 12% from 35% before the invasion.
The hunt for new exporters comes at a price. Europe’s race to stock up on oil from other producers has driven the price of high-quality crudes produced from West Africa to Azerbaijan to levels not seen for years. With China emerging from Covid-19 shutdowns that have tamed oil demand, Europe will face greater competition for those crudes.
“There’s going to be even higher competition for crude,” said Ms. Sen.
For Europe, replacing Russian diesel will be even more difficult than finding new sources of crude. The fuel, which powers a bigger share of the auto fleet in Europe than in the U.S., will likely arrive from the U.S., the Middle East and India, analysts and traders say. Ms. Sen said diesel will be in short supply globally this winter.
The loss of most of the European market would be a big blow to the Russian budget, even though Moscow has already redirected some of the flows to customers in Asia. Oil-and-gas sales contributed nearly 42% of federal budget revenues in the first quarter of the year.
The EU ban adds to the challenges for the Russian oil industry, which has already seen major traders shun its cargoes and forced its flagship oil blend to sell at a large discount to global prices.
The oil that would have gone to Europe will be hard for Russia to sell. The country has struggled to charter ships to transport its oil as insurers and banks fear the impact of sanctions. Some of Russia’s Chinese and Indian customers, such as refineries, have been having trouble getting bank funding for the shipments, analysts said.
Russian President Vladimir Putin has ordered his government to expand energy-export infrastructure to Asia, including building new oil-and-gas pipelines from Siberia as well as the development of the Northern Sea Route, a shipping passage along the Russian Arctic coast. Those projects, however, are mainly still in planning stages and will take years to be completed.
India has been buying record amounts of Russian crude in recent weeks but analysts say that won’t be enough to mop up the barrels that the EU is aiming to ban. “This means that, in time, Russian storage will fill and production will begin to falter,” strategists at RBC Capital Markets wrote in a note to clients.
Russian officials have said that oil production this year could decline by as much as 17% because of Western sanctions. This presents a longer-term issue for Russia since much of its oil infrastructure isn’t geared to quick and deep production cuts. The frigid Siberian climate means pipelines can burst without oil in them and low-yielding Soviet-era fields are expensive to maintain and restart. Analysts say that much of the production that Russia closes now would be permanently lost.
