This is how an EU Oil embargo impacts Russia
Oil is where the European Union has more leverage against Russia and in the Russian invasion of Ukraine, this could be a major tool to hurt the Russian economy.
The Institute of International Finance says while Europe is very dependent on Russian natural gas, the continent has the ability to limit—or fully cut off—its purchases of crude oil.
“As far as additional sanctions in the context of Russia’s invasion of Ukraine are concerned, an oil embargo appears to be the next major step currently being discussed in the European Union—although significant opposition remains,” says the IIF.
Saying that oil is where the EU has leverage, it adds that it is because the EU’s diversification away from oil is less challenging than natural gas.
A partial or complete EU embargo of Russian crude oil would undoubtedly have a meaningful effect on prices, possibly driving Brent up to $200/bbl, but substituting volumes would likely be possible.
“Russia’s reliance on oil for FX inflows and budget revenues is substantially higher. We expect an oil embargo by the EU to be a multi-step approach rather than an abrupt discontinuation of imports.
“Current policy discussions focus on specific modalities (monthly targets vs. tariffs) and implementation challenges (use of U.S. secondary sanctions’ leverage vs. sanctions on the shipping industry),” it says.
The EU’s upcoming 6th sanctions package is expected to contain at least a reference to oil. However, EU sanctions require unanimity, and a more comprehensive embargo may take time to pass.
While paying for oil into an escrow ac- count—another often discussed option—might be technically easiest to implement, Russia could consider it a breach of contract.
Easier oil embargo
Russian crude oil imports would be easier to replace for EU countries than those of natural gas for two reasons: Supply is substantially more diversified (Exhibit 1 – above)—with Russia accounting for roughly 25% of total imports (vs. 35% for natural gas) and Europe’s own production making up a larger share as well.
Second, while natural gas imports from Russia almost exclusively occur via pipelines—with significant implications for their substitutability—the corresponding share for crude oil lies only at around 30% (Exhibit 2 – above).
The Druzhba pipeline network, fully commencing operations in 1964, transported 720 thousand bbl/day from oil fields in Russia’s Western regions to refineries in the Czech Republic, Germany, Poland, and the Slovak Republic last year.
The remaining roughly 70% are so-called “seaborn” oil, exported overwhelmingly from Baltic Sea ports. To put these numbers into perspective, daily crude oil production in Russia amounted to 10.5 million bbl/day, total exports to 4.4 million bbl/day, and exports to EU countries to 2.3 million bbl/day in 2021.
A partial or complete EU embargo of Russian crude oil would undoubtedly have a meaningful effect on prices, possibly driving Brent up to $200/bbl, but substituting volumes would likely be possible, says the Institute.
The impact on Russia
Hydrocarbon exports in Russia have accounted for around 50-60% of total goods exports in the recent past and reached $76.3 bn in 2021Q4, the highest in ten years (Exhibit 3).
For the year as a whole, their value stood at $243.8 bn. Considering price dynamics in 2022, especially since Russia’s invasion of Ukraine, this is unlikely to have changed in 2022Q1.
In fact, an all-time record current account surplus of $58.3 bn points to a further increase. Depending on Russia’s ability to redirect exports to other buyers, an EU embargo could dramatically impact FX inflows.
Russia is dependent on such inflows as it imports mostly non-commodities, including consumer goods and machinery/equipment.
“From the Russian perspective, an EU embargo on crude oil exports could have significant implications—from an external financing as well as fiscal perspective,” says IIF.
On the fiscal side, Russia relies heavily on revenues from the extraction and export of hydrocarbons (Exhibit 4).
Crude oil, petroleum products, and natural gas brought in RUB11 tn over the past twelve months—or 25% of total revenues over the same period—with mining and quarrying taxes on crude oil accounting for almost two-thirds of the total.
“A significant decline in exports and eventually production, as a result of an embargo, could have a meaningful impact on the budget and may make difficult spending cuts necessary.”
Read the full report @IIF