The changing structure of the global oil trade – which includes new roles for Russia and Saudi Arabia and the rise of non-state actors such as ISIS – has important implications for Russia’s energy industry.
Russia’s top energy companies, already grappling with the consequences of lower global oil prices over the past 18 months, now face additional challenges brought on by the shifting structure of the global oil trade. Most importantly, the rise of Saudi Arabia as a crude oil supplier to Europe is forcing Russia to accelerate its energy pivot to Asia.
As a result of increased tensions over Ukraine, European reprocessing plants have cut their purchases of Russian crude and started to replace it with oil from Saudi Arabia, setting the stage for increased competition between oil suppliers in their struggle for global market share.
Protecting market share is an important task, since crude oil trading has actually peaked, and room for crude suppliers is tightening. It is oil product markets that continue to expand and globalize.
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In this context, the European market is especially important. The EU is the second largest producer of oil products after the U.S.: its refining capacity is about 15 million barrels per day, about 16 percent of total global capacity. After the economic crisis of 2008-2009, the European refinery industry has experienced difficulties, including weak demand for its output and growing competition from export-oriented refineries in the Middle East, Russia, the United States and India.
According to the 2015 oil market report by the International Energy Agency, “Just over 2 million barrels per day of refinery capacity has been permanently shuttered since 2008, largely in line with the decline in regional demand and throughputs over the same period.” What this means is that the demand for crude that comes from the refineries in Europe is declining as well.
At the same time, there is a trend of lightening the quality of traded refinery feedstock worldwide, with medium and heavy grades increasingly refined closer to the wellhead rather than exported.
Russia’s strategy in Europe since the end of the 1990s and up until 2010 was moving further downstream into the European refinery industry. Vertically integrated oil companies such as Lukoil, Rosneft, Gazprom Neft and Surgutneftegaz all were working on bringing their refining closer to the key consumers, thus acquiring assets in the European refinery industry. This meant the strategic choice of the European market as key for crude oil exports, as well as control in the European refining industry.
There are several major aspects, which have changed the basics of Russia’s approach to this market. One of the factors is the aforementioned crisis in European refinery industry due to weak demand and increased competition of product supplies from refineries in other parts of the world (primarily Asia and the U.S., but also the Middle East). Another factor is the changed tax regime in Russia. The changes to the law came into force at the start of 2015, reducing crude oil export duties while increasing the mineral extraction tax. Export duties for diesel and other light products will be kept at 63 percent of those for crude. The main consequence is that refiners have an incentive to maximize their light-product output and exports. Naturally, this makes exports of crude for European refineries in particular less of a priority.
This should be understood in the context of the start of exports through the East Siberia – Pacific Ocean oil pipeline and further through the ports of the Far East to Asian buyers. It is part of Russia’s pivot to the East.
Overview of Russia’s crude oil exports by destination, 2010-2040, million tons. Source: ERI RAS & ACRF 2014
In recent years, Saudi Arabia has faced a decreasing role in Asian markets as buyers there strived to diversify a market heavily dependent on crude oil from the Middle East via Russia. Now in an effort to keep market share, Saudi Arabia plans to ship more crude oil to Europe.
Recent reports show that light Saudi crude is a new favourite for energy importers in Europe, threatening the traditionally Russian dominated market. Low prices in addition to strained relations between Russia and the West are factors that have led companies like Shell and Total to make the switch.
There has long existed a desire for energy supply diversification in Europe, recently with Poland taking the lead by announcing a natural gas pipeline deal with Latvia, Lithuania and Estonia. An injection of Saudi oil into the European market would provide another much-desired avenue to achieve this goal.
The Polish port city of Gdansk has been slated as a possible storage hub, where Kingdom oil can be stockpiled for eventual shipment to refineries in Western and Mediterranean Europe. One possible customer is Germany. Ambassador to the Kingdom, Boris Ruge,stated in a recent interview that, “The exchange of the traditional range of goods — mechanical engineering and chemical products against crude oil and petrochemical products — continues to play an important role.”
The moves are aggressive enough to have caused sufficient concern among Russian leadership. The head of Rosneft, Igor Sechin, claims that Saudi Arabia is price dumping in an effort to muscle Russia out of the market. Nikolaj Rubchenkov, a representative of Tatneft, urged the Russian Ministry of Energy to consider adding protective measures to safeguard Russian interests in Western markets to the government’s energy strategy. Minister of Energy Alexander Novak has characterized the entry of Saudi Arabia into the current market as Russia’s toughest competition.
The combination of concrete measures taken by European buyers and the amount of concern among top Russian executives strongly suggests that this move by Saudi Arabia has the potential to dramatically change the face of the European oil market. So long as Saudi Arabia keeps prices sufficiently low by discounts, high production, or both, Russian market share in Europe will continue to be threatened.
The emergence of the Islamic State of Iraq and the Greater Syria (ISIS) complicates the notion that the geopolitics of energy are traditionally set by sovereign states. ISIS enjoys a crude output of 34-40,000 barrels per day, banking an estimated $1.53 million per day.Reportedly some of this oil is sold and consumed by both rebels to the Assad governmentand the Assad government itself. This strange interdependence between enemies further complicates the already labyrinthine set of allegiances in the region.
What we are witnessing is, firstly, a change in the geography of the oil trade. Russia is turning to the East, winning market share from the Middle East. At the same time, Saudi Arabia is replacing Russia in the European gas market.
The factors that explain this development are rooted in the security of supply considerations of Asian oil importers, who have a historically high degree of dependence on Middle Eastern supplies and use Russian supplies as a way to diversify.
Moreover, the deteriorated relations between Russia and the West have had their impact on this process, with decreased participation of Russian companies in the European refinery business, as well as the smaller degree of involvement of international energy companies in Russia’s modernizing refinery sector.
Secondly, the nature of the oil trade is changing as well. It is not the crude oil trade but refined products trade that has central meaning for the globalization of trade flows in the medium-term perspective. Therefore such players as Saudi Arabia and Russia are actually focusing on developing their own refinery capacities and taking over their positions in the products markets. Importantly, the end-markets for their output are located in Asia rather than the stagnating European market.
Thirdly, the recent developments in the Middle East, which has seen increased production from fields controlled by ISIS, signify a serious change – a birth of the new geopolitics of oil where non-state actors have increasing importance.
As a result, the notions of sovereignty over national resources, traditional trade barriers associated with national borders and trade legislations, and energy diplomacy all acquire a very different context.