EXPLAINER: What’s the impact if Europe cuts off Russian oil?

PTI, Apr 22, 2022, 9:02 AM IST

Europe is struggling to find ways to stop paying Russia USD 850 million a day for energy and hit the Kremlin’s finances over its invasion of Ukraine. Leaders of the 27-member European Union are finding that reversing decades of dependence on Russian oil and natural gas is not a simple matter. The EU is now discussing sanctions on Russian oil, including a possible boycott. Here is what such a move could mean for people in Europe and the rest of the world:

HOW MUCH DOES EUROPE PAY RUSSIA FOR ENERGY?

Gas and oil are flowing to Europe even as governments denounce the war. The EU sends USD 450 million a day to Russia for oil and USD 400 million per day for natural gas, according to calculations by analysts at the Bruegel think tank in Brussels. That means energy revenue is bolstering the Kremlin’s budget, adding to foreign currency reserves even as Western sanctions have targeted Russia’s reserves abroad. The Russian government got an average of 43% of its revenue from oil and gas between 2011 and 2020.

HOW MUCH RUSSIAN OIL GOES TO EUROPE?

Europe is the biggest purchaser of Russian crude, receiving 138 million tons in 2020 out of Russia’s total exports of 260 million tons — or 53%, according to the BP Statistical Review of World Energy. Europe, which imports almost all of its crude, gets a quarter of its needs from Russia. Oil is refined into fuel for heating and driving as well as being a raw material for industry.

WHY IS THE FOCUS ON OIL INSTEAD OF NATURAL GAS?

It’s harder to find alternative sources of natural gas because it comes mainly by pipeline. It would be easier to find other sources for oil, which mostly moves by tanker and is traded globally.

Natural gas is off the table for now. Heavy users like Germany say an immediate cutoff could cost jobs, with industrial associations warning of shutdowns in glass and metals businesses.

Cutting off both natural gas and oil would likely cause a recession in Europe, economists say. European governments agreed to stop Russian coal imports starting in August, but that’s a relatively small part of energy payments to Russia.

WHAT WOULD HAPPEN IF RUSSIAN OIL SUPPLIES STOP?

Europe imported 3.8 million barrels a day from Russia before the war. In theory, European customers could replace those barrels from suppliers in the Middle East, whose exports now mostly go to Asia, as well as from the United States, Latin America and Africa. Meanwhile, cheaper Russian oil could take the place of the Middle East shipments to Asia. But it would take time for global markets to make that adjustment. In Europe, customers might scramble to reverse the usual east-west movement of oil using rail, truck and river barge. Refineries making gasoline and other products are set up for Russia’s particular kind of oil. Several major refineries depend on a pipeline from Russia.

Analysts at the Bruegel think tank say European countries should be ready to impose measures to reduce fuel use, such as making public transport free and incentivizing car-sharing. If those measures don’t work, tougher ones such as odd-even driving bans based on license plate numbers would be needed. Similar measures were taken during the 1973 OPEC oil embargo, when Germany imposed car-free Sundays. “This would give markets enough time for a structural reorientation away from Russian oil,” the analysts said.

Phasing in a ban over the rest of the year would be one way to prevent shortages. Germany has already said it plans to end Russian oil imports by year’s end. Prices for oil would likely go up, not just for Europe but for everyone, because oil is a global commodity and a net loss of supplies from Russia would be likely. That would mean higher costs for driving and heating fuel and more consumer inflation. Russia is a major supplier of Europe’s diesel fuel for trucks and farm equipment, meaning its price affects those for a wide range of food and goods.

WHAT WOULD HAPPEN TO THE GLOBAL OIL MARKET?

All of Russia’s oil couldn’t be redirected from Europe to Asia due to shipping and logistical constraints. It’s not clear to what extent buyers in countries like India and China would buy Russian oil if it means possible sanctions trouble with the West. The OPEC oil cartel led by Saudi Arabia — which sets production levels along with allied non-members like Russia — has made it clear it won’t increase output to make up for any supply loss from Russia due to a boycott.

“It would be a major, major, major rebalancing of crude flows,” said Claudio Galimberti, senior vice president for analysts at Rystad Energy. “From a theoretical standpoint, it’s possible. From an operational standpoint, it’s more complicated because not everything can be redirected.” Global demand for oil was already high as economies rebounded from the COVID-19 pandemic, and uncertainties over the war exacerbated the tight market and high prices. U.S. President Joe Biden has ordered releases from the strategic petroleum reserve to combat rising gasoline prices for Americans, while 30 other nations also have agreed to send more oil to the global market.

In the most severe scenario of a loss of Russia’s 3.8 million barrels to Europe and other countries refusing its oil, a huge price spike to USD 180 per barrel could happen, followed by a sharp fall due to declining demand and economic growth. However, “that does not look like it’s going to be the case,” Galimberti said. Rystad’s expectation is a loss of 1.5 million to 2 million barrels per day and oil reaching USD 120 to USD 130 per barrel by year’s end. A milder scenario, in which most Russian oil shunned by Europe is snapped up at a discount in other energy-hungry countries, would see a loss of only 1 million barrels per day. Oil prices would drop below USD 100 by June and keep falling to USD 60 by year’s end. That’s not too far from today’s situation, with some traders and banks shunning Russian oil even without sanctions.

“It’s a huge price range, but that’s reflective of the huge uncertainty we have on the Russian loss,” Galimberti said.

HOW MUCH WOULD A BOYCOTT COST RUSSIA?

The price for Russia’s main export benchmark to Europe, Urals crude, has been knocked down to a USD 35-per-barrel discount compared to international benchmark Brent. Yet because of generally higher oil prices, Russia’s revenue losses have so far been limited. Those foreign currency earnings are helping prop up Russian finances amid sanctions.

“As long as Russian barrels find a market, then Russia is in business,” Galimberti said. “The moment they stop finding a market, that is the moment when oil prices shoot up and Russia will have serious economic problems.”