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Russia’s energy industry begins to receive sanctions

The sanctions don’t directly hit Russian oil and gas, but early signs of trouble have emerged.

Russian President Vladimir Putin’s military campaign in Ukraine and a wave of Western sanctions are starting to have an impact on the oil and gas industry – the engine of Russia’s economy. The US and Canada have stopped importing Russian oil, although they also buy relatively little. Meanwhile, the European Union is still considering this ban.

In general, Western sanctions have so far avoided a direct impact on Russia’s energy exports. However, they have blocked Russia’s access to finance and advanced technology to develop the energy sector.

The withdrawal of Western energy companies from Russia is disrupting major projects from the Arctic to the Pacific Ocean. Traders and banks have avoided shipping Russian oil in recent weeks.

Oil refinery in Omsk, Russia.  Photo: Reuters

Oil refinery in Omsk, Russia. Photo: Reuters

All this threatens Russian oil production, of which one in 10 barrels is exported. Other sanctioned oil and gas nations, such as Iran and Venezuela, have struggled to recover from the impact of the massive production hit by the ban.

Analysts warn Russia could face a similar situation. “This will affect the industry for years, making it uncompetitive,” said Mikhail Krutikhin, an expert at consulting firm RusEnergy.

The signs of trouble are already starting to show. Earlier this week, Russia said that oil exports via the Caspian Pipeline Consortium from Kazakhstan to the Black Sea could temporarily fall by about a million barrels per day – or 1% of world oil demand – due to storm damage.

Russian officials say repairs could take up to two months. The Caspian Pipeline Consortium said finding parts “could be very challenging given the current market situation”. A Chevron spokesman said the company “is assessing the situation”. The Caspian Pipeline Consortium is owned by Russia, Kazakhstan, Chevron Corporation (USA) and many others.

According to the International Energy Agency (IEA), Russian oil production is expected to fall 15% this year to its lowest level since 2003. Consultant Rystad Energy said production may never return to pre-conflict peaks if sanctions continue for several years.

Russian natural gas is the main energy source for Europe. While it is impossible to ban gas imports, European policymakers are also rushing to reduce dependence on Moscow. Germany has frozen the $11 billion Nord Stream 2 pipeline project, potentially doubling Russia’s existing transmission capacity.

And although Russian oil still flows into Europe, many traders avoided buying because banks refused to finance after the Ukraine conflict broke out. Currently, Russia’s benchmark Ural crude is selling at around $85 per barrel, significantly lower than Brent ($115).

“If this trend continues, even if oil exports are not directly approved, Russia’s storage tanks will be full and there will be nowhere else to store oil,” said George Voloshin, an analyst at consulting firm Aperio Intelligence.

Russian officials said the country would diversify its export market and try to maintain stable oil production. “Maybe we’ll get less,” Deputy Prime Minister Alexander Novak said earlier this week. “We will do our best not to reduce exports.”

On March 23, Novak said that Russian oil and gas companies would face logistical and payment difficulties in April and May because of the sanctions.

As soon as Russian troops entered Ukraine, BP said it would relinquish its nearly 20% stake in oil producer Rosneft. Shell said it would stop the joint venture with Russia. Exxon Mobil has said it will halt production of a multibillion-dollar oil and gas project under development on Sakhalin Island in the North Pacific.

In recent days, the world’s largest oil services companies, Halliburton, Baker Hughes and Schlumberger, said they were closing or suspending investment and deployment of new technologies in Russia. This will have a major impact, as foreign companies provide significant support for Russia’s oil and gas sector.

According to Moscow-based energy consultancy Vygon Consulting, foreign companies provide 60% of software for industry. In addition, while Russian companies are responsible for most of the bottom drilling, international companies dominate in terms of advanced exploration and processing techniques.

“This will have an impact on oil production, because you will be short on new investment and the technology needed,” said Audun Martinsen, head of energy services research at Rystad.

Russia’s oil production is expected to peak this decade. Most of the operating wells are old and require expensive, labor-intensive engineering. Russian companies are looking for ways to access engineering from the US shale industry, to exploit more oil resources.

“Russia has been struggling for years to stem the production slump,” Martinsen said. So, without new foreign technology, the decline could be even faster.

Similarly, with gas, Moscow is betting big on increasing its share of the global liquefied petroleum gas market, relying on international companies to exploit harsh Arctic conditions. Martinsen said Russia currently does not have access to the technology needed to develop its infrastructure. Meanwhile, refiners will struggle to get some of the chemicals needed for the distillation process.

However, Alexander Gabuev, a senior fellow at the Carnegie Moscow Center, said that Russian energy companies have many engineers trained in the West. They will try to develop technology even though it may not be as sophisticated and secure as that.

In addition, analysts expect Russia to turn to China for help with energy investments. But Beijing will also be in a difficult position for fear of Western sanctions, said Henning Gloystein, director of energy, climate and resources at consulting firm Eurasia.

Energy is currently Moscow’s most powerful geopolitical weapon, being used to gain influence at the negotiating table with foreign customers and governments. The decline in the energy sector will have a major impact on the economy, as the oil and gas sector accounts for around 40% of the budget. According to analysts, about 1.5 million people in the industry could lose their jobs next year.

An session (according to WSJ)

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