Since the end of February 2022, the Russian oil and gas industry has faced continuous pressure. While Europe initially expected the process of reducing dependence on Russian hydrocarbons to take several years, by mid-autumn it became clear that European countries had nearly eliminated their total reliance on Russian oil and gas. In a recent interview, Aleksey Belogoriev, Deputy Chief Director for Energy at the Institute of Energy and Finance (IEF), discussed how the oil and gas industry has developed since the start of Russia’s military operation in Ukraine and what to anticipate in the future.

Aleksey Belogoriev leads IEF initiatives on analyzing and forecasting international energy markets, integrating and advancing national and international markets for natural and liquefied gas, processes of the energy transition and decarbonization of the world energy and ferrous metallurgy, waste management, energy, and climate policy of foreign countries. He specializes in developing documents for corporate, state, and interstate strategic planning, such as the concept for the formation of a common gas market of the Eurasian Economic Union (EAEU) and the general plan for the development of the oil industry for the period up to 2035, among others.

– How prepared was the oil and gas industry for the events of 2022?

– It demonstrated significant flexibility, which can be attributed to the fact that the past two years of the pandemic were crisis years, and in general, companies in the industry are used to operating in conditions of high unpredictability and instability – traits that are inherent to the oil and gas markets. Moreover, the imposition of sanctions was not entirely unexpected, as many had been in place since 2014, especially those related to access to Western technologies.

Nonetheless, Russian energy resources, particularly crude oil and liquefied natural gas, remain in high demand worldwide. Since 2015, the global oil market has been grappling with a persistent funding crisis, meaning that investment in exploration and production has remained insufficient to meet long-term demand. This situation has only worsened each year, and by 2022, production challenges had become noticeable in many countries, including within OPEC+. Against this backdrop, Russian oil exports have become crucial.

The LNG market has a different problem. 2022-2024 marks a low between two investment cycles: one has ended, and the other has not yet begun. Consequently, there are few new plants being commissioned, while demand is growing faster than expected. At least until the second half of 2025, there will be a significant supply shortage in the LNG market, and Russian LNG is also indispensable. With oil products and pipeline gas, the situation is more complex, as they are more niche products. Nevertheless, Russian hydrocarbons will be vital for the sustainability of the industry in the years to come.

Of course, 2022 was still a shock year for both Russian companies and global markets. Nonetheless, many countries and companies made substantial profits during this crisis.

– Why was Europe able to adjust so quickly in terms of oil and gas supplies?

– During the first two or three months, that is, in the spring of 2022, no one foresaw the possibility of Russian energy supplies to Europe almost entirely ceasing. It appeared to be an extremely alarmist scenario. This was particularly true for gas and oil products, primarily diesel fuel, since oil and coal are more liquid commodities and easier to find on the market.

However, in all fairness, it should be noted that the European Commission announced back in early March that it intended to reduce Russian gas imports by two-thirds (or approximately 100 billion cubic meters) by the end of 2022. At that time, though, many Western experts reacted skeptically to the plan’s feasibility.

Both in Russia and Europe, there was a stable notion that if a “divorce” happened between them in terms of gas, it would take at least 15-20 years. Because the mutual ties were too strong, and there was simply no comparable spare capacity on the world market. Russia is tightly linked to the European market by a pipeline network. The way events unfolded with respect to Russian pipeline gas afterward is perhaps the most remarkable and striking thing.

In the so-called sixth EU sanctions package, an almost complete embargo on imports of Russian oil and oil products was declared in June. However, its implementation was postponed by 6-8 months. As a result, deliveries remained at a high level for most of the year.

This enabled both European and Russian companies to prepare for “D-day.” European companies actively purchased oil and oil products from other markets, while Russian companies started constructing their large fleet of tankers and redirecting supplies to Asian countries. Both parties accomplished their tasks.

Oil has been successful in the face of a Western embargo because the global oil market is a zero-sum game, with a tight balance between supply and demand controlled by OPEC+, where Russia and Saudi Arabia are key players. If Western countries stop buying Russian oil, they will have to find other suppliers, which creates an artificial redirection of oil supplies and higher transportation costs. The U.S. leadership proposed a price ceiling on Russian oil as a mechanism for easing European sanctions, but the sixth package of sanctions allowed for European companies to continue to insure and transport Russian oil and oil products to third countries.

On the other hand, the gas market is more complex, and Europe would consume more Russian pipeline gas if it were not for Russia’s reciprocal pressure, such as offering to buy gas for rubles, refusing to use the Yamal-Europe gas pipeline for transit, and problems with Siemens gas turbines affecting Nord Stream. The process of reducing Russian gas supplies would have been slower if not for these factors, and Europe could have been supplied with a greater amount of gas.

Europe’s rapid abandonment of Russian oil and gas was influenced by three factors: Europe’s willingness to pay high prices for gas, which negatively affected industrial production, increased inflation, and reduced the EU’s competitiveness.

– What factors contributed to Europe’s adaptation to the oil and gas crisis?

– High prices have become a major factor in Europe’s adaptation to the crisis, leading to a decline in consumption, but attracting many new suppliers to the European market. Additionally, the low demand for LNG in Asia due to a combination of regional factors and high prices made it possible for LNG shipments destined for Asian buyers to be redirected to Europe. Finally, luck with weather conditions from October to mid-January allowed for the accumulation of large reserves in underground gas storage facilities, ensuring that the market was secured as much as possible from any shortage.

– Were forecasts about a “freezing Europe” a mistake of Russian oil and gas analysts?

– While it may be considered a mistake from the perspective of today, this was not just a Russian error, as foreign and European experts also shared the same beliefs. This is due in part to the inertia of thinking, as everyone was sure that Europe would not be able to abandon Russian gas before the 2040s, making it difficult to abandon this paradigm. Additionally, the mild weather conditions in Europe and low demand for LNG in Asia were unforeseen circumstances that played a significant role.

The third factor is the remarkable speed at which the demand for gas consumption in Europe has reduced, exceeding even the early August target values of the EU. The decreased consumption is seen in energy-intensive industries and public utilities. However, the conditions mentioned before will continue to bring uncertainty for the next two or three heating periods, which could lead to an entirely different situation.

The experts realized that Europe would not freeze back in September, but the propaganda and self-hypnosis continued to fuel this topic. As a result, the sober assessments of experts reached a Russian audience with a delay of two to three months.

Regarding crude oil, almost all the volumes that left the European market were redirected to other regions, primarily to Asia, based on current observations. The short-term failure in mid-December was quickly compensated by mid-January as the logistics of supplies were being rebuilt. The physical volume of deliveries looks favorable in the next few months, but the situation beyond that is uncertain as India and China may eventually reduce their consumption of Russian oil.

The situation is more complex for oil products since the market is narrower. The main buyers of Russian oil are China, India, and Turkey, which are large producers of petroleum products, especially motor fuels. These countries do not require our diesel fuel since they produce it for export. Furthermore, China and India are considered among the primary exporters of diesel fuel to Europe in exchange for Russian supplies. Hence, no easy recipes can fix the situation. Russia has to look for several smaller markets worldwide instead of one large and affluent market in Europe. The exports to Ghana and Senegal have witnessed explosive growth, while deliveries to Morocco and Brazil are increasing.

The process has begun, and Russian companies will face a struggle for small market niches. While they may emerge victorious, there will still be a certain amount of failure for a certain period of time.

At present, there is a minimum estimated failure of 400-500 thousand barrels per day, which accounts for roughly 15-20% of oil exports by sea.

To help Russian exports, foreign companies can increase their purchases of Russian oil products for their domestic market and redirect their own production facilities to export to Europe. Another possibility is blending, which involves mixing Russian raw materials into oil products from third countries. This would allow the origin of the oil products to be disguised, and they can theoretically be supplied to Europe, the United States, and Japan. We will see how popular these schemes become in the coming months.

Regarding gas, it is important to differentiate between LNG and pipeline gas. The situation with LNG is good, as Russia significantly increased its supplies last year. However, Russia cannot increase them further, despite the high global demand for LNG. NOVATEK may be able to commission the first stage of the Arctic LNG 2 plant within a year to create new export capacities.

For pipeline supplies, it is difficult to redirect volumes elsewhere in a short time. The only market where Russia can send these falling volumes, using the same infrastructure, is Turkey. However, demand in Turkey also fell noticeably in 2022.

What can be done with the surplus gas volumes? One option is to redirect them to the domestic market, but this market is already saturated and mostly limited to low-rise residential building gasification. Another option is to construct new LNG terminals in the European part of Russia, particularly in the Baltic, but this is hindered by technological sanctions and the absence of equipment for large-tonnage LNG production.

A third option is to build Power of Siberia 2 in China, which has been discussed by Gazprom for a long time, but this gas pipeline, even if built, may not be completed until 2030, and it may reach its maximum capacity by 2035, after which there may not be a large surplus. These three options are incapable of completely replacing the European market. Globally, the problem cannot be solved in terms of physical gas supplies, and in terms of delivery costs, it is virtually impossible to address.

The European market was the most profitable market, serving wealthy countries. Other buyers, including China, are not willing to pay as much for gas. As a result, China will be unable to replace Europe in terms of export earnings or profits.

– How will this impact the Russian budget?

– We will see a significant decline in oil and gas revenue this year, which was anticipated, but the extent of the drop is still uncertain. Last year’s revenue totaled 11.6 trillion rubles, a significant sum. For comparison, oil and gas revenues were 9.1 trillion rubles in 2021. The budget for this year includes oil and gas revenues of 8.94 trillion rubles, equivalent to 34.2% of total budget revenues. However, expert projections for oil and gas revenues are much lower, around 6.5-7 trillion rubles. Oil and gas revenues in January 2023 amounted to only 426 billion rubles, or five trillion in annual terms.

The unfavorable revenue decline is largely unrelated to production and export reductions, as these parameters were relatively predictable. The main issue is the price of Urals oil, which is used for tax purposes. The Russian Ministry of Finance relies on quotes from the Argus pricing agency, which is now averaging around $44-52 per barrel in Primorsk and Novorossiysk ports. The possibility of significant price increases in the near future is low.

On the one hand, there are doubts among experts and the Ministry of Finance that current oil prices reflect the true income of companies. However, the overall situation is likely not as dire as it seems. Two reasons contribute to these doubts.

First, after the introduction of price ceilings, a significant portion of supplies went into the black market, and price agencies may not have an accurate picture of the market. This can lead to the underestimation of FOB quotes due to methodological errors.

Secondly, the Urals discount to Brent, which is around $35-40 per barrel according to Argus quotes, is suspiciously high. The buyer only receives $5-10 per barrel from this discount, so where does the rest of the cost come from? This raises the suspicion that Russian companies controlling the freight and trading have a significant share in the “surplus profits”. In other words, their incomes have been redistributed rather than decreased.

These are only assumptions and suspicions, but if the Ministry of Finance adjusts its approach to calculating the price of oil for tax purposes, budget revenues will likely increase.

In terms of oil export, India and China are sensitive to secondary sanctions. India stopped importing oil from Venezuela and Iran due to U.S. sanctions, while China still buys oil from Russia but in smaller volumes and through gray schemes such as transshipment through Malaysia.

The same trend is observed with Russian oil and oil products sent to the United Arab Emirates, Malaysia, or Singapore, where they are mixed or transferred before being shipped to the Chinese market.

Given the current geopolitical situation, it is unlikely that China will stop purchasing oil (and to a lesser extent, oil products) from Russia. However, if secondary U.S. sanctions are imposed, which is not currently a foregone conclusion, some purchases may be halted, primarily by the largest private companies, and may be pushed into the gray zone.

In the case of India, there is a much greater risk with the implementation of secondary sanctions. Nevertheless, it is difficult to imagine a scenario in which the United States would go for it, as it would severely impact the global balance of oil supply and demand, which is unprepared for such a scenario.