Full Russian Crude Embargo Approaching
Oct. 28, 2022
As the EU embargo on imports of Russian crude approaches on December 5th of this year, we wanted to revisit the topic. EU nations are mandated to stop buying waterborne Russian crude oil as of December 5th and refined oil products beginning February 5th of next year. Russia has historically exported approximately 4.5 – 5.0 million b/d of crude oil and about 3.0 million b/d of refined oil products, accounting for approximately 40% of their total export revenue.
As a result of the December 5th sanctions, we project a major contraction of VLCC cargoes in the West to East flow due to increased appetite for Russian crude oil from China and India. The thinking is that Russian crude will pivot to the markets of India and China, which logically “backs-out” other crude imports; otherwise, imports would greatly exceed these countries’ requirements. As a result, we have projected the net contraction on traditional VLCC demand to China and India to reach 0.71 million b/d and 0.56 million b/d, respectively (Figure 1). Our trade flow model points to a reduction of 240k b/d of VLCC volume from each Northern Europe and West Africa to China, 160k b/d from the USG to China, among other disruptions while India is projected to reduce Middle East imports by 340k b/d. All-in-all, the net change to VLCC demand equivalents from these trade flow re-shuffles is negative 21 VLCCs. With this in mind, we are skeptical about VLCC fundamentals as we pivot into next year, particularly if/when the US ceases releases from the SPR, which upon switching from almost all medium-sour to all light-sweet crude oil, has been one of the primary drivers for the VLCC earnings surge since July.
Suezmax and Aframax demand projections reveal more constructive fundamentals following Dec 5. Firstly, Russian crude oil shipments will continue to favor the mid-sized tankers, effectively replacing short-haul movements to Europe with longer-haul routings to Asia. However, due to the EU sanctions, these will require Russian tankers or “ghost” ships. Our analysis concludes that the demand equivalents to place our projected Russian flow to these countries is 23 Suezmaxes and 63 Aframaxes, or 10 Suezmaxes and 13 Aframaxes short of the current Russian fleet. As such, we anticipate additional S&P activity for older tankers of these sizes to Russian (or other) interest to conduct this trade, which lightens the supply side for conventional demand. However, we should note that current tonnage engaged in Russian trade will rotate back into conventional, moderating some of the positive impact.
At the same time, the substitutive impact for Russian flows to Europe also points to high utility of Aframaxes and Suezmaxes, although the net calculation requires reducing previous demand from Russian to Europe and adding back the substitution impact. On this basis, we project that Europe will in total need to replace 2.1 million b/d of Russian crude following full sanctions implementation, of which we project 810k b/d will come from Suezmaxes (Middle East, West Africa, Americas), 850k b/d from Aframaxes (primarily intra Europe and USG loaded cargoes), while VLCCs will cannibalize up to 500k b/d as they rotate out of longer haul West to East movements (Figure 1).
In conclusion, we remain cautious about the direction of the VLCC market following the end of this year, although the current firm environment is projected to remain in place through then as the US SPR continues to unwind and Russian volumes absorb more tonnage in advance of the December 5 sanctions.
Figure 1 – Projected Demand Change after Russian Crude Sanctions (Figures vs. 2021 Full Year)
Source: McQuilling Services
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