Is Russian refining on its knees?

Myths and reality about the effects of drone attacks on Russian refining

Few people forwarded me an article in Foreign Affairs and asked what I thought. The article was on Ukrainian attacks on Russian refineries. I had mixed feelings. In my opinion, the authors based their argument on hypotheses and facts that might look plausible, but, in opinion, are not. I would not bother, but I see these arguments based on the same “fact base” over and over, and I am afraid that they might start to be taken for granted and recognized as a basic truth.

With that in mind I’d like to offer an alternative picture – how I see it.

Here is the article Why Ukraine Should Keep Striking Russian Oil Refineries | Foreign Affairs

Let me go over some facts presented there.

The quotes from the article are in italic.

By the end of March, Ukraine had destroyed around 14 percent of Russia’s oil-refining capacity and forced the Russian government to introduce a six-month ban on gasoline exports. One of the world’s largest oil producers is now importing petrol.

Destroyed is a strong word. Damaged would be a more appropriate one. Some of the damaged units were back in operation in less than a week, some in 2-3 weeks.

A gasoline export ban was introduced before the main wave of the attacks. The government was over-cautious to not to allow a repetition of the last year's summer fuel crisis (which had nothing to do with production capacity but was caused by a botched attempt of price controls).

Petrol imports happened in the past and are miniscule now. Russia is a vast country and it is easier to supply some territories with imports, rather than domestic deliveries. (I will cover this more later). And just an example - US is a major LNG exporter, nevertheless, LNG terminals in the Northeastern United States regularly accept LNG deliveries from outside the US (and in fact only from outside the US, as there is not a single US-built modern LNG carrier and Jones act demands transports of any goods between US ports on US built, owned, flagged and crewed vessels which makes LNG deliveries from the Gulf coast to Everett, MA next to impossible).

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Washington’s criticism is misplaced: attacks on oil refineries will not have the effect on global energy markets that U.S. officials fear. These strikes reduce Russia’s ability to turn its oil into usable products; they do not affect the volume of oil it can extract or export. In fact, with less domestic refining capacity, Russia will be forced to export more of its crude oil, not less, pushing global prices down rather than up. Indeed, Russian firms have already started selling more unrefined oil overseas. As long as they remain restricted to Russian refineries, the attacks are unlikely to raise the price of oil for Western consumers.

Russia is a major exporter of diesel. True, if Russia has to export crude oil rather than refined products, oil price would go down and not up. However, diesel supply would diminish and diesel prices might go up, hurting global consumers, and fuels prices is what really matters. Global refining capacity has not been keeping up with demand, so knocking out a substantial portion of it might push global fuel prices up.

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Yet they can still inflict pain inside Russia, where the price of refined oil products, such as gasoline and diesel, has begun to surge.

Did the prices really begin to surge? Here is the chart and detailed tables at this page Об объеме производства нефтепродуктов с 29 апреля по 5 мая 2024 года и потребительских ценах на них (rosstat.gov.ru) (All in Russian, but Google translate works) – does not look like surging to me. They did surge – last summer, but not now.

Legend translation:
Green line inflation, two orange lines are main grades of gasoline, dark blue is high-octane gasoline and light blue is diesel.

One may argue, whether Rosstat is a reliable source, or if it is a sort of propaganda statistic, but this is what we have and I have not seen any publications based on any different domestic price sources.

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The strikes are achieving the very objectives that Ukraine’s Western partners set but largely failed to meet through sanctions and a price cap on Russian oil: to degrade Russia’s financial and logistical ability to wage war

It does not seem that there is a shortage of gasoline or diesel in Russia, (see the production volume charts), so I am not sure the attacks at their current scale and scope managed to degrade Russian logistical capacity. And talking of financial ability – the Russian government is to a large extent indifferent, whether Russian oil companies sell their production as crude or products. It taxes crude oil at the wellhead rather heavily, using a formula, linked to the global prices, and then taxes corporate profits. Sure, corporate profits go up when oil companies export products instead of crude, but the effect for the state budget is rather small. Moreover, in Russia refining is subsidized, at the current oil prices Russian oil companies get up $10/bbl per barrel that they run through their refinery. A smaller refining run means a smaller subsidy payment. The companies, on the other hand, are earning up to $15/bbl above the export value of crude oil, when they export a basket of refined products. Assuming that Russia has lost 700 kbbl/d for the past 2 months this means a loss of $315 mln per month – a sizeable amount, but small compared to the total oil and gas revenues Russia is earning.

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The Ukrainian strikes have dealt a significant blow to Russia’s refining capacity, knocking out up to 900,000 barrels per day. 

This might be a capacity loss at the peak. By mid-April most observers were placing it at 600kbd, it’s probably smaller by now.
See the charts:

Repairs will be slow and expensive, in part because refinery stacks—where oil is distilled into its constituent parts—are huge and complex pieces of equipment that take years to design and build, and in part because Western sanctions are hampering Russian firms’ access to specialized components.

As the experience shows, the repairs are relatively quick. “Refinery stacks” (or atmospheric or primary distillation units) are indeed huge pieces of equipment, but they are quite simple and can be (and apparently were) patched within weeks with Russian equipment and materials. PDUs are not dependent on Western equipment. Secondary units (Crackers, cockers etc.) are, but PDUs are not.

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 Russia can sell its oil only to select countries, including China, India, and Turkey, whose facilities are equipped to use the specific oil grades produced in Russia. These countries thus have leverage over Russia to buy at lower-than-market prices. 

Russia sells to a handful of countries not because there is something special about its crude. Urals is a rather standard blend, not that different from sour medium weight Persian Gulf grades. In the last decade it was a popular grade because of high diesel yield and started to sell above Brent (it used to sell for a discount of a few dollars per barrel reflecting sulfur presence in the crude, but as more and more refineries in the world were installing desulfurization equipment, it stopped being a discount factor)  ESPO, exported from the Russian Far East is a premium blend, looked after as a good component for blending into incoming flow of oil by refineries to improve yield and throughput. Both grades can be easily processed at dozens refineries.

The reason why Russia sells predominantly to these countries is that they are willing to help Russia to circumvent the price cap. It does give them certain market power over Russia, hence there is a discount for the Russian crude – but this discount has been shrinking in recent months. There is not that much stray oil in the market, so just as Russia does not have many alternatives where to sell, these countries do not have that many alternatives for where to buy, since European refineries are taking the oil from traditional suppliers to India and China since December 2022 instead of the Russian oil they used to buy.

When Russia starts to sell more crude but less products, demand for products from other than Russian refineries goes up, and crude demand goes up as well in sync with the additional Russian crude in the market.

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Since the Ukrainian strikes began, diesel production has fallen by 16 percent and gasoline production by nine percent. 

True for one moment in time – but production levels did recover. And these fluctuations within a year a quite common.

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The average weekly wholesale price of gasoline and diesel in western Russia rose by 23 percent and 47 percent, respectively, between the end of 2023 and mid-March. In April, the cost of gasoline hit a six-month high, up more than 20 percent from the start of the year. 

Fuel prices on Russian exchanges did go up. But was it because of the attacks or because of the price rise in global markets? Take a look at the chart - two dotted lines are exchange-traded prices for gasoline and diesel in NY Harbor as quoted by US DOE Energy Information Agency, solid lines are composite indices for these products from the main Russian commodity exchange, converted to USD per gallon from Roubles per ton.

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Russia imported 3,000 tons of fuel from Belarus in the first half of March—up from zero in January—and the Kremlin has been forced to ask Kazakhstan to ready 100,000 tons of gasoline for supply in case of shortages.

Russia produces circa 800 000 tons of gasoline per week. 3 000 tons for two weeks is less than 0.2% Seems like a rounding error. Russia did ask Kazakhstan to reserve some emergency volumes of gasoline, but it had nothing to do with the attacks on refineries. There was a strong flood in the region, adjacent to the Kazakh border, and a risk that a refinery in that region would have to be stopped amidst elevated fuel demand for evacuations. It was not required at the end of the day.

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But in the last week of April, retail diesel prices jumped by ten percent. 

This is an excellent story. The original source of this claim seems to be Politico Europe https://www.politico.eu/article/vladimir-putin-russia-diesel-prices-skyrocket-ukraine-war-drone-strikes-oil-refineries/ It links to this article at TASS, the Russian state news agency. https://tass.ru/ekonomika/20641185.

What does the article say? “Бензин и дизель в России за неделю подорожали на 5 копеек. Они составили 54,98 рубля за литр, говорится в материалах Росстата” – “Gasoline and diesel in Russia have risen in price by 5 kopecks over the week. They amounted to 54.98 rubles per liter, according to Rosstat (Russian state statistical agency) materials”. Politico journalist has clearly confused kopeks ( a 1/100 of a rouble, an equivalent of a cent ) with roubles. The actual price increase was not 10% but 0.1%. Well, looks like, fact-checking is an improvement area for Politico.eu as well as FA

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According to some reports, the Russian government may also consider lifting restrictions on low-quality gasoline usage to prevent a fuel shortage, a move that risks damaging engines, , placing further strain on an already weak military vehicle maintenance capacity and rendering void the warranties of foreign-made vehicles.

Lower quality gasoline (Euro 3) does not damage engines. It’s a more polluting fuel, that’s why it was banned, but it does not harm engines. Russian military equipment drives mostly on diesel, which is plentiful, and the engines in these machines are designed for lower grades of fuel, long before Euro-X standards went in force. In fact, fuel with higher sulfur content is beneficial for engines – sulfur acts as a lubricant. Void of the warranties of the foreign-made vehicles is probably the least of concerns for Russian motorists, as these warranties are not really enforcible since foreign manufacturers left Russia.

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In practice, inconsistent enforcement and monitoring have undermined the price cap’s effectiveness: Russia’s federal revenues hit a record $320 billion in 2023. The price cap may also have been set too high. A recent assessment by the Center for Research on Energy and Clean Air, a Finnish think tank, determined that a lower rate could have slashed Russia’s oil export revenues by 25 percent between December 2022 and March 2024 without pushing Russian companies to shut off the taps. 

Is the price cap working really? It seemed so for the few months in 2023 when the combination of the lowish oil price, high freight rates and high discounts for the Russian crude has sent its effective price below the capped price. In the last months, as the size of the shadow fleet was growing, oil prices were rising and cap-busters honed their skills, which led to lowering freight rates, was trading at higher than $70/bbl since February. Urals Oil - Price - Chart - Historical Data - News (tradingeconomics.com) (the prices were going down lately together with the rest of the oil market). Indeed, if the price cap would be set lower AND if it was enforcible, Russian export revenues would be lower, but this is a big if. If $60/bbl is unenforcible, what would make the lower price cap work?

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The current strategy comes with limited risks….

Ukrainian strikes on Russian oil refineries also seem unlikely to widen the conflict. At the very least, Russia will struggle to escalate in kind, given its long-running and far broader campaign to destroy Ukraine’s energy infrastructure: its forces destroyed Ukraine’s Kremenchuk oil refinery within weeks of the 2022 invasion, and the Ukrainian energy minister has said that Russian strikes earlier this year hit up to 80 percent of Ukraine’s conventional thermal power plants. Rather than threatening escalation in response to Ukraine’s strikes, the Kremlin has tended to play down their effects to avoid embarrassment.

And this is the question to ask. Is this strategy coming with a limited risk?

The article downlplays the effects of the latest wave of Kremlin attacks on Ukrainian electric power system, and I think, that we should not.

The Kremlin attacked elements of Ukrainian power infrastructure last winter with limited success, but then the attacks stopped. Back then the attacks targeted easy to hit transformers with relatively simple UAVs.

This time the Kremlin is not threatening, but it has methodically attacked Ukrainian power generation capacity, aiming for turbines, generators and control equipment with massive combined attacks, that were rather effective, targeting both thermal and hydro – there was a devastating hit at generation units of DniproGES, the largest Ukrainian hydro station. It is possible, that Putin would make a step up the escalation ladder regardless of the attacks on refineries. Nevertheless, these attacks at the power infrastructure happened after attacks on refineries. These attacks are quite damaging and it will be expensive to fix the power stations. In some cases, the owner DTEK, says that they do not know exactly how they are going to do it.

Russia has also started to hit Ukrainian gas infrastructure, beginning from the injection site of the largest underground gas storage in Ukraine that it was offering to European gas traders. This is a first, until recently Russia was abstaining from attacks on gas infrastructure, probably as a quid pro quo for unhindered gas transit to Europe.

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Attacks on the Russian refining sector do create losses for Russia, but so far it has been mostly “bothering fire”. They do have good morale effects for Ukrainians and damage the morale of the Russians, they impose certain monetary costs on Russian oil companues, but so far, it has not been material, it has not created any shortages of fuels, it did not have serious effects on fuel prices in Russia. These attacks might also provoke Russian escalatory hits on Ukrainian power infrastructure.

There might be reasons to keep the attacks on refineries going or redeploy the weaponry toward other targets - I am not arguing or advocating one way or the other. But these decisions should be made on facts and sober analysis, which seems to be missing at the moment.