In the wake of the Kremlin aggression in Ukraine, Europe found itself painfully unprepared to define a common foreign and energy security policy to counter Russia. EU member states remain deeply dependent on Russian energy. Russian oil and gas imports (to the amount of EUR 900 million per day, out of which 75% consist of crude/oil products sales) have become the primary source of funding for the Russian war. Meanwhile, the EU is suffering a heavy economic blow from the spike in energy prices that further fuels inflation and by extension, political instability. Despite the short-term economic pain, the most effective way to change Kremlin’s policy direction would be for Europe to ban oil and gas imports from Russia.[1] In this context, refined oil products, although representing a smaller share in Russia’s total oil exports to Europe, play a strategic role in maintaining the stability of the Russian energy sector and its dominant position on European markets.
Why it matters?
While Russia exports roughly half of its crude oil production, the other half is processed domestically into a variety of products, including gasoline, diesel, and aviation jet fuel. Of the total oil products refined domestically, Russia again exports roughly 50%. Yet, there is a significant disproportion in the composition of oil product exports. Russia has very little surplus gasoline available for export, especially during the spring/summer season when domestic demand rises. About two thirds of Russia’s oil product exports are composed of gasoil/diesel[2] and residual oil products.[3]
This disparity in the oil products composition is important because its gasoil/diesel sales are heavily dependent on the European market. If Europe bans Russian diesel sales, it will be hard to find a viable alternative buyer. Europe is the main import market for diesel globally, attracting supply not only from Russia, but also from the US, the Middle East, India and even from as far as Singapore. Russia could not really replace Europe as the Latin American market is heavily dominated by the US, while the import demand of Africa could not absorb significant additional volumes. Residual oil exports are in a similar situation, with the US being the main alternative outlet for Russian exports, which is now shut for Russian companies.
At the same time, Russia has limited storage capacity that could absorb the surplus production. A squeeze of the Russian diesel and residual oil exports would soon force Russian refiners to shut a significant part of their operations. Lower crude oil processing would result in a reduction of the supply of all other oil products, including gasoline and jet fuel. Due to the relatively low technical complexity of the majority of Russia’s refinery fleet, it has very limited flexibility to shift its production towards more gasoline and jet fuel supply.
Carpe diem
A significant cut in overall oil processing activity in Russia would lead to gasoline shortages in the country. Because Russia is typically a gasoline exporter albeit a marginal one, a shift to being a net importer implies infrastructure constraints, especially considering Russia’s geographical vastness. Moreover, Europe is the main source of gasoline exports on the global market, with its typical outlets being the U. S. and the Middle East. Essentially, Russia would have to paradoxically rely on Europe for its gasoline imports.
Gasoil/diesel imports from Russia by European countries (‘000 b/d and share of the total imports)
Source: CSD calculations based on Eurostat data (using 2019 data due to the usual fluctuations in 2020 and 2021 data due to the COVID-19 pandemic).
High gasoline prices and potential gasoline shortages have always been a particular worry for the Kremlin. More than once, the Russian government has faced social protests and has had to make major concessions to its refiners so that they would guarantee cheap and plentiful supply to the domestic market. These include generous subsidies, without which the operations of refineries would not be economically feasible.
What’s next?
A significant reduction of Europe’s diesel imports from Russia would be a strategic blow to the Kremlin’s ability to sustain its military aggression in Europe.[4] The diesel market in Europe is already facing very high prices due to the threat of a potential supply disruption and low storage levels. In addition, structurally, a tidal shift in passenger car sales, driven by EU climate policies has already started to eat into the demand for diesel in Europe. The EU countries which are most vulnerable to the import of Russian diesel and need to be the main target of such strategies are Germany, France, the Netherlands, Poland, and Greece, together accounting for 66% of European imports (see above figure). The UK is also a key importer of Russian diesel with 22% of the total.
Hence, there is an urgent need to adopt the following demand and supply-side measures to effectively change Russia’s strategic calculations:
Demand Response Measures
- Information campaign for EU citizens that they can help Ukraine by not using their diesel cars;
- Car-free days in major cities and restrictions on diesel cars in cities;
- Free public transport for a 6-month period.
Reducing Russian Supply
- Step 1: 20% import tax on Russian diesel to incentivise imports from alternative suppliers (within 2 weeks);
- Step 2: Establish an escrow account for any payments related to Russian diesel imports (within 1 month);
- Step 3: А full embargo on Russian diesel in Europe (within 2 months).
The demand-side measures should aim to reduce European diesel demand by at least 30% within the next 3 months. This would be the most sustainable measure to bring regional and even global prices lower and at the same time contribute to cut emissions. A demand-driven response must be prioritised over a simple diesel supply diversification, as such a move would lead only to the reshuffling of global diesel trade flows.
Meanwhile, the proposed supply-side measures should be implemented in three steps, ensuring that a gradual shift will avoid market panic and price spikes, giving enough time for the demand-side measures to take effect.
[1]EU Energy and Climate Security Strategy to Counter the Russian Aggression in Europe, Sofia: Center for the Study of Democracy, 2022.
[2] Gasoil/diesel refers to a fraction of middle distillates, which differ mainly in their sulphur content. The lower sulphur diesel fuel is used for road transportation, while gasoil has a higher sulphur content and slightly higher density and is used primarily as heating fuel.
[3] Residual refined products refer to fuel oil and vacuum gasoil (VGO). These products are mainly used as a bunker fuel or as a refinery feedstock to be transformed into higher-value products such as gasoline and diesel by more technically advanced refineries.
[4] A sharp drop in Europe’s diesel demand would also result in lower need for buying residual oil from Russia, as they are mainly used by European refiners to make more diesel.
