How will new Russian oil sanctions affect Azerbaijan?
Anaysis by Caliber.Az

ANALYTICS  07 February 2023 - 14:23

The day before, a slight increase in crude oil prices was recorded, associated with the entry into force of sanctions against the export of Russian petroleum products. The price cap on Russian petroleum products came into force on February 5, and a day earlier, the Council of the European Union, as part of sanctions measures, agreed on a price cap for fuel, motor oils, and other petroleum products produced in the Russian Federation and supplied to third countries. According to Bloomberg experts, the price cap for Russian petroleum products and restrictions on their export will only strengthen global demand, contributing to the preservation of high prices in European and other markets. Producers of fuel and petrochemical products in Azerbaijan may become beneficiaries of these processes in the future.

The war in Ukraine, which has been going on for about a year, and the related EU sanctions restrictions do not contribute to the normalization of Europe's fuel market, which is facing a shortage. At the global level, the oil market is affected by the conservative policy of limiting oil production carried out by the pool of countries participating in the OPEC+ agreement. According to Bloomberg, the continuation of the conservative course on oil production in 2023 was again confirmed by the Minister of Energy of Saudi Arabia, Prince Abdulaziz bin Salman, who spoke at the International Association for Energy Economics conference held last weekend: "Sanctions against hydrocarbon-producing countries will only lead to a deficit during a period of growing demand for oil." At the same time, the Saudi minister stressed that the Kingdom will make decisions with extreme caution regarding the increase in oil production, despite analysts' forecasts of a possible increase in the price of Brent above $100 per barrel.

In turn, oil prices are supported by expectations of additional demand from China, which may demonstrate a stronger recovery than expected, which will increase demand for crude oil and petroleum products. However, in the Old World region, sanctions restrictions remain the leading factor affecting price parameters: this negative only intensified after the EU restrictions on crude oil exports from Russia that came into force on December 5, which set the price cap for Russian oil at $60 per barrel. The EU's decision is supported in the UK, USA, Canada, Japan, and Australia.

In particular, at the end of last year, an embargo was already imposed on oil deliveries from Russia to Europe by sea, maintaining limited exports only through the Druzhba pipeline. As a result, about half of Russia's total oil supplies to the EU - 4.5m bpd - stopped arriving on December 5. According to forecasts by the International Energy Agency (IEA), the embargo will reduce Russian oil production by 1.4 million barrels this year, which will increase pressure on oil prices, including diesel prices. In the emerging circumstances, Russian producers have only been able to partially redirect oil exports to markets in India, China, and some Southeast Asian countries, while losing much of their income from having to sell energy resources at a large discount.

On February 5, 2023, a price cap was introduced for exports of oil products from Russia: the day before, the Council of the European Union had agreed on a price ceiling for Russian oil products supplied to third countries, provided that prices must be at least 5% below market prices. The price cap is divided into two categories: for oil products sold below the price of crude, with a price ceiling of $45 for low value-added products such as fuel oil and naphtha, and for oil products sold above the price of crude - gasoline, diesel fuel, jet fuel, motor oil - of $100. These price caps mean that Western transport companies are forbidden to transport Russian oil and petroleum products to third countries and to provide other services if they are supplied at a price above a limit determined by the West. Moreover, Western financial institutions are also forbidden to insure the transportation of petroleum products if they are carried by independent operators. In the European region, sales of Russian petroleum products are completely stopped, with a few exceptions. In particular, Bulgaria until the end of 2024 will be able to buy oil products from Russia, and Croatia until the end of 2023 will be allowed to purchase Russian vacuum gasoil, which is essential for the work of refineries.

Not surprisingly, the sanctions against Russian oil products had an immediate effect on global oil prices: in the morning of February 6, the price of April futures for Brent increased by 0.31% to $80.19 per barrel, and March futures for WTI grew by 0.2% to $73.54. Experts do not rule out further growth in demand amid the still recent tangible decline in crude prices. In the short term, pressure on supply will also be exerted by the devastating 7.7 magnitude earthquake that occurred on February 6 in various regions of Türkiye. As a result of the disaster, tanker loading operations at the Ceyhan oil terminal have been temporarily suspended by Botaş International Anonim Şirketi (BIAS), the operator of the Baku-Tbilisi-Ceyhan (BTC) pipeline in Türkiye, and oil shipments via the Kirkuk-Ceyhan pipeline have also been frozen.

In the longer term, demand in Europe and a number of other related regions could further increase on the back of growing shortages of Russian petroleum products. The maintenance of high prices for oil and its derivatives is certainly beneficial for Azerbaijan, as it will allow it to maintain an acceptable level of revenues from energy exports. In particular, taking into account the noticeably increased expenditure items in the state budget for 2023, it is optimal for Azerbaijan to keep the average price of Azeri Light oil within the range of $80-90.

In turn, the global demand for oil products will give our country a chance to increase revenues from their exports, and in this regard, this year there is a chance to significantly improve statistics on their output. Last year, the output of oil products in monetary terms declined by 4.2% to about $2.433 billion: the main drawback affected the production of naphtha, diesel fuel, and lubricating oils, as well as fuel oil, bitumen, and coke. A slight increase was in car petrol production - by 1.4% to 1.282 million tons and aviation paraffin production - by 14.6% to 563.6 thousand tons. The reason for the decline in refining was not caused by a lack of export demand or a decline in domestic consumption but was purely technical due to scheduled maintenance work carried out from April 4 to May 27 at the Heydar Aliyev Oil Refinery (HAOR) in Baku. At the same time, the activities of a number of enterprises belonging to the State Oil Company (SOCAR) of production association Azərikimya, technologically related to the work of the HAOR, were suspended.

The forced decline in production was also reflected in export figures: last year's exports of petroleum products were just over $527 million, down 4.2% year-on-year. Nevertheless, last year was marked by a sharp increase in the production of gas products, mainly supplied to foreign markets. According to the Centre for the Analysis of Economic Reforms and Communications (CAERC), last year urea fertilizers were exported for $209.7 million, an increase of 77%, as well as methanol - $131.9 million, an increase of 46.4%.

The situation in the fuel and petrochemicals sector is significantly more stable this year, with the refinery largely completing the installation of new main process units designed to produce Euro-5 diesel fuel. The HAOR plans to complete all technical work for the production of higher-quality AI-92 gasoline and later high-octane AI-95 compliant with the Euro-5 standard in 2023. By 2024-2025, SOCAR plans to complete all reconstruction and modernization works at HAOR tentatively, as a result of which the annual refining capacity will increase to 7.5 million tons and the plant's operation term will increase up to 2040. After the modernization, the refinery will produce 2.2 million tons of motor gasoline annually instead of the current 1.2 million tons. The production of diesel fuel will increase to 2.9 million tons a year instead of the current 1.9 million tons and the production of paraffin will reach 1 million tons compared to about 0.7 million tons today.

Thus, as the supply of Russian oil products to European and some related markets decreases and the modernization of the domestic petrochemical complex are completed, Azerbaijan will have additional opportunities to expand exports of various fuels, petrochemicals, and fertilizers, and this business will be highly profitable, given the current oil and gas prices.

Caliber.Az