Russia’s reckless and bloody invasion of Ukraine in February set in motion a cascade of events for which it was ill-prepared. Europe began the process of divorcing itself from Russian fossil fuels, the U.S. coordinated sweeping export controls on key inputs such as semiconductors with Asian partners, and the Russian military considerably underperformed expectations, forcing Moscow into a longer war of attrition than it had planned for.
All Russia can do is worsen the damage from inflation to the West and bully its Eurasian partners to maintain an image of strength. Gazprom is cutting deliveries to EU importers and Turkey, and in late June the export of Kazakh crude via the port at Novorossiysk was suspended. The suspension was said to be temporary, to allow for demining, but came just days after Kazakh President Kassym-Jomart Tokayev asserted that the Kazakh government would not recognize the Luhansk and Donetsk People’s Republics as legitimate states while sitting next to Russia’s Vladimir Putin on a stage at the St. Petersburg International Economic Forum.
The Russian regime appears to have assumed that China and, to a lesser extent, India and other non-Western partners, would effectively bail them out by buying up whatever energy exports the West did not and providing the equipment lost because of sanctions, export controls, and self-sanctioning. Although China and India have done much to cushion the blow in terms of export volumes thus far, they have their Russian counterparts over a barrel as commodities flows are rewired and energy markets adjust. The outlook for Russia’s oil, gas, and coal industries is dimming, if not yet completely bleak. But there is little reason to see a full “pivot to Asia” sustainably addressing the problems Russia faces.
A half year prior to the invasion of Ukraine, Gazprom began a game of chicken with the EU, refusing to sell natural gas on spot markets. As contracts expired and European importers insisted they would not sign long-term deals indexed to oil prices or LNG prices, Russian natural gas exports fell and set off a global scramble for gas supplies, which continues to roil markets. Russia’s capacity to lift exports to Asia, however, is heavily constrained by existing export infrastructure and sanctions. Instead, Gazprom thus far seems to be focusing on driving prices higher.
Gazprom has not notably increased natural gas deliveries to China via the Power of Siberia pipeline, a pipeline with an annual capacity of 38 bcm, despite the loss of market share in Europe. The Chayanda field, which currently supplies the pipeline, is not connected by any infrastructure to gas fields in West Siberia. Current increases remain in line with a supply contract set to reach maximum capacity utilization by 2025. Preparatory talks and works are still taking place for Power of Siberia 2, a pipeline that would run through Mongolia to China with a capacity as high as 50 bcm. A third Power of Siberia project is now being discussed. Both are years away from being realized.
Net Russian natural gas exports were down 27.6 percent for January-May. Pipelines take a long time to build, particularly given that state procurements – roughly one-third of Russia’s GDP – face considerable pressures from inflation at the same time the Ministry of Finance is expanding the use of instruments designed to hide information about firms from foreign financial bodies. Russia also can’t increase exports using LNG. Although works for Novatek’s Arctic-2 LNG project continue, sanctions are beginning to increase costs and delay project times for the company in general. Gazprom is now seeing European partners for the Baltic LNG project bail, throwing it in doubt. These challenges similarly raise concerns about output expansions once the first train is launched.
In short, China and the larger Asia-Pacific offer little relief when it comes to new export markets. Russia is gambling on a short-term strategy focused on high prices with a raft of unintended consequences.
There wasn’t an explicit sanction limiting oil exports to Europe until the EU adopted its sixth package of sanctions and effectively set a target of a 90 percent reduction in oil imports from Russia by year’s end. The decision to ban the insurance and reinsurance of seaborne cargoes of Russian crude further raised costs for Russian firms in need of transport and Asian buyers unsure where to turn for their insurance needs. At the same time, these developments also increased the discounts Asian buyers are provided in exchange for taking on the risk of buying Russian crude oil. Exports of Urals blend and ESPO blend are regularly trading at discounts of $30-35 a barrel against Brent crude, the international benchmark price.
Since the invasion, Russian crude supplies to China have surged to record levels at about 2 million barrels per day, equivalent to 55 percent year-on-year growth for May. Crucially, Russia has bested Saudi Arabia as China’s top supplier. All this has taken place despite a net crude production decline in the range of 1 million barrels per day, with expectations that output will continue to decline, if not immediately.
India has been the main surprise, massively increasing its purchases of Russian crude up to about 800,000 barrels per day in May. For the month, Russia supplied 18 percent of India’s imports vs. the 1 percent it regularly supplied pre-invasion. Russia has overtaken Saudi Arabia as India’s second-largest crude oil supplier because of its lack of export options.
All told, the loss of European markets is by no means fatal for Russian crude exports in the short term. Nevertheless, the structural shift east comes with rising costs and limited options. Nearly all – 97 percent – of seaborne crude tankers from Russia headed to India in April-May were insured by firms in the U.K., Norway, and Sweden, all parties to the insurance/reinsurance ban that has now taken effect. The loss of these providers will buoy the discounts Russian firms will have to offer buyers.
Worse, declining European imports will eventually mean reduced purchases of Russian diesel. There’s little scope to export diesel to Asian markets. Nearly one-third of China’s refining capacity is currently being idled and refiners across Asia have chased huge margins for diesel. Declining Russian product exports will then force Russian refineries to close and further dent Russian crude production. Asian consumers aren’t saving the day.
Russia’s coal miners are doing all they can to move more product to Asia in response to EU bans on coal imports. January-May saw rail exports from Kuzbass – Russia’s primary coal-producing basin – decline 8.7 percent thanks to lack of eastern export capacity on the rail network.
China’s coal imports surged 51 percent in May to 3.3 million tons, but were lower than they were in May 2021. In late April, China’s State Council pledged to increase domestic thermal coal production by 300 million tons this year to reduce import dependence in the wake of Beijing’s ongoing ban on Australian coal imports and sanctions risks for Russian supplies. Russian miners are offering significant discounts to entice Chinese buyers and focusing on coking coal exports used for steel manufacture while facing a structural decline in exports to China. Thermal coal is by far the primary driver for Russian exports to the Chinese market.
India has increased purchases of six-fold year-on-year and exploited the political pressure on Russian firms to win 25-30 percent discounts on supplies of Russian coal, particularly coking coal, from traders in Singapore. Data is squirrely and sensitive given the political anxiety around Washington’s response, but India is currently importing volumes of coal similar to China, assuming roughly 1 million tons in total were imported for March and inferred from month-on-month growth.
Given greater demand in Asia, Russian firms are begging the government to subsidize and speed up the expansion of rail capacity for export in East Siberia and the Far East as well as the construction of barges to be used on the Amur River. Businessman Albert Avdolyan, owner of the new Elginskoye coalfield in Yakutia, is so fed up with the sluggish pace of construction conducted by Russian Railways and state contractors that he’s pushing ahead with building his own railway to the Sea of Okhotsk despite labor shortages, high construction costs, and the general creeping crisis across the Russian economy.
Future exports are running into logistical limits and a narrowing window to win market share while facing steep declines in westbound deliveries and pressure to discount supplies to win buyers.
Less Pivot, More Stumble
Overall, Russia is reorienting its energy exports to China, India, and Asia-Pacific markets at a rapidly accelerating pace due to sanctions, import bans, and self-sanctioning from businesses. But it’s quickly running into the logistical limits of what existing infrastructure can sustain and is doing so in a haphazard, uncoordinated manner.
For example, declines in natural gas volumes exported to Europe going back to last year helped drive up coal prices. That, in turn, led Chinese authorities to commit to this year’s coal push, which will significantly lower the ceiling for potential coal exports form Russia to China in years to come. Crude exports face a tough environment later this year as European purchases of Russian diesel decline, something that will inevitably affect companies’ ability to maintain output for Asian consumers as domestic refinery throughput falls.
Russia cushioned the initial blow of sanctions with huge influxes of energy revenues supported by demand in Asia. These new trade flows ultimately depend on selling at prices below the market rate realized elsewhere. That works when prices are high. They won’t stay high forever, as recession risks in the U.S. and Europe grow and China’s growth for the year weakens. Unfortunately, Asia is the only plan B Moscow has – and buyers know it.