The Peter Zeihan Podcast Series - Russian Oil Thrives Despite European Sanctions (Here's How...) || Peter Zeihan

Episode Date: October 5, 2023

While sanctions on Russian natural gas have proven highly effective, those imposed upon Russian oil have somewhat backfired. Although oil exports have dropped by 10%, several factors have skyrocketed Russia's earning potential.Full Newsletter: https://mailchi.mp/zeihan/russian-oil-thrives-despite-european-sanctions

Hey, everybody, Peter Zeyn here, coming to you from Colorado. Now, yesterday, we talked about how some of the European sanctions on the Russian energy industry were working much better than expected. So now let's kind of flip that and talk about some that are not doing nearly as well. That has to do with oil. Whereas with natural gas, Russian exports to Europe are down by 85% and Russian production is now the lowest in 40 years. Oil has dropped off a little bit, about 10%. But the Russian ability to profit from it has skyrocketed.

They're earning significantly more now than they did before the war, and it's worth explaining why, and the sanctions are part of the reason why the Russians are doing so well in that field. So there's three things to keep in mind when you're talking about oil markets. Number one is the physicality of things. Natural gas is a gas. It's hard to move from place to place, and you pretty much have to have a dedicated piece of physical infrastructure,

typically a pipeline, to get it from A to B. You can chill it down at a liquid-fied form, roughly negative 300 degrees, and move it via specialized tankers that unload and specialized facilities, but those things are so specialized, they're not really, they don't allow for a really liquid market. Oil's different. Oil is a liquid, and it is a liquid at room temperature. So you can put it into pretty much any type of container or shipping device that you want.

And while the Europeans did, for the most part, stop taking oil from the Russians in piped form, the Russians are able to export over half of their oil by water, be it to be a tanker, and they were even able to redirect some of the piped crude to their ports, which brings us to the chemistry problem. Not all crude is the same. In the world of natural gas, methane is methane is methane. In the world of oil, there's different varieties, light and sweet versus heavy and sour. Light and sweet has very few contaminants, and it is very, very,

been almost clear, whereas the heavy sour is thick and gooey, might even be solid at room temperature, and is black and viscous. And different refineries around the world are designed to run on different grades of crude, sometimes even specific crude types from specific fields. And that makes it a little bit more of a mismatch problem that natural gas just doesn't have to deal with. So, for example, in the markets right now, there is an oversupply of light sweet on a global scale, primarily because of the... United States. U.S. shale crude is different from most crude in that it's trapped at the moment of geological formation, and so it never migrates through the rock strata, and it's the

migration that picks up the contaminants that makes crude heavier and more sour. Well, American refineries are designed to run on heavier and sour so that light sweet is kind of stranded in North America, so it has to be exported by a tanker to the wider world, and so light sweet crude is trading at a significant discount to a lot of global crude grades, despite the fact that it's considered high quality. On the flip side, we're running out of heavy sour. Venezuela used to be a massive producer, and it's found ever more creative ways to commit national suicide. The Mexicans used to be a reasonably large supplier, and they're keeping their crude at home because their economic development has demanded more energy. And the world's single largest crude grade of

all is none other than Russia's Ural's blend, which is a medium-sour, medium-heavy blend. And so taking even small amounts of that off the market has had an outsized impact on pricing. And so even though there's supposedly a price cap that the Europeans said at $60 a barrel, that anything above that the Russians shouldn't be able to sell it, right now Russian euros is going for 85. And there's not much the market can do about it, which brings us to the third point, which is the legalities and the niceties. When the European stopped taking the piped oil and started to slim down their taking of the tanker shipped oil from Russia, they used their ability to influence global financing and global insurance,

specifically saying that anyone who delivered or participated in a supply chain that took Russian crude, and if it was sold above $60, they wouldn't be able to qualify for any European-based insurance or financing, trade finance included. And since that is the source of the vast, vast, vast majority of the world's maritime shipping insurance, the thinking was that that is going to discourage anyone from doing it. Well, they also didn't want to destroy their own economies when they were doing this. So they phased all this in over the course of the year. And it turns out that that was enough time for everybody who was interested to set up alternative systems.

So India, China, and Russia now all offer state-sponsored insurance programs for maritime shipping. And the Chinese and the Russians in particular have gone out and purchased huge numbers of really, really old, decrepit tankers and are running them kind of under the radar turning off the transponder. so they can't be tracked easily. And those two things together has allowed a huge amount of Russian crude to sail the world's oceans without any even tangential connection

to the European financiers that was thought would be able to keep all of this stuff off the market altogether. The very act of providing the market with time to adjust gave the market time to adjust for all players. And so this stuff is still coming out.

Now, if the Europeans, and to a wider degree of the Western General, is going to take an axe to Russian crude, they're going to have to get a lot more creative, or they're going to have to act a lot more directly. Keep in mind that roughly one million and a half barrels of crude every day, Russian crude, are flowing out of the port of Pramorsk on the Baltic Sea and another million and a half on the port of Noversisk on the Black Sea. And as long as the Europeans are not willing to take direct action against that, and they definitely have the military capacity do so, should they so choose. This seems like it's going to keep flowing.

About the only potential fly in the ointment there is on the Black Sea and that the Ukrainians have now said that they are willing to attack targets in Russian ports. Now, since they made that threat about, I think it's five weeks ago now, they haven't acted on that threat, even though they're opposed to deadline now has expired three weeks in the past. But it's probably going to take some sort of military action by someone to remove this from the market or one other possibility is we have some sort of mishap where those insurance claims get called upon and the Indians and the Chinese and the Russians who have never offered these insurance plans before now will probably find themselves an arbitration almost immediately when

they try not to pay. But that's a series of if-then statements that are impossible to predict at the current moment. Honestly, I'm a little surprised. It hasn't happened by now, considered everything that's gone down in the Ukraine work. But that is where we are. So Europeans, natural gas working better than expected. Still, not working nearly as well as expected.