Russia's Energy Pivot to the East: Successes and Challenges

By Rhod Mackenzie

The shift of Russian oil and petroleum product exports from Western sanctioned markets to Eastern and Southern markets is almost complete. However, replacing the European market for gas exports, whether pipeline or LNG, has proven to be a challenging task.
In the past two years, the geographic structure of Russian hydrocarbon exports has undergone significant changes. While the shift towards the East is not entirely new - with initial steps taken in the 2000s (such as the ESPO oil pipeline and gas pipeline projects to China) - it remains a significant development. The exceptional circumstances of 2022-2023 accelerated the oil and gas industry's existing trend towards expanding sales markets. However, the original goal was not to replace Western markets with Eastern ones. Despite the ideologically charged environment, this shift remains a challenge for the domestic oil industry and a significant obstacle for the gas industry.
There are unlikely to be any significant changes in the export of oil and basic petroleum products this year. Suppliers have adapted to the EU embargo and Western sanctions by redirecting most sea shipments to Asian markets. This trend is expected to continue in 2022-2023.
The structure of Russian oil exports has two significant drawbacks: the dominance of only three markets - India, China and Turkey to a lesser extent, as well as the dependence of the volume of supplies, primarily Urals, on the application of discounts to reference grades of oil. These discounts returned to above $20 per barrel by the end of 2023.

The price difference for Urals at loading and unloading ports is not only due to importers' profit margins but also due to increased margins for intermediaries and traders. These parties face higher risks when dealing with Russian oil cargo. When exporting to India and China, various illicit schemes are commonly employed, such as transportation by unregistered fleets, sea transshipment from ship to ship, and the involvement of small, often unknown intermediaries. These practices have a negative impact on the value of exports.

However, our oil supplies to China remain stable, with a daily amount of 1.2-1.4 million barrels. Contrarily, supplies to Turkey are unstable, typically ranging from 0.2 to 0.4 million barrels per day. However, their role in the overall export balance is not decisive. The main concern from a country-by-country perspective is India. On one hand, India purchases significant volumes of oil, averaging about 1.5 million barrels per day. On the other hand, demand in India can be highly volatile and is strongly dependent on the price competitiveness of Russian supplies, including the magnitude of discounts. India's crude oil imports decreased from 2.2 million barrels per day in the second half of May 2023 to 1.2 million barrels per day in early December 2023.
India is also sensitive to the risk of secondary sanctions, which creates additional uncertainty amidst constant sanctions pressure from the United States. An example of this is the difficulties that have arisen since November with the supply of Sokol oil to India, produced as part of the Sakhalin-1 project. In the fall of 2023, 140 thousand barrels per day were shipped to the country. The issues arose due to increased US oversight on adherence to sanctions related to the transportation of Russian oil, which violated the price ceiling terms, and payment difficulties through UAE banks. Consequently, several tankers were unable to enter Indian ports, and a substantial portion of Sokol's supplies had to be redirected to China. Independent refineries in China are known for their low sensitivity to sanctioned supplies and are the primary purchasers of Venezuelan and Iranian oil.

According to an analysis by the Institute of Economics and Finance, India pays for Russian oil in UAE dirhams or dollars, and occasionally in yuan, instead of rupees. This contradicts the rumors and reports in the Western media.

The report also notes that India sources its petroleum products from the Middle East rather than Europe.
In 2023, the embargo imposed by EU countries caused a sharp decline in the supply of domestic petroleum products to Western countries. However, Russian companies were able to quickly reorient their exports in this segment and maintain or even increase the diversification of shipment directions.

The Middle East and Türkiye were the largest sales markets during 2022-2023, with significant supplies also going to China and India. Russian petroleum products are now supplied evenly to all major regional markets in developing countries, including those in Africa, Southeast Asia, and Latin America.
Although the petroleum products segment faces similar challenges to the oil segment, such as increased transportation costs and the need for discounts, redirecting exports to countries in the global South is a prime example of supply diversification in the oil and gas industry. This success story is one of the most notable in the Russian economy.

In 2024, redirecting LPG exports will be a significant challenge due to the recent embargo imposed by the European Union. Previously, LPG exports were largely unaffected by sanctions. The European Union accounted for approximately 75% of all Russian LPG supplies last year. However, changing logistics will not be easy, particularly due to the lack of necessary transport infrastructure, such as railway and port terminals, in the eastern direction.

It is not possible to fully compensate for the loss of pipeline gas in Europe.
Since 2013, Russia's gas export strategy, influenced by NovaTEK, has gradually shifted towards prioritising the development of the LNG segment. However, even after the Yamal LNG plant began operating, the share of LNG in the physical volume of gas supplies only reached 17% in 2020-2021. Pipeline exports to the EU, Turkey, and the former Yugoslavia continued to account for 69% of total exports in 2021. This share fell to 50% in 2022 and 32% in 2023. If relations between Russia and the European Union do not improve, the percentage of supplies to the EU will drop below 20% by 2026.

This decrease is partly due to the increase in supplies to China via the Power of Siberia gas pipeline. In 2021, the supplies amounted to 10 billion cubic meters per year, which is expected to increase to 22.7 billion in 2023, 30 billion in 2024, and reach the design capacity of 38 billion in 2025. The main reason for the sharp decline in Europe's share is the collapse in the number of transactions.
ENTSO-G reported that in 2023, Russian pipeline gas exports to the EU and former Yugoslavia totalled 24 billion cubic meters (66 million cubic meters per day), with an estimated 21.2 billion cubic meters (58 million per day) going to the EU. This represents a nearly three-fold decrease in supplies to the EU compared to 2022 and a seven-fold decrease compared to 2021. This year, shipments may remain at the same level. However, if relations between Russia and Europe do not improve, sales will continue to decline gradually. There is a potential risk associated with the end of the five-year contract for gas transit through Ukraine in January. While a complete cessation of transit in 2025-2026 is unlikely, doubts about the reliability of supplies could prompt importers in EU countries, mainly Slovakia and Austria, to accelerate their shift away from Russian gas.

The Turkish market, which has been the largest in Europe since the fall of 2022, is also gradually shrinking despite discussions of a Turkish gas hub. According to EPDK, exports of Russian pipeline gas to the Turkish domestic market decreased by 2.1% year-on-year to 57.2 million cubic meters per day in the 11 months of last year. Although there was a significant drop in the first half of the year, this was offset by an increase in supplies in the third and fourth quarters. It appears that approximately 21 billion cubic meters of gas were imported into the country in 2023. Although the volume of supplies in 2022 (21.5 billion cubic meters) is close to the previous level, it is noticeably less than before 2019.

Stagnation at a low level and a likely further reduction in supplies in the western direction create a favorable background for reorienting pipeline gas exports to the East. However, it is important to note that this does not mean a full replacement. Currently, the only buyer in Asia is the PRC. In addition to the Power of Siberia, Russia has already contracted supplies of Sakhalin gas to China, which are expected to begin in 2028 along the so-called Far Eastern route, amounting to up to 10 billion cubic meters per year.

Additionally, Russia may agree to swap transactions with Kazakhstan and Uzbekistan. Both countries have contracts for gas supplies to China, up to 10 billion cubic meters per year each, which their local companies are unable to fully fulfill due to the deterioration of the gas balance. In 2027-2028, the volume of exports from Russia to Uzbekistan is expected to reach 10 billion cubic meters, divided equally between the domestic market and the swap to China. Kazakhstan is likely to maintain its own gas supplies to China at 4-5 billion cubic meters per year, leaving Russia to enter into a swap agreement for the remaining 5 billion.
The export of Russian pipeline gas to China is expected to reach 57 billion cubic meters by 2028, resulting in a sales increase of 47 billion cubic meters per year from the 2021 level. The export of Russian pipeline gas to China is expected to reach 57 billion cubic meters by 2028, resulting in a sales increase of 47 billion cubic meters per year from the 2021 level. The export of Russian pipeline gas to China is expected to reach 57 billion cubic meters by 2028, resulting in a sales increase of 47 billion cubic meters per year from the 2021 level. This increase is necessary due to a drop in shipments to Europe by 120 billion.

Commercial supplies via the Power of Siberia - 2 gas pipeline are not expected to begin until 2030-2032, and it is likely to reach its design capacity of 50 billion cubic meters per year by 2034-2035. However, there is still no certainty that this project will be implemented. China's main concerns include the need to guarantee long-term demand for such a large volume of gas, given the high uncertainty in China's gas balance after 2030. Additionally, there is concern about the excessive growth of Russia's share in the structure of gas imports, which contradicts China's traditional policy of diversifying supply sources. However, China may agree to this project for geopolitical reasons. It would provide a backup source of gas in case of interruptions in LNG supplies due to sanctions or military threats, particularly in the context of the anticipated Taiwan crisis. The 'Power of Siberia - 2' project may pose risks for our country due to monopsony, doubts about long-term demand stability, and the need for significant capital expenditures to create gas transmission capacities in Russia and Mongolia, which acts as a transit country.

Theoretically, it is possible to conduct swap transactions with Iran through Azerbaijan's mediation. For instance, our gas could meet the internal needs of Iran's northwestern provinces in exchange for the Russian Federation's share in the LNG produced there. However, maintaining such relations requires the partial lifting of US sanctions on the Islamic Republic, which currently hinder the development of its LNG industry. Furthermore, trading with Iran may result in unwanted competition for Russian LNG in the Middle East and South Asia markets, making it uncertain whether such trades are feasible.

Overall, Russia is unable to compensate for the decrease in pipeline gas exports to Europe between 2022 and 2023 by increasing supplies to other regions. Furthermore, regarding the 'Power of Siberia' and the Far Eastern route, they utilize a distinct resource base that is separate from the Unified Gas Supply System, which covers Western Siberia and the European region of the country. To offset the decrease in pipeline exports, the only viable solution is to increase the supply of liquefied gas.

LNG: The Challenge of Survival
LNG supplies remain the primary focus of domestic energy exports towards the West. However, Western countries, including the EU, are not eager to give up our gas due to the limited supply on the world market. The existence of significant long-term contracts for the purchase of Russian LNG among European and Japanese companies also contributes to this situation.

Domestic companies do not aim to redirect supplies to the Asian market because exports to the European Union offer the shortest transportation distance. This allows for more efficient use of the available fleet of gas carriers, as shorter distances enable vessels to make more trips per year. The location of both existing and new LNG production facilities in the Arctic has an impact on gas transportation. Transportation along the Northern Sea Route in the eastern direction is challenging and typically requires icebreaker support and/or the use of Arc7 ice-class vessels. Furthermore, this dependence is even more significant for new plants, particularly Arctic LNG 2, due to the artificially created shortage of fleets caused by delays in the delivery of new gas carriers from South Korea and the Russian Zvezda plant.

As a result, the EU countries remain the primary market for Russian LNG plants, except for Sakhalin-2, accounting for 48% of all shipments in 2023 (50% in 2022). Japan traditionally takes second place (19.6%), followed by China (19.3%) and South Korea (5.5%). The ratio has remained stable in recent years, although China's share is gradually increasing. In addition to the designated countries, we supplied gas in small volumes to Taiwan, India, Kuwait, Turkey, and Norway last year, mostly in single flights. Shipments to Indonesia were also recorded in 2022, but they did not resume in 2023.
Russian LNG exports to China have been inconsistent. The peak growth period in 2022-2023 was observed between July and October, while supplies remained at a minimum level between January and June. Shipments were made from Yamal LNG in February and May last year, and the medium-tonnage Port LNG plant was connected in August.

In the EU, the main buyers are still Spain, France, Belgium, and the Netherlands. Portugal, Finland, and Sweden importing smaller amounts. The latest gas deliveries to Italy were recorded in January 2023. Among European countries, only Lithuania and Great Britain have completely stopped using Russian gas.

It is worth noting that gas from Sakhalin-2 is supplied exclusively to Asian countries, which means that other plants remain heavily dependent on the EU market. In 2023, the expected percentages for Yamal LNG, Cryogas-Vysotsk, and Port LNG are 72.5%, 91%, and 45%, respectively. These figures represent a decrease from the percentages projected for 2022, which were 75% for Yamal LNG, 96% for Cryogas-Vysotsk, and 20% for Port LNG.

In December, the European Parliament and the EU Council reached a tentative agreement on a bill that had been under discussion since March of last year. The bill grants EU national governments the right to temporarily prohibit Russian and Belarusian exporters from booking infrastructure capacity needed for LNG and pipeline gas supplies. This measure is intended to protect the fundamental security interests of member states while also taking into account security of supply and diversification objectives. Therefore, it is possible that within the next two to three years, some EU countries may impose restrictions on reserving capacity at regasification terminals for gas carriers transporting our LNG. This ban is unlikely to affect France, Belgium, the Netherlands, Finland, and Greece. However, it is probable in Spain, whose authorities have repeatedly stated their intention to stop importing Russian gas in the near future.

The EU's quasi-embargo on LNG exports will inevitably redirect them to the East. However, factories are not yet prepared for this scenario.

Sanctions imposed by the US in the fall of 2023 against the Arctic LNG 2 project aim to prevent gas supplies from this plant. Regarding the export structure, the project operator will likely aim to send as much cargo as possible to Europe due to a temporary shortage of gas carriers, particularly Arctic classes. However, shipments to Europe from the Gydan Peninsula are unlikely to become widespread due to political opposition within the EU.
It is important to note that the long-term fate of the Arctic LNG 2 contracts is uncertain. TotalEnergies of France has announced that it will not be accepting gas from the plant this year. The other shareholders, CNPC, CNOOC, and the consortium of Mitsui and JOGMEC, have reportedly requested that the United States lift sanctions, but it is unlikely that they will receive any relief. Arctic LNG-2 LLC previously announced force majeure in its contracts with Shenergy Group, Zheijang Energy, Repsol, etc. As a result, this year, it seems sensible to rely solely on spot sales, with all gas being sold by Arctic LNG-2 LLC.

The products of the first stage of the plant (6.6 million tons per year) can theoretically be sold on a spot basis, typically lasting up to three months. In 2022, spot accounts for 28% of all global LNG trade, with an additional 7% for short-term contracts lasting up to four years. Several countries rely heavily on spot and short-term transactions for exports, including Angola (98%), UAE (86%), Norway (75%), Egypt (73%), and the United States (61%). However, this is not yet the prevailing method of international trade. Following the price crisis of 2021-2022, buyers have become more cautious, as deliveries under long-term oil-linked contracts have proven to be significantly cheaper. While spot contracts may offer a partial and temporary solution, relying solely on them poses a constant risk and can greatly reduce selling prices as buyers demand significant discounts. Furthermore, due to the direct sanctions imposed on the project operator, it is unclear who can sell gas without causing concern for counterparties regarding secondary sanctions.

The shift towards the East could be more aptly named the shift towards the Global South, as South and Southeast Asian countries play a significant role in it, and in the future, possibly Africa and Latin America as well.

The oil industry has almost completed this turn, but the gas industry has barely begun. Exporting gas, including liquefied gas, will be the most difficult, lengthy, and dramatic.
Despite the regionalization of international energy trade in the 2010-2020s, local oil and gas markets remain interconnected. The cessation of direct supplies of Russian hydrocarbons to Western countries does not mean that these countries are completely independent of imports. They remain sensitive to the overall supply of the Russian Federation on the world market. An example of this is the rise in imports of petroleum products from India and other countries into the EU, sourced from our oil. This is completely legal and transparent. The 'turn' does not imply a complete cessation of Russia's involvement in energy supply chains to Western countries. On the contrary, it paradoxically brings the markets of East and West closer together, supporting the overall globalization of world trade.