Not so long ago, in 2021, a quarter of the EU’s EUR 48 billion worth of oil came from Russia. The invasion of Ukraine prompted the EU states to impose sanctions on this commodity. However, the sanctions contain loopholes that have made Poland the largest importer of Russian oil in the EU. Nevertheless, tightening the restrictions is possible, while electrification of transport in the long run will protect against the risk of replacing dependence on Russia with dependence on other petrodollar states – writes Maciej Zaniewicz, analyst at the Energy Forum.
Dependence on oil used to pay off
In 2021, one in four barrels of oil processed in the European Union came from Russia. The largest importers in the EU were Germany, the Netherlands, Poland and Italy. Most of the Russian oil (approx. 90 percent) went to Western European markets by sea. Therefore, these countries could relatively easily stop importing raw materials from Russia. They did not do this, because importing and processing Russian oil was profitable, as it was cheaper than Brent – the reference for Europe (See: Annex).
The countries of Central and Eastern Europe were in a worse position. Their level of dependence on Russian oil imports often reached 100 percent, which was due to historical and geographical conditions. Refineries in these countries were built during the existence of the Eastern Bloc, along the route of oil pipelines running from the USSR. Therefore, they were adapted for the processing of Russian, sulfurized and heavy fossil fuels.
As a result, these countries, despite the collapse of the USSR and the end of the Cold War, remained economically dependent on oil supplies from Russia. This state of affairs remained unchanged, due to a conscious economic decision. The processing of non-Russian crude was possible, but it would result in worse financial results for oil companies. In some cases, diversification of supply would also require investment in infrastructure.
In 2021, 60 percent of the oil processed in Polish refineries came from Russia. Poland gradually reduced this share, but the competitive price and existing long-term contracts supported maintaining import from this direction. Russian oil constituted about 80% of the raw material processed in Lithuania and 40% in the Czech Republic (refineries controlled by PKN Orlen). Also, the plants controlled by Hungarian MOL, especially the Slovak refinery, used the Russian fossil fuel to a large extent.
Sanctions – leaky on purpose
Profits from oil exports are the most important component of the Russian budget. In 2020, they accounted for almost 30 percent of the revenues of the Russian Federal Budget. Back then Russia sold about 45% of its oil to the EU. The profits from the sale of oil alone are roughly equal to the entire defense expenditure (for the war) of the Russian Federation.
Given the crucial importance of revenues from oil sales to the functioning of the Russian budget and its war machine, in June 2022, the EU imposed sanctions on Russian oil and petroleum products (including fuels, except LPG). This was the most severe blow to the Russian economy.
Sanctions on oil came into force in November and December 2022, and on petroleum products in February 2023. For oil, only imports by sea were prohibited. Exemption from sanctions was granted to the Czech Republic, Germany, Poland, Slovakia and Hungary, which can import oil through the Druzhba Pipeline. In practice, this mainly affects two companies: Hungarian MOL (which has refineries in Hungary and Slovakia, where it controls Slovnaft) and PKN Orlen (which has two Unipetrol refineries in the Czech Republic). In addition, Croatia and Bulgaria have received permission to import Russian oil by sea until 2023 and 2024, respectively.
In December 2022, the G7 countries (including the EU) further agreed to introduce restrictions on transport services. Companies from the EU and G7 countries will be able to provide maritime transport, brokerage or financial services related to the export by sea of oil or petroleum products originating in Russia only if the purchase price of the raw material is equal to or less than USD 60/bbl. The price cap is to be updated every two months to remain 5% lower than market prices for Russian oil.
The aim of such a solution is to limit Russia’s profits from redirecting oil exports outside the EU. About 2/3 of Russian oil transported by sea is handled by EU companies. The first weeks of operation of the mechanism showed its effectiveness – the average price of Urals in December fell below 60 USD/bbl and is about 30 USD/bbl lower than the price of Brent oil.
Can sanctions be tightened?
During the discussion on sanctions, the key issue was the introduction of solutions that, while hitting Russia, would not cause more damage to the economies of EU states. The biggest objections were raised by countries dependent on Russian supplies and deprived of access to the sea – Hungary, Slovakia and the Czech Republic – which would bear the greatest costs of sanctions and perhaps would not maintain liquidity in the fuel market. This would result in them needing to buy more expensive fuel, use oil of a different kind, procure other petroleum products, and bear additional costs for maritime transport and freight. It would also force them to limit processing, due to the alternative routes not having enough capacity – in the long term this is possible, but in the short term it is very difficult.
Refineries in Hungary and Slovakia are connected to an oil terminal in Croatia via the Adria pipeline. However, due to its capacity these refineries would have to limit processing to about 75 percent. The Polish refinery in Płock can be fully supplied by the Gdańsk Naftoport. From the Polish oil terminal, oil can also go to the German Schwedt refinery. In turn, the Leuna refinery can be supplied through the port of Rostock. Refineries in the Czech Republic could replace supplies from Russia with imports via the TAL oil pipeline, but they would also have to reduce processing or supplement supplies, for example, by rail, which would negatively affect financial results.
Poland – the largest importer of Russian oil in the EU
Following Russia’s full-scale invasion of Ukraine, the Polish government announced that it would stop importing Russian oil by the end of 2022. This declaration was not kept, although the import dropped significantly. In January 2023, according to PKN Orlen, the share of Russian raw materials in the company’s portfolio was at 10%, in comparison to about 60% a year earlier.
However, in comparison to the rest of the EU the situation looks bleak. The largest importer of Russian oil – Germany – has abandoned its main supplier this January. Thus, Poland not only did not comply with the declaration, but also moved up to the first place in terms of imports of Russian oil in the entire European Union.
This situation may continue until December 2024, when the last long-term contract that the Polish company has with the Russian company Tatneft expires. Pulling out of the deal would trigger a contractual penalty, so it will be possible only if EU sanctions are applied to oil imports via pipelines (and not just by sea as at present). Given the difficult situation and the political resistance of Hungary, Slovakia and the Czech Republic, the imposition of sanctions on imports of Russian oil through pipelines is unlikely. A compromise solution could be to impose sanctions on oil supplied via the Northern Druzhba Pipeline, which runs exclusively to Poland and Germany.
Are the Saudis better than the Russians?
Until 2022, Poland imported approx. 60 percent of oil from Russia, paying for exports an average of 46.6 billion rubles per year. In recent years, it has been slowly moving away from Russian crude, mainly in favor of oil from Saudi Arabia and, secondly, from Nigeria.
Concerns may arise about the growing exposure of the Polish economy to Saudi crude, which will increase even more after Saudi Aramco takes over the refinery in Gdańsk. Replacing dependence on Russian raw materials with dependence on Saudi Arabia in the short term increases Poland’s energy security and reduces the cost of switching suppliers. Having various suppliers, and thus different types of the commodity, increases the cost of transportation and processing, limiting the profitability of refineries. In the long run, however, such a policy poses political risks with regard to Saudi Arabia, which, like Russia, is an authoritarian state.
Electrification of transport = energy security
Although oil attracts the most attention, ultimately dependence on liquid fuels (gasoline, diesel, LPG) is Poland’s fundamental problem. Of course, these phenomena are related – in Poland, fuel was produced mainly from Russian oil, which will be replaced primarily by Saudi oil.
However, Polish refineries are not able to meet the domestic demand for fuel, which further deepens our dependence on factors beyond our control. About 1/3 of diesel demand and more than 80 percent of LPG demand is met by imports. So far, Russia has been the main source. After the EU embargo had been introduced, this direction was closed. However, fuel produced from Russian oil will still go to Poland, e.g. from the Czech Republic or India.
From the perspective of Poland’s energy security, it is crucial to reduce the dependence on the supply of fuel and oil from abroad. Increasing the capacity of domestic refineries is not an option. While high investment expenditure would decrease dependence on the import of fuels, it would increase dependence on the import of oil.
The solution to this problem is the electrification of transport, which will translate into a reduction in fuel consumption and more domestic production. In addition to the electrification of light passenger vehicles, it is also important to include freight transport. Given the difficulties in the electrification of freight and long-distance passenger wheeled transport, more emphasis should be placed on the development of railways.
The popular practice of replacing oil with LPG or natural gas (CNG, LNG) in passenger transport does not improve the country’s energy security. The reduction in dependence on imports of diesel and oil comes at the expense of increased dependence on imports of other liquid fuels.
The current crisis is an opportunity for Poland to break its dependence on imports of not only Russian oil and liquid fuels. By intensifying measures for the electrification of transport, it is possible to significantly increase the resilience of the Polish economy to external factors such as the volatility of oil and fuel prices, while achieving climate goals. Abandoning this chance will expose Poland to the risk of further crises and manipulation by authoritarian states.