Adam: Hello, and welcome to an episode of The Crude Report, the APAC Series. I'm Adam McCarthy, the VP of Crude Oil for Asia Pacific and the Middle East. And I'm joined today by Fabian, our crude editor based out of Singapore. So Fabian, I think our topic for today is going to be, have sanctions worked in suppressing Russia's Far Eastern Crude flows?
Fabian: Yes, Adam, thanks. Yeah, I think it's actually a really good time for us to check in on the latest situation going on with Russian Far Eastern crude flows because we have recently seen an impasse in the Russian-Ukraine ceasefire talks, and we actually have seen that the EU has adopted this latest package of sanction measures against Russian crude exports on 20th of May.
Adam: Excellent. So in that case, let's dive straight into it. So my first question to you then is, how have recent sanctions impacted the flow of crude exports from Russia's Far East?
Fabian: I mean, we can really see that there has been some disruptions to Russian crude flows, especially after the January sanction package that the U.S. had put in place. So that really saw a disruption to ESPO Blend exports. And we saw shipments out of Kozmino dropped to its lowest since 2022 back in February. That was around just under 770,000 barrels per day. And we also saw the impact elsewhere immediately after those January U.S. sanctions. We saw that regular buyers of ESPO Blend and Sokol, which are the refiners in China and India, they actually were really worried about that impact back then and they turned to alternative supplies because of the fears of supply disruptions. So this boosted values of other crude such as, for example, from sour crude from the Middle East Gulf.
Adam: I see. So does this mean the sanctions have been successful in restricting the volumes of Russian crude that have been exported?
Fabian: Yes, I think there was some initial success, if you will, in seeing the volumes drop. So like I mentioned back in February we saw, you know, ESPO Blend exports drop to its lowest since 2022, right? But very quickly thereafter, I think we have seen that exports have recovered after that initial shock. I believe that we have all observed that workarounds have been found allowing essentially the market to sidestep these sanctions. So while the U.S. blacklisted around 180 vessels back in January, this included 40 Aframax ships that were used to ferry crude out of Kozmino. But since then, there have been sufficient replacements found to keep flows going. And with this influx of ships that are not subject to U.S. sanctions, this essentially replaces those blacklisted ships and allows seaborne ESPO Blend exports to essentially recover steadily. And we actually saw it climb to its highest on record last month at around 1 million barrels per day.
Adam: I see. But are there sufficient ships to replace all these blacklisted vessels?
Fabian: For now, it does seem to be the case because roughly speaking, we can count that there's about 40 Aframax-size cargoes being pushed out each month out of Kozmino. So the amount of ships not subject to U.S. sanctions that have joined this route, there's sufficient ships to load this 40-plus cargoes each month, and this is actually already testing the current export capacity at the Kozmino terminal. So I think that the balance is about right.
Adam: You mentioned workarounds earlier. Do you see that there's other workarounds happening at the moment?
Fabian: Yes, so I think we have been using the example of ESPO Blend. So in that case, it's a pretty straightforward case where they're essentially replacing blacklisted ships with those that are not subject to the U.S. sanctions. And so that's a clear cut one for one replacement, and that's allowed crude flows out of Kozmino to continue. On the other hand, we have also observed that exports of Sokol crude has also recovered after that initial shock, but it's using kind of a different method to sidestep the sanctions. In the case of SOCO, they actually require the use of specialized vessels to look at the Castry [SP] Port where the grid is exported from because of the challenging icy conditions there. So they need really ships that are, you know, designed to be able to lift in those terminals.
At the same time, these same ships have been targeted by U.S. sanctions, so they're essentially blacklisted, so they cannot be used to deliver cargoes to their eventual destinations. But because they cannot be easily replaced because of their specialized nature, a new pattern has emerged in the past few months. So instead of replacing them, these ships are being used to engage in ship-to-ship transfer operation or STS operations to transfer the cargoes to other non-sanctioned ships. And by doing so, this allows that cargo to be transferred onto an unsanctioned vessel that can then transport it to its eventual home.
And the other interesting trend that has happened is that actually STS operations for Sokol crude is not new, but previously has always been done offshore Korea before it then travels to its destinations in India. But for now, in the past few months, we have seen that all STS operations for Sokol crude have taken place near Nakhodka, which is actually really near Kozmino Port, and it is just a few days journey away from the Castry. So this just means that those specialized tankers that I was talking about that loads at the Castry, they can just take that short journey to Nakhokda, do the STS transfer there, and then shuttle back to the Castry to load yet another cargo. So this allows, you know, exports of Sokol crude to really continue smoothly. And that's the other workaround that the market has found in order to circumvent these sanctions.
Adam: Thanks, Fabian. And how has all of this affected prices then?
Fabian: It definitely had an impact on freight rates. So Kozmino freight rates have actually fallen really steadily from reaching a peak in February. So the lump sum cost to ship an Aframax of ESPO Blend from Kozmino to North China, which is the main destination for the crude, is now about $2.15 million. This is about 32% higher than 10 of January, which was right when the sanctions were introduced by the outgoing Biden administration. But it's now sharply down from a peak of around $4.5 million reached at the end of February. And this is really because of that big influx of unsanctioned ships that have now joined the route.
At the same time, on an FOB Kozmino basis, the price for ESPO Blend has also essentially recovered somewhat because right after the Jan sanctions were introduced, those supply fears that I was telling you about, those concerns, those worries really dragged down the price. So we saw the FOB Kozmino discount dropped from it was something like $1.60 against Dubai. So that really widened up to $10 against Dubai because of those concerns. But ever since the past few months as flows have released, like kind of stabilized, we have seen the FOB discount now recover to around a $6 to $7 range against Dubai.
Adam: I see. Do you not think buyers are worried about these sanctions?
Fabian: I think definitely in such conditions there will always be some concerns, but at the same time, ever since 2022, I think the market has clearly established that there is always going to be some mechanism that allows the buyers to assess the crude that they want to get. And ESPO Blend now goes mainly to buyers in India and China who purchase the cargoes on a delivered basis. So there is this G7-led price cap of $60 per barrel that applies to exports of Russian crude on an FOB basis. And essentially if you're buying above that cap, then that also prevents you from accessing Western Maritime Insurance and Services. So buying on a delivered basis actually is very helpful to help buyers manage the risk associated with buying these cargoes.
At the same time, ESPO Blend has always been popular with Chinese refiners, particularly the independence based in Shandong Province. So the grid has actually really high yields of middle distillates and it takes less than a week thereabouts to shuttle the cargo from Kozmino to Shandong. So that short haul nature of the route makes it really very popular with refiners over there. But at the same time, we have noticed that certain sectors of the market are appearing to be more concerned. For example, ever since the Jan sanctions, we have seen that the Chinese state-owned firms have been much more careful because they are more wary of this sanction measures. They have been buying less of ESPO Blend in comparison to the independent refiners.
Adam: I see. And all, you know, these buyers, are they actually able to absorb all these exports?
Fabian: Actually, I don't think so because, for example, let's use the latest trading cycle for ESPO Blend. We have seen that the Chinese are the primary source of demand and when their strength flags, it opens up this opportunity for Indian refiners to actually snap up some cargoes perhaps at prices that are more competitive. So we did see that the delivered Shandong price of ESPO Blend dropped to $1.40 premium against Argus ESPO Blend for June arrival cargoes earlier in the cycle. This was a drop of around 60 cents compared to trades for May delivery cargoes at premiums of around $2. So as a result of that dip in buying, and this was because Shandong refiners had pulled back on their purchases because being impacted by weaker margins as well as concerns over the mechanics of buying the cargoes.
But at the same time, this means that there's an opportunity now for other buyers to step in. So we have seen that the Indians actually bought plenty of June cargoes and some in the market have also suggested that perhaps the recent geopolitical tensions in their region may have spurred a need for them to pick up more prompt cargoes as well. So that help in clearing the available June cargoes. And ESPO Blend trades on a prompt cycle. So that makes it really ideal if you need, like, to pick up cargo for delivery in the near future. And prices are also discounted compared to other crude that's not subject to any sanctions.
Adam: I see. And are there any other factors that affect in these markets?
Fabian: One interesting point is that when we're talking about sanctions that's having an impact, one package of sanctions that's impacting the ESPO Blend market is actually not against Russian crude flows, but Iranian. So the White House has been ramping up this maximum pressure campaign on Iranian exports, even as they're been having Shandong have the negotiations on the nuclear talk side. But the U.S. has, to this date, blacklisted three different independent refiners to date. So this has really sparked genuine concern because these small refiners are the ones that really rely on discounted sanctioned crude as a lifeline in a tough margin environment. So there's a Chinese saying that translates to punishing an individual as an example to others. And the other Shandong firms certainly seem to be taking the message sent by Washington seriously.
So the concerns over disruptions to Iranian crude and the logistics in procuring this cargo is expected to drive independent refiners towards buying more ESPO Blend to replace their Iranian purchases. As the workarounds that we have discussed earlier for Russian crude have created a more stable environment in which they have more confidence in receiving the cargoes. So in fact, talking about the delivered Shandong price for ESPO Blend, by the end of the trading cycle for June cargoes, we have saw that premium rebounded back to that $2 per barrel level with more supplies now fully sold.
Adam: I see. And what do you think happens next?
Fabian: I think that it is unlikely that the sanctions against Russian exports will ease anytime soon. But the market has shown that workarounds tend to be found in order to overcome any new challenges. But it is worth bearing in mind that buying the Russian crude has always been popular with refiners elsewhere in Northeast Asia. And in the right circumstances we might potentially see that destinations for ESPO Blend and Sokol exports to once again expand beyond China and India.
Adam: Well, thanks, Fabian. I think that has really shone a spotlight on the current state of the Far Eastern Russian crude market, and I really appreciate your time in joining me.
Fabian: Thank you, Adam.
Adam: And thank you all for listening to this episode of The Argus Crude Report.
Fabian: Thank you.
Adam: Bye.
