The European Union and the G-7 nations, along with Australia and Japan, imposed sanctions on Russian refined product exports on February 5. Russian crude exports have been restricted since December 5. The system was designed to keep Russian cargo flowing — and it certainly does.
“We see no indication that Russia will have to reduce its crude or refined product exports,” said David Wech, Vortexa’s chief economist, during a presentation Thursday.
And, contrary to popular belief, he believes there will be enough vessels to handle rerouted refined product flows, as has already been demonstrated in crude shipping.
The reason is that Russian sanctions have resulted in a massive increase in the so-called “dark fleet” or “shadow fleet,” which are older tankers with unclear ownership that operate outside of Western insurance, financial, and shipping-service circles and have a habit of turning off their location beacons.
According to Trafigura, one of the world’s largest trading companies, the shadow fleet now numbers around 600 vessels, accounting for 10% of the world’s crude tankers and 7% of its product tankers.
“To be honest, it’s becoming a big deal,” said Svein Moxnes Harfjeld, CEO of crude tanker owner DHT (NYSE: DHT), on a quarterly call on Thursday, February 8.
“Perhaps the politicians who imposed the current sanctions were aware of this possibility and saw it as acceptable collateral damage… but there’s a lot of murky stuff going on.”
The ‘new scrapping’ is the shadow fleet.
Older tankers that pollute more and are less safe to operate would normally be recycled and replaced by newer, more efficient vessels. But why throw them away when they can make huge profits in sanctioned or semi-sanctioned trades?
When the United States sanctioned Iranian and Venezuelan oil exports, the shadow fleet first appeared on a smaller scale. It has grown in size over the last year as older tankers have been acquired to transport Russian cargoes.
“The shadow fleet could be viewed as the new scrapping,” Harfjeld speculated.
“We have seen a significant amount of funds made available to companies in Dubai that are either owned by Russians or other people in the last six to nine months,” he explained.
“We have a sense that a lot of the businesses buying the older ships are funded by Russian capital in some shape or form and they are buying these ships to transport Russian crude oil — and they do that at a significant premium. They profit more than in the ‘complaint’ market.
“We have seen a lot of sales and purchases in different clean [product] tanker sizes over the last year, and the majority of those are over 15 years old and were probably purchased in preparation for carrying Russian products,” Wech says.
“It is not illegal for a non-EU, non-G-7 country to purchase Russian diesel without using European services. This is entirely legal, as well as entirely legal on the crude side.”
Some freight upside is returning to Russia.
“Freight rates are high in the sanctioned or semi-sanctioned environment, not in the rest of the market,” Wech continued.
On the crude shipping front, Russian Urals-grade crude trades at a significant discount, leaving a large margin to be paid for shipping and logistics, a portion of which is likely to flow back to Russia, undermining the goal of Western sanctions to cut Russian profits.
Wech stated, “There is no shortage of shipping capacity,” citing recent tanker acquisitions. “There are a lot of new players, very nontransparent players, a mix of Russian interests, partly located in the Middle East, and some other trading bodies in the Middle East, and also Indian and Chinese companies.
“The point is that it is difficult to get details on what price is paid by refineries in India and China [for Russian crude], but there’s about a gap [discount] of up to $30 a barrel, so there’s a lot to be made on the logistical side. It’s difficult to say who makes that money, and how much of it flows to the Russian side.”
How have trading patterns changed?
Since the EU ban on Russian crude imports took effect on December 5, almost all Russian crude has gone to India and China, with Turkey, a previously major buyer, withdrawing.
“There are basically only two countries left buying Russian crude,” Wech explained. As a result, “they are in a very strong position to ask for significant discounts.”
Crude from Russia’s European ports is loaded on Aframaxes (tankers with 750,000-barrel capacity) and Suezmaxes (1 million-barrel capacity), then transferred via ship-to-ship (STS) transfers, primarily off Ceuta, Spain, and Kalamata, Greece, before being shipped to India or China.
The scenario for product tankers is different. “There are far more markets for Russian diesel than there are for Russian crude,” said Vortexa senior analyst Pamela Munger.
Turkey continues to purchase Russian diesel, and Morocco has significantly increased its imports, replacing Saudi Arabian cargoes.
Wech observed that the media’s attention is firmly focused on Russian crude flows. “Based on the number of media requests we’ve received, I have the impression that every single journalist out there is currently tracking Russian oil on VLCCs,” he explained.
Diesel transports a greater number of smaller product tankers that are more difficult to track, whereas STS operations are much easier to conceal. “If the vessel is at port where there’s a refinery, it’s harder to track because you’re not sure if it’s refined product from that refinery. “The origin [of diesel] quickly becomes very mixed,” Munger observed.
With less of a “spotlight” on diesel flows and “more players out there that need Russian diesel than Russian crude,” Wech believes buying countries will be more interested. He believes that “transparency” in crude shipments is “one of the key reasons that most countries around the world are not buying Russian crude.”
Price cap challenges continue
While the shadow fleet transports the majority of Russian crude and products, sanctions allow mainstream tankers to transport cargoes under a price cap set by the EU and G-7. Western shipping service providers are eligible to participate if they have a written attestation that the cargo is priced below the cap.
Wech predicted that “European services, shipping companies, and insurance will be more likely to stay involved on the clean product side than on the crude side.”
Russia has stated that no cargo will be transported under any of the caps. But, according to Wech, Russia exports twice as much diesel as it does crude, so it may be willing to look the other way. “I believe they will miss it or fail to document it internally.”
Nonetheless, Western insurers — the tanker-covering Protection & Indemnity (P&I) clubs — continue to face sanctions challenges, which has kept most Russian flows on shadow tankers.
At the Hellenic-American/Norwegian-American Chambers of Commerce shipping conference in New York on Tuesday, Nik Ivanos of Skuld P&I explained, “There needs to be some form of protection for a P&I club that receives an attestation and isn’t able to verify the price cap. The approach taken by the United States is known as’safe harbor.’ You are given some protection if you act in good faith and comply with the documentary requirements.
“However, there is no safe harbor in the EU implementation. In fact, they necessitate due diligence, which is a moving feast,” Ivanos explained.
When asked if Skuld had provided coverage for any cargoes moving under the price-cap mechanism, Ivanos said he wasn’t aware of any.
However, some cargoes have been transported using Western shipping services. American Club P&I COO Dan Tadros confirmed his company had covered at least one cargo and would cover more if the system was improved.
Shadow fleet safety risk
Tankers are governed by international laws promulgated by the International Maritime Organization and enforced by individual countries. The rise of the shadow fleet is feared to result in a catastrophic maritime casualty.
“When we talk about the expansion of the dark fleet, that is not quality shipping,” Ivanov said. “These are ships that have changed hands and are insured by dubious internal Russian insurers. Who knows what will happen if a major maritime casualty occurs?”
“The EU authorities and NATO are extremely concerned about the STS activity in the Mediterranean,” said Henning Gloystein, director of energy at Eurasia Group, during the Vortexa presentation. I’m fairly certain there will be pressure to limit STS activity off the coast of Spain and in Greek-Cypriot waters.”
“I question whether some of these ships are complying with laws and regulations,” Harfjeld says. I’m curious what would happen if a large oil tanker carrying 2 million barrels capsized near where people live, such as in the Singapore Straits, the West Indian coast, or the middle of the Arabian Gulf. Unfortunately, that may be what it takes to get the attention of politicians.”
