In 2021, about a quarter of the oil used in the EU, about €48 billion worth in total, came from Russia. The invasion of Ukraine prompted EU countries to impose sanctions on this commodity. However, the sanctions contain loopholes that have made Poland the EU’s largest importer of Russian oil. While sealing the sanctions regime is possible, electrification of transportation will in the long run safeguard against the risk of replacing dependence on Russia with dependence on other petrostates.
Disclaimer: The article was published on February 20, 2023, under the title "Russian oil disappearing from Europe, but not yet from Poland." At the time, Poland was still buying Russian crude according to the contract with Tatneft, which was to last until December 2024.
February 27, 2023. Russia stopped exporting oil to Poland. This was Russia's decision, not Poland's. Exports were halted by the Transneft - Russian operator of the Druzhba pipeline. The formal reason was the exporter's failure to pay for transit via the northern line of the oil pipe. De facto, Russia stopped oil exports to Poland in response to the policy of European sanctions for its aggression against Ukraine.
With this in mind, we felt that the original title had become outdated and could mislead readers. We have therefore changed it to "Russian oil disappears from Europe." However, the other theses and data contained in the opinion remain valid and unchanged. Oil from Russia, moreover, is still shipped via the southern Druzhba oil pipeline, and goes to the refineries of PKN Orlen and the Hungarian company MOL, among others.
Oil dependence was profitable
In 2021, one in four barrels of oil processed in the European Union came from Russia. Among the EU’s largest importers were Germany, the Netherlands, Poland, and Italy.
Most of the Russian oil (about 90%) imported into the EU came by sea. Western European countries, which did not import oil from Russia via pipelines, could relatively easily stop importing crude from this direction. However, the profitability of importing and processing Russian oil, which is cheaper than Brent crude, the benchmark oil for Europe (see Appendix), meant they kept importing it.
The countries of Central and Eastern Europe (CEE), though, were at a disadvantage. Their level of dependence on Russian oil imports often reached 100% as a result of historical and geographical conditions. Refineries in these countries were built during the Eastern Bloc era, along the routes of oil pipelines running from the USSR. They were adapted to process Russian sour and heavy crude (see Appendix). 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. Maintaining this condition was the result of a conscious economic decision. Processing of non-Russian crude was possible, but would have resulted in poorer financial performance for CEE oil companies. In some cases, diversification of supply also would have required investment in infrastructure.
As late as 2021, 60% of the oil processed in Polish refineries came from Russia. Poland gradually reduced its share, but the competitive price and long-term contracts in force argued for maintaining imports from this direction. Russian oil accounted for about 80% of the crude processed in Lithuania and 40% in the Czech Republic (refineries controlled by the Polish firm PKN Orlen). Also, plants controlled by Hungary’s MOL, especially its Slovak refinery, used Russian crude to a large extent.
Profits from oil exports are the most important component of the Russian budget. In 2020, they accounted for just under 30% of Russian federal budget revenues. In the same year, Russia sold about 45% of its oil exports to the EU. The profits from oil sales alone are roughly equal to the entire war machine expenditure of the Russian Federation.
Given the crucial importance of oil revenues to the functioning of Russia’s budget and its military, sanctions covering Russian oil and oil products (including fuels, except LPG) were adopted in the EU in June 2022. This was the most severe blow to the Russian economy.
Sanctions on oil went into force in November and December 2022, and on petroleum products in February 2023. With regard to oil, only sea imports were banned. Exemptions from the sanctions were granted de facto to the Czech Republic, Germany, Poland, Slovakia, and Hungary, which can import oil through the Druzhba pipeline. In practice, this mainly affects two companies: Hungary’s MOL (which owns refineries in Hungary and Slovakia, where it controls Slovnaft) and PKN Orlen (which owns two Unipetrol refineries in the Czech Republic). In addition, Bulgaria has been given permission to import Russian oil by sea until the end of 2024.
The G7 countries (including the EU) additionally agreed in December 2022 to introduce restrictions on transportation services. Companies from the EU and G7 countries will be allowed to provide shipping, brokerage, or financial services related to the export of oil or petroleum products by sea from Russia only if the purchase price of the crude is at or below $60/bbl. The price cap level is to be updated every two months to be 5% lower than market prices for Russian oil.
The purpose of this arrangement is to limit Russia’s ability to profit from the diversion of oil exports outside the EU. About two-thirds of Russian oil transported by sea is handled by EU companies[1]. The first weeks of the mechanism’s operation have shown its effectiveness—the average price of Urals oil in December fell below $60/bbl and is about $30/bbl lower than the price of Brent oil (see Appendix).
During the discussion of sanctions, a key issue was the introduction of solutions that, while hitting Russia, would not cause major damage to the economies of EU countries. The biggest objections were raised by countries that depend on Russian supplies and are landlocked—Hungary, Slovakia, and the Czech Republic—which would bear the biggest costs of the sanctions and perhaps would not maintain liquidity in the fuel market. These costs would be related to the need to purchase more expensive crude, use a different grade of oil, obtain other petroleum products, additional shipping and transit costs, the need to reduce refining due to lack of capacity on alternative routes, which in the long term may be possible, but in the short term difficult.
Refineries in Hungary and Slovakia are connected to an oil terminal in Croatia by the Adria oil pipeline. Its capacity, however, would force these refineries to reduce processing to about 75%[2]. The Polish refinery in Plock can be fully supplied by Naftoport Gdansk. From the Polish oil terminal, oil can also go to the German Schwedt refinery. The Leuna refinery, on the other hand, could be supplied by the Port of Rostock. Refineries in the Czech Republic could replace supplies from Russia with imports via the TAL oil pipeline, but would also have to reduce throughput or supplement supplies by rail transport, for example, which would negatively affect financial results.
The Polish government, following Russia’s full-scale invasion of Ukraine, declared that it would abandon imports of Russian oil by the end of 2022. This declaration was not fulfilled, although Russian oil imports have dropped significantly. In January 2023, according to PKN Orlen’s declarations, the share of Russian crude in the company’s portfolio was about 10% (compared to about 60% a year earlier). On an EU-wide scale, however, the situation is very unfavourable. The largest importer of Russian oil to date—Germany—abandoned this supply direction in January this year, and thus Poland has not only failed to keep its pledge but also moved into first place in terms of Russian oil imports among European Union members.
This state of affairs may persist even until December 2024 when the last long-term contract that the Polish company has with the Russian company Tatneft expires. Early termination would risk contractual penalties, so it is only possible if oil imports by pipeline (and not just by sea, as at present) are subject to EU sanctions. Given the difficult situation and political resistance of Hungary, Slovakia, and the Czech Republic, extending the sanctions to Russian oil imports via pipelines is unlikely. A compromise solution could be to extend sanctions to oil delivered via the Northern Druzhba pipeline, which runs directly to Poland and Germany only.
Until 2022, Poland imported about 60% of its oil from Russia, paying an average of PLN 46.6 billion a year for it. Over the past few years, a strategy of slowly moving away from Russian crude has been pursued, mainly in favour of oil from Saudi Arabia and secondarily from Nigeria.
The growing exposure of the Polish economy to Saudi crude, which will increase further after Saudi Aramco’s takeover of the Gdansk refinery, raises concerns. Replacing dependence on Russian crude with dependence on Saudi Arabia increases Poland’s energy security in the short term and reduces switching costs. The diversity of suppliers, and thus of crude grades, increases transportation and processing costs, reducing refinery profitability. In the long term, however, such a policy raises political risks vis-à-vis Saudi Arabia, which, like Russia, is an authoritarian state.
While oil gets most of the attention, ultimately dependence on liquid fuels (motor gasoline, diesel, LPG) is the primary concern for Poland. Of course, these issues are related: in Poland, fuels were produced mainly from Russian oil, which will be replaced primarily by Saudi oil.
Polish refineries, however, are unable to meet domestic fuel demand, further exacerbating the country’s dependence on factors beyond its control. About a third of the demand for diesel and more than 80% for LPG is met by imports. Until recently, the main direction was Russia. After the EU embargo, this direction was closed (except for LPG, which was not sanctioned). However, fuel produced from Russian oil will still come to Poland, for example from the Czech Republic or India.
From the perspective of Poland’s energy security, the key is to reduce this dependence on fuel and oil supplies from abroad. Increasing the capacity of domestic refineries is not the solution. High investment expenditures, while reducing dependence on fuel imports, would increase dependence on oil imports.
The solution to this problem is the electrification of transportation, which will translate into reduced fuel consumption and greater production from domestic sources. In addition to the electrification of light passenger vehicles, it is also important to consider freight transportation. Given the difficulties in electrifying truck and long-distance passenger wheeled transportation, more emphasis should be placed on developing railroads.
Often implemented, especially in passenger transportation, the replacement of diesel fuel with gasoline, LPG, or natural gas (CNG, LNG) does not improve the country's energy security. Reducing dependence on diesel and oil imports comes at the expense of increased dependence on imports of other fuels
The current crisis is an opportunity for Poland to break not only its dependence on imports of Russian oil and liquid fuels but also, by intensifying efforts to electrify transportation, to significantly increase the resilience of the Polish economy to external factors resulting from the volatility of oil and fuel prices, while meeting climate goals. Failure in this area will expose Poland to the risk of further crises and manipulation by authoritarian states.
Date of publication:: 9 February 2023