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It has been a week and a half now since excess organic chloride levels were detected in Urals crude supplies exported from Russia via the Druzhba pipeline. Later it was confirmed that contaminated oil was supplied to the Baltic port of Ust-Luga as well. It seems now increasingly likely that it will take Russia

several weeks to restore normal operations via Druzhba and Ust-Luga, so the Central-Eastern European refineries which heavily rely on Urals need to take immediate steps to ensure uninterrupted operations. This is an update on our previous flash alerts on this topic (see 24 April & 25 April).

Fig 1: Central-Eastern Europe Crude Oil Infrastructure

Europe’s dependency on Russian oil is here to stay :

For historical and political reasons, Central-Eastern Europe has always relied largely on Russian crude, with the Druzhba pipeline as the key piece of infrastructure recently pumping some 1 mmb/d of oil via Belarus to Poland and Germany and via Ukraine to Hungary, Slovakia and the Czech Republic.

Fig 2: Druzhba Exports to Europe 2017/2018

Among these countries, Slovakia is most dependent on Urals supply, with 100% of its deliveries coming via the Druzhba pipeline. Even Poland, which in recent years has made efforts to diversify away from both Russian oil and gas, still sources about 80% of its crude from Russia. Hungary and the Czech Republic – depending on alternative sources – process more or less 50% Russian crude. Germany is the least dependent in the region with approximately 35% of its crude coming from Russia, most of it via Druzhba but some of it seaborne via Russia’s Baltic ports.

Fig 3: Central & Eastern European Refiners’ Dependency on Russian Crud

The reasons for persisting dependency on Russian crude in the region despite an existing will to diversify away are complex with geographical, technological and commercial condiserations. However, all of the European refineries supplied from Druzhba have alternative routes available. Below is a table for alternative pipelines or accessible ports. Yet, it may not be so easy to turn to alternative supply routes

at such short notice for all of them (see below).

Fig 4: Refineries connected to Druzhba pipeline and their alternative crude import facilities

For those refiners who have no infrastructure that would allow a quick access to other crudes other than contaminated Urals, drawing down stocks is essentially the only short-term solution. EU member states are required to hold 90 days’ supply of combined crude and product stocks. These strategic stocks can be tapped in a supply emergency, in addition to commercial working stocks.

The below chart shows the impacted EU member states’ current strategic crude reserves by country and the corresponding days’ supply (excluding Germany, who by far has the largest strategic crude reserves with over 100 mmb that would be sufficient to supply its two impacted refineries in theory for over 200 days!).

Fig 5: Central & Eastern Europe – Strategic Crude Reserve

In the following sections, we assess the strategies the impacted refiners have chosen and other. opportunities they might have to deal with the current disruption to Russian Urals supplies.

Slovakia – the most vulnerable one :

Slovakia, as mentioned above, processes essentially only Russian crude, making it the most vulnerable country to supply disruptions from Russia. Although Slovakia can technically import crude from the Med via the Adria pipeline via Hungary, we do not see it as an immediate solution to the problem given the time it could take to source crude and have it delivered on site.

Slovakia has a long-term supply contract that covers 100% of the 110 kb/d Bratislava refinery’s demand, therefore accessing the spot market in the Med would mean 1) unplanned expenses for the refinery and 2) and could come potentially with practical difficulties too, given that the country has never imported crude from the Adria pipeline via Hungary. In addition 3) even if all obstacles are overcome, it could take a considerable time to purchase suitable crude cargoes (the Bratislava refinery is geared towards processing medium heavy sour crude like Urals) and deliver them to the plant.

As for strategic crude stocks, Slovakia has enough to supply the Bratislava refinery for about 40 days, though these stocks are partly stored in the neighbouring Czech Republic which could take an additional 2-3 days to deliver to the plant.

To summarise, we think the Bratislava refinery can draw down crude stocks in Slovakia and then from the Czech Republic in the coming weeks. However, should the issue persist longer than that, the refinery would potentially need to reduce runs. This may prove difficult as the refinery completed a planned maintenance turnaround in March, during which its commercial product stocks were probably drawn down.

Czech Republic – Litvinov refinery asks for access to strategic crude reserves :

The Czech Republic has two refineries, 86 kb/d Kralupy and 109 kb/d Litvinov, both of which are supplied partially via Druzhba. Both of them have access to the TAL pipeline and regularly import non- Russian crude from the Med. However, Unipetrol has asked the government to provide access and a loan to tap into the country’s strategic crude reserves to ensure that the Litvinov refinery can continue running at normal rates. The Litvinov refinery reportedly had commercial crude stocks enough for about 7 days supply in late April.

The state currently holds 7.3 mmb of strategic crude reserves in Nelahozeves right next to the two refineries, which is enough to supply both refineries for about 40 days.

Hungary – state releases a substantial 60% of strategic crude reserve :

Hungary has only one refinery, the 163 kb/d Danube (Szazhalombatta) plant owned by MOL. The refinery has substantially reduced processing Urals, which in recent years has taken up “only” about 60% of the plant’s crude diet. The refinery’s alternative supply route is the Adria pipeline via Croatia.

The plant has commercial crude stocks enough to cover for about 35 days; also, MOL has said it will increase crude imports via the Adria pipeline in the coming weeks to make up for the loss of Urals barrels. Therefore the Danube refinery should be little impacted by the Druzhba supply disruptions. However, the government has made available about 3 mmb or 60% of its strategic crude stocks

available, a substantial proportion considering that the refinery is not in need of tapping into emergency reserves for at least a month and a half. FGE believes the government may have made this statement with the intention to prevent a “panic” situation arising in the domestic fuel markets.

Poland – Gdansk refinery already drawing down strategic reserves :

Poland has two refineries, the 356 kb/d Plock and 211 Gdansk plants, which are connected to the Druzhba pipeline. The Plock refinery operated by PKN Orlen, although it is not a port refinery, has direct access to all crudes in the Baltic/North Sea area via the Plock oil terminal and also has an existing supply contract with Saudi Arabia.

The Gdansk refinery operated by Grupa Lotos has already started processing crude from strategic stocks. Poland currently has about 15 mmb of strategic crude stocks corresponding to about 25 days’ supply, most of which is located in the salt caverns near Gora. The government released 500 kt of the strategic crude stocks on 26th of April and further 300 kt on 30th of April. It also helps that Grupa Lotos in recent years managed to increase the share of non-Russian crude to 40%, most of which comes from the US and Canada.

Germany – the least impacted country :

Of all the countries affected, Germany is the one which should feel the impact of the Urals problem the least. Out of the country’s 14 refineries, only two are supplied via Druzhba: the Schwedt and Leuna refineries, 240 kb/d each, both of which have access to the international crude markets via Rostock. In addition, Germany also gets about 50-100 kb/d of seaborne Urals, so altogether the country runs about

35% Russian crude in all of its refineries.

The Schwedt refinery has just finished a full maintenance turnaround; it has stated that it has commercial crude stocks for 10 days’ supply. While the Urals disruption persists, the refinery plans to import cruvia Rostock. Reportedly, a Urals cargo from Primorsk is expected to arrive on 3rd May at Rostock, intended for the Schwedt refinery.

What are the options to get rid of the contaminated oil ? :

To summarise, all impacted refineries have sufficient crude stocks – either commercial or strategic – and alternative supply routes to ensure uninterrupted crude processing for at least the next month or so. The real question is therefore – is this enough time for Russia’s Transneft to restore clean Urals supply via the Druzhba pipeline and send it all the way to Germany and the Czech Republic?

The main difficulty appears to be the removal of the contaminated oil that is already in the pipeline system. FGE estimates its volume at 15 mmb, now stored in oil depots along the pipeline as the impacted refiners have all suspended taking Urals. In order to get clean oil to the refineries, this contaminated oil has to be removed from the depots. What are possible ways of doing it?

Refiners could drip feed it while blending it with other crudes in order to dilute the contamination levels. However, limited storage facility could be an issue as pipeline-fed refineries typically have less storage available than their sea-fed counterparts. Reportedly the organic chloride levels were 15-30 times above the upper limit of 10ppm (but is typically less than 3 ppm).This implies that it needs to be blended with approx. 15-30 times more clean/uncontaminated crude. That could mean a total of 300-500 mmb crude if the clean crude does not contain chloride at all! If the clean crude to be blended in with contaminated Urals contains any organic chloride, this figure will be even higher.

Fig 6: –“Clean” Crude Volume Required to Dilute Contaminated Ur

Alternatively, the contaminated oil, which is currently in storage depots along the pipeline system could be transport back to Russia and diluted there. For this the crude either needs to be transported via rail or via pipeline. For now the rail option seems to the more likely. However, rail capacity is very limited and access to it could also depend on location. Until about 20 years ago Russia moved about ~150 kb/d of crude via rail to the Baltic ports, and this system is also

connected to Belarus. However, this route has not been in use for many years, which could mean technical complications as well as a guaranteed slow speed given the fairly small capacity. In addition, most of the contaminated oil has actually been pumped further away to Poland, Germany, Slovakia, Czech Republic and Hungary, for whom even access to rail infrastructure is questionable.

Belarus has suggested that the contaminated oil theoretically could be pumped back to Russia by reversing the pipeline flow. The Druzhba pipeline is designed for East to West direction only, and it has never been reversed. However, assuming that it is technically feasible, reversing the flow will come at great costs, too. This means that oil flow to Europe via the Druzhba will need to be halted completely for

the duration of the operation. With normal flows, we estimate it takes up to 20 days for Russian crude from Samara (where the contamination originated) to reach German refineries. With reverse flow it is expected to take substantially more.

Whichever of these options will be chosen by Transneft and the impacted states to get rid of the contaminated oil, it is increasingly likely that this problem will not be solved in the next couple of weeks, it could – just as Belarus oil officials have warned – take even months, which is beyond the horizon that some impacted refineries could draw down stocks. After that point, refiners would need to cut runs and release product stocks to continue supplying their domestic markets. Though of course, the impacted countries also have similar volumes of strategic products stocks, in additional to the crude stocks detailed above (the split tends to be about 50:50).

And let us not forget, getting the crude back to Russia still does not mean that the job is finished. What will Russia do with the contaminated oil? Its domestic refineries would be just as reluctant and as likely to see difficulties in processing and/or blending it as their European counterparts. It would most likely end

up in storage and then get gradually blended with clean Urals. This way, to fully get rid of the contaminated oil even over a year may be required.

However the various players in this game play the game, it will be expensive !

© 2019 FGE

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The LNG market continues its transformation. We have witnessed very few FIDs since 2016, but we expect a flood of FIDs over the next 24 months.

After witnessing FIDs of some 15-20 million tonnes per annum for the past 15 years, in 2016, we had 6 mmt of FIDs; in 2017, only 3 mmt; and in 2018, so far only 4 mmt.

The slow pace of FIDs is due to the low interest in customers willing to sign long-term contracts to underpin financing for the building of liquefaction plants. So what has changed?

It has become clear that the lack of FIDs will inevitably result in a major shortage of LNG in the 2022-24 period. Many international players want to enter this tight market. As often happens in the LNG business, when everyone thinks of the same idea at the same time, we should start to worry about the consequences !

The deep pockets of the majors after record profits in 2017 and 2018 have encouraged key players to move forward without waiting to sign up customers—relying on equity lifting and portfolio management to sell their products.

As of today, we expect over 80 million tonnes of new LNG projects to be sanctioned over the next two years. These are all primarily non-US, non-Russian projects. If Arctic 2 is included, we are looking at 100 mmt of new LNG to come into the market during the 2024-26 period, inevitably resulting in a major surplus before the end of the decade. A substantial shortage of LNG is followed by a huge surplus.

From the 80 mmt, less than 20 mmt currently have identifiable customers. For instance, the first LNG project which might be sanctioned is LNG Canada. Shell and PETRONAS will take their volumes in their portfolios; KOGAS and PetroChina will move their volumes into their own economies, and Mitsubishi Corp has quietly secured back-to-back sales for most of its volumes in Japan. This is a far cry from the days that SPAs with end-users were signed for the bulk of the volumes before the project was sanctioned.

How about the many US projects? There is little doubt that the US projects are more competitive than most, if not all, of the projects in the queue to receive FIDs. But the US project owners are either private equity or small players. This is contrasted with large majors Shell, ExxonMobil, Total, or Eni, who are driving their non-US projects forward. Most of the US projects need firm SPAs to move forward. At the same time, US projects can deliver LNG at US$7-9/mmBtu to the customers at today’s Henry Hub prices. It is not easy to find many new projects which can beat them, beyond Qatari projects.

Customers who have been reluctant to sign new long-term contracts, but were getting nervous that they must move to secure some new supplies, feel reassured that all these new projects will offer them a strong buffer against shortages. They feel confident that they will be offered medium term and more flexible contracts since supplies from these new projects are entering the market in any case. This further slows down their commitment to sign new long-term SPAs. This poses a major challenge to the US projects who may have the best economics, but not the deep pockets to move forward in the next year or two. In short, the lowest-cost projects may enter the market after the higher-cost projects!

For the tight period of the early 2020s, very few can enter the market before 2024/25. Only one supplier has substantial volume from existing projects that can be sold in the gap—Qatar.

In conclusion, the next transformation of the LNG market is not about the lowest-cost projects going forward. It is about the deep pockets and the courage to take on risks before customers sign up. Inevitable results will be the boom and bust cycle. A tight market in the early 2020s to be followed by a surplus market in the mid-2020s. But LNG has powerful inherent demand growth prospects. The inevitable mix of LNG bunkering and even more China imports for pollution issues, plus an expected jump in Indian LNG needs after the general elections in 2019 will slowly wipe out the surplus by the early 2030s and then once more, the boom and bust cycle will start. It is hard to understand why we cannot learn from history !

Fereidun Fesharaki

While long-term cycles in the refining business may come to a slow end in the latter part of the 2020s, the short term cyclical movements are remarkable as we head towards IMO.

Gasoline cracks have seen a stunning rebound, lifting refining margins globally. Everyone is asking whether it can last. We think it can, but it will be a mixed bag for products.

A string of planned and unplanned refinery turnarounds quickly reduced gasoline supplies in the Atlantic Basin. Record high US inventories now seem a distant memory, with stocks seeing a massive drawdown (29 mmb) over the past eight weeks to below year-ago levels. Spot demand from India and Indonesia, combined with lower Chinese exports, offered additional support.