View From the EU: Vladimir's Coin-Op Laundromat

Current Chairman of the Joint Chiefs of Staff, U.S. General Mark Milley, asserted in February 2022 that Kyiv could fall “within 72 hours.” He was only off by 72 hours and 16 months. Instead of proving the cynics right, the Ukrainians and their fight for independence ended up inspiring the world.

While Ukraine held off Russia’s initial attack all on its own, its ongoing endurance is thanks to foreign support. By January 2023, estimates pegged aid, including weapons, received by Ukraine at $150 billion with the majority of it – $77 billion – coming from the U.S. You can buy a lot of freedom with that!

Meanwhile, in Russia, both soldiers and cash are now in short supply. Thucydides, the ancient Greek historian and general, pointed out that “…war is not so much about arms as it is about money, for it is the money which makes the arms useful.”

That logic has been the impetus for Western economic sanctions against Russia: Take away income from selling pipeline gas and oil and the invasion will falter. At the same time, squeeze Russia by halting its access to goods that can be used or repurposed for the military, like lasers, computer chips and telecommunications, as well as farming and motor vehicle equipment.

Off-the-Books Economy

Russia’s newly off-the-books economy, and its hunger for foreign goods, have encouraged illicit trading and risk-taking behavior. Blocked off by all but a few of its big trading partners, the market for Russian exports like unrefined Urals crude oil has sucked in a motley group of profiteers, ranging from Greek, Arab and Chinese shipowners to – bizarrely – U.S. and Dutch oil stalwarts like Trafigura and Vitol.

South American and Asian buyers are eager to get their hands on Russian fuel because it sells for a discount. That discount helps make up for expensive daily charter rates for product tankers and for longer journeys.

Sanctions mean less efficient trips from Russia. Since not all customers will accept Russian oil, product tankers need to travel further before they can find a friendly port of call. Some end up as far away as Singapore, where Russian oil is blended with non-sanctioned oil, then reclassified and resold as being from a non-Russian source, as reported by Bloomberg.

For much of 2022, the price of Urals crude was significantly lower than Brent crude, up to $35 per barrel. Today, Urals crude is still cheaper, but only by about $20 per barrel. That spread, which is why blending sanctioned oil in Singapore is so wildly profitable for those who do it, was supposed to soak up Russia’s profit margin while still keeping the lights on in Europe. Let’s look at why prices converged.

Shadow Fleet

Sovcomflot, Russia’s premier shipping company, once controlled a fleet of 92 LNG and oil tankers. In April 2022, ownership of these vessels transferred to Sun Ship Management, a Dubai-based subsidiary of Sovcomflot. The E.U. noted that these vessels contribute 70 percent of Russia’s energy revenue, and in February 2023, the E.U. added Sun Ship Management to its sanctions regime.

One month later, CNN reported that a “mysterious fleet,” potentially comprising more than 600 vessels, was helping “Russia ship oil around the world” and involving “shell companies in Dubai or Hong Kong.”

Vortexa, a consultancy, suggested that an “opaque” tanker market comprising an estimated 1,000 vessels was carrying Russian crude to customers around the globe. According to the Wall Street Journal, fully 80 percent of the cargoes carried in that “opaque” market now consist of Russian crude oil.

The bulk of that cargo has been redirected from Europe to other customers who are glad to save a buck. Consider: Russian oil exports to Asia have doubled since the start of the war from roughly one and a half million to three million barrels per day while Europe’s imports, presumably of non-sanctioned Russian oil costing under $60/barrel, have shrunk by – quelle surprise! – an equivalent 1.5 million barrels per day.

The sudden demand for tankers in the dubious spiderweb of Russian oil transactions has prompted some big, legitimate players like Mitsui O.S.K., Euronav, Frontline and Hafnia to part ways with their older vessels in exchange for excellent sale prices. Braemar, a shipbroker, noted that 15-year-old Aframax and Suezmax tankers doubled in price in the past 12 months – and these are not young ships. Euronav noted in a report that the “economic lifespan of an oil tanker has historically been 25 years, although more recently this has dropped closer to 20 years.”

These are the proverbial 1985 Chevrolet El Caminos of the product tanker world, the classic Hollywood backdrop to a smuggling run.

But it’s not much of a smuggling run when the White House is egging you on. The U.S. Department of Treasury, wrote the Financial Times, invited several big names, including Trafigura, to a private meeting on how best to “shed concerns over shipping price-capped Russian oil.” To keep Russian oil moving, the White House enlisted shipping companies. “We’ve been actively encouraged by the Americans,” said one trader.

But Biden’s officials demurred, stating that their “goal is to communicate what is allowed under the price cap architecture,” akin to a public service announcement, and that “individual companies” can make their “own decisions.” Another White House official explained the wish to keep Russian oil on the market, “albeit at a lower price to deprive the Kremlin of revenue.”

Evading Sanctions

Meanwhile, Russia has tapped into its own network within “near abroad” vassal states such as Kazakhstan, Belarus, Armenia, or Tajikistan so as to legally import billions of dollars’ worth of foreign, especially German, goods.

Sales of German auto parts, chemicals and metals have increased by percentages that beggar belief. The German Federal Office of Statistics noted, for example, that German trade with known economic powerhouse Kyrgyzstan grew 994 percent last year. The reports, virtually all of which show three-digit annualized growth, are so outsized that they must be true. All the items in question would be illegal to import directly into Russia as they would run afoul of sanctions.

Is it that buyers in these countries have suddenly grown much richer while simultaneously developing an appetite for fine Teutonic wares? Of course not. Something else is afoot. According to the Wall Street Journal, Imex-Expert, a Russian forwarder, brazenly advertised that it will “import sanctioned goods from Europe, America to Russia through Kazakhstan” while boasting it can “bypass sanctions 100%.”

When I later reviewed the same website, I found the more ambiguous-sounding intimation that Imex-Expert would “work under sanctions from the European Union and carry out parallel imports” and that it can “develop legal and profitable logistics solutions for the supply of goods for bypassing sanctions by road and rail.” A rose by any other name would smell as sweet.

Can’t Kill a Good Deal

Between oil exiting Russia and the flow of European goods to Russia’s doorstep, it’s plain to see that rumors of the death of Eurasian commerce have been greatly exaggerated. Try as you might, you can’t kill a good deal. To paraphrase Jeff Goldblum in Jurassic Park: “Money, uh, finds a way.”

Meanwhile, commodity intelligence provider Kpler estimated that in February 2023, 36 percent of Russian crude was still being carried by European-linked tankers, just a hair more than the 33 percent carried by the “shadow fleet,” which is down from the “shadow fleet’s” 90 percent share at the beginning of the war.

In other words, Europe’s share in the “opaque” oil market is growing over time, not shrinking. This suggests that European shipping companies are learning to navigate around Russian sanctions. They are figuring out how to earn money from trade with Russia while remaining on the right side of the law.

Turkish Clearinghouse

The other twist to all this is Turkey, which under Prime Minister Recep Erdogan has touted its “special relationship” with the Kremlin. Erdogan stated plainly in a recent CNN interview that Turkey is “not bound by the West’s sanctions” and emphasized Turkey’s “positive relationship with Russia.” This behavior is exemplified by, as of a recent counting, 32 superyachts belonging to Russian oligarchs, which have flocked to Turkey’s southern coast and remain at anchor in friendly Turkish marinas.

The Centre for European Policy Analysis highlighted how Turkey can operate as a clearinghouse for sanctioned Russian oil. It remains a “leading buyer for Russian oil products.”

This is how it works: A Russian oil seller will mark its cargo value down for Russian export customs, which creates a low sticker price. A vessel will transport the oil to Istanbul on a charterparty to order, i.e., with an open-ended final destination pending instructions provided by the consignee. In Istanbul, the cargo will change ownership as it is “bought” by an entity in an unsanctioned third-party state, e.g., Dubai.

The difference between the price told to Russian customs and paid by the new buyer accrues to a foreign currency account held by the Russian seller, thus conveniently evading restrictions on Russian banking transactions. Meanwhile, it appears that sanctions are working, since the oil’s pro forma sale price is low.

Front Line

Western sanctions are forcing some awkward contortions, but their effect on paper is greater than their effect in the real world. CNBC reported breathlessly in March 2022 that Russia’s “financial system and currency are collapsing on multiple fronts.” But the only front that really matters is the front line – and while Russia can cleverly circumvent sanctions, it’s much harder to circumvent a bullet.