More sanctions drafted by the United States Senate aim to punish Russian oil companies and banks, but Russian sources insist they will not harm the countrys lubricant industry, which in the event would rely more on local products. However, they warn it could effectively cut the industry off from international markets.

The August draft of the Defending American Security from Kremlin Aggression Act – leaked by the Russian newspaper Kommersant a week before its official publication – seeks to impose sanctions on investments in any oil industry project backed by the Russian government or state-affiliated companies outside Russia that are worth more than U.S. $250 million. This could be especially damaging for European companies involved in several trans-continental oil and gas pipelines. Foreign businesses would also incur penalties for any participation in new oil projects inside Russia valued above $1 million.

The main role of the draft legislation, called the sanctions bill from hell by Republican Senator Lindsey Graham of South Carolina and five of his colleagues, is to consolidate previously imposed laws, including the Countering Americas Adversaries Through Sanctions Act of 2017 and the Magnitsky Act of 2012.

According to a press release by Grahams office, the proposed legislations goal is to increase economic, political and diplomatic pressure on the Russian Federation in response to its continued interference in U.S. elections, influence in Syria, aggression in Crimea and other activities.

Sanctions Pile Up

In summer 2017, the U.S. imposed another package of sanctions targeting the Russian oil industry. At the start of August this year, the U.S. Department of State slapped the Kremlin with additional sanctions related to the chemical attack on a former Russian agent and his daughter in Salisbury, United Kingdom. This sent the ruble tumbling to a two-year low before the sanctions went into effect.

Combined with a decline in the export quality of Russias flagship Urals crude oil to European refiners, these fresh sanctions have spurred a general distrust among foreign buyers of the countrys future oil production and the reliability of the state budget, which led to an additional ruble devaluation, according to Artem Mazaev, an independent lubricant industry consultant.

Regarding finished lubricants, the main factors remain the same – the weak ruble in turn will [result in] increased prices for imported products that could trigger a switch by Russian consumers to local products with more affordable prices, Moscow-based Mazaev told LubesnGreases. Mazaev believes that the dwindling income of Russian households will reinforce such a change.

Meanwhile, the pressure on the ruble in the short term could support base oil exports from Russia, according to Denis Varaksin, director of base oils and waxes at the Berlin-based commodity trading company DYM Resources.

Domestic prices will need to go up in rubles to be competitive versus export alternatives denominated in U.S. dollars, he said.

Varaksin added, however, that in the medium term, more severe sanctions may limit trading activity as banks are getting more and more cautious about financing or even processing transactions with Russian oil companies.

Every deal takes more paperwork and time. For some clients, it is easier to switch to other suppliers, for example, from Europe, he said.

The threat of a ban on lubricant additives imported from the U.S. may have some impact on finished lubricant production, but the situation could improve in a while, Mazaev noted.

International producers of additives used for automotive lubricants have no production facilities in Russia, and it is expected that the countrys blenders would adapt to such restrictions and may switch to additive supply from other sources, he said.

Domestic Regrouping

DYMs Varaksin stressed that domestic production of high-quality and niche lubricant products is still very much dependent on imported additives packages.

If sanctions limit this flow, it can hurt the development of local blenders, he said.

The most entrenched additive companies in the Russian lubricant market, which help local suppliers with formulations and OEM approvals, are the American-British-Dutch joint venture Infineum, based in the United Kingdom, and the Berkshire Hathaway-owned Lubrizol, based in Wickliffe, Ohio.

Other observers countered that the Russian oil industry is resilient to foreign pressures thanks to huge past investments, numerous tax breaks and a history of government bailouts. State-owned Rosneft, which recently promised a strategic overhaul by 2022 that included its base oils and lubricant production, posted strong second-quarter net profits.

Russia has nameplate base oil capacity of some 2.5 million metric tons per year, according to LubesnGreases 2018 Global Guide to Base Oil Refining, which is set to increase. Almost all Russian oil companies have introduced or are getting ready to introduce high-quality base oil production, which in turn means better quality in-house finished lubricants.

At the end of 2014, vertically integrated oil and gas company Tatneft unveiled its Nizhnekamsk base oil plant with capacity to stream 90,000 t/y of API Group II and 110,000 t/y Group III base oils, while Slavneft (a joint venture between Rosneft and Gazprom Neft) opened a 100,000 t/y Group III base oil unit in Yaroslavl in 2017. Lukoil is also getting ready to expand its Volgograd-based 35,000 t/y Group III and Group III+ base oil production by 2021.

Bearing Up

The crushing sanctions pressure is useless. It could not harm the business of Russian lubricant companies, while large-scale foreign investments are not planned in the coming years, said Tamara Kandelaki, CEO of energy research company Infotek-Consult.

Russian car manufacturers – motivated by the government to produce more cars locally and spurred by the desire to reduce the influence of forex markets on their production costs – will also continue switching from imported to locally produced lubricants, according to Mazaev.

Russian car sales amounted to about 1.4 million units in 2017, fewer than a half of the peak in 2012 of 3 million units. Lukoil, Rosneft and Gazprom Neft lube makers have all signed factory-fill deals with the majority of local car assembly plants and automakers.

Automotive companies are expected to choose between lubricants produced by Russian oil companies and local blending plants of international blenders, he continued. This could hamper lubricant imports to Russia, reducing the number of lubricant brands available there as independent blenders in Russia and Belarus replace them.

Base oil trading firms are busy when new sanctions are imposed, Varaksin said. Sanctions are good for trading firms. We find ways to minimize risks and deliver the product for clients in Europe or other parts of the world. The harder the sanctions the more work we have.

Mazaev noted that Russia exports significant volumes of base oils. The proposed sanctions will hardly change this situation. The importation of base oils to Russia is not large, and it is a sensitive issue for local blenders, especially for subsidiaries of international blenders like Shell, Fuchs and Total, he said.

Total Vostok, the local subsidiary of the French energy giant, is preparing to open a blending plant in Russia in the coming months that does not fall under the restrictions of the proposed fresh sanctions.

Both Kandelaki and Mazaev are confident that the additional sanctions could only make the Russian lubricant market less dependent on outside industry influences and market trends, which in turn could effectively shut it off from international markets.

It may look good in the short term, but it will inevitably have a negative effect in the longer run, Mazaev said.

This was echoed by Varaksin, who said that in the long term, harsher sanctions do not produce anything positive.

Isolated industries become less competitive on a global scale and lose market share. Lukoil and Gazprom Neft are actively trying to develop their international lubricant business. They could be hurt as a client can chose between risk-free suppliers from another country or get exposure to a supplier from a sanctioned country.

In a competitive and interconnected global market, these new sanctions are a double-edged sword. While Russia has already deployed countermeasures, U.S. and Western companies that do business in Russia will surely be punished by losing valuable projects and market share.

From a historical perspective, sanctions alone rarely succeed in forcing change in the targeted country. What is certain is that business will suffer.

It makes it very hard to develop anything in a state of mutual embargoes and restrictions. Russian companies will have to offer better prices and services versus their international competitors, Varaksin said.