Russian Dirty Oil Scandal: What Happened and What Will it Cost?

BusinessRussian Dirty Oil Scandal: What Happened and What Will it Cost?

Russian Dirty Oil Scandal: What Happened and What Will it Cost?

Back in April, global oil prices struck a six month high as a result of the Russian dirty oil scandal. 
This involved about 36.7 million barrels – 5 million tonnes – of oil contaminated by organic chloride.

What Happened?

Approximately 36.7 million barrels of Russian oil were found to be contaminated with organic chloride earlier this year.  Organic chloride is the chemical compound used to clean wells and boost crude flow, improving oil extraction.  It must also be removed from the oil before it is sent on to refineries as this substance can destroy equipment. Moreover, at high temperatures, it will produce poisonous chlorine gas.
According to the Transneft Russian pipeline monopoly, the contamination occurred in Samara’s Volga region.  Transneft pointed the finger at unnamed “fraudsters” as being to blame for the contamination.  That said, Russian President Vladimir Putin said that Transneft failed to establish adequate systems to prevent contamination.

What Was the Impact?

The contamination crippled the use of the Druzhba pipeline.  That pipeline was built back in the Soviet Union.  Today, it serves German, Polish, Czech Republic, Hungarian, Slovakian, Belarusian, and Ukrainian refiners. The pipeline is capable of pumping 1 million barrels per day (bpd), which is the equivalent to 1 percent of global oil demand.
On 25 April, all importing nations ceased accepting any Russian oil by way of the Druzhba pipeline.  Sending clean oil flowing to Belarus has been the first priority.  Belarus is the location of the split in the pipeline for its northern and southern spurs. On 24 May, Russia announced it would be pumping dirty oil back from Belarus to clean that segment of the pipeline.
That said, even after Belarus would start to undergo the procedures to begin clean oil, areas further along the pipeline network continued to suffer from contamination.  At that point, it was already clear to Russian officials that this was the worst disruption the country had ever experienced to its oil exports. According to Belarus, it would be months before normal operations would resume once more.

What Are Refiners Doing?

Refiners have responded differently depending on their location.  For example, the main refiners served by the Druzhba pipeline in Germany are Leuna (owned by Total) and Schwedt (co-owned by Royal Dutch Shell, Rosnef, and Eni).
Leuna and Schwedt each purchased a tanker of oil by way of the Gdansk port in Poland.  This provided the refineries with enough on-site crude to maintain their operations.  According to Industry sources cited by Reuters, the refiners continue to seek alternatives to keep up the necessary inventories.
In Hungary, the country promised the release of 400,000 tonnes of oil from its own emergency reserves. This was provided to an MOL-owned refinery.
In the Czech Republic, a Litvinov refinery owned by Unipetrol, a unit of PKN Orlen, was in receipt of state emergency reserve oil starting on 2 May.
Lotos, in Poland, also said it would be willing to offer some of its strategic reserves. On the other hand, PKN Orlen in the country, Lotos’ larger rival, said it did not intend to take a similar step.

Other Oil Players Affected by the Scandal

Other oil outlets aside from those directly connected to the Druzhba pipeline were also affected by the Russia’s contaminated oil. For instance, Ust-Luga, one of Russia’s largest ports in the Baltic Sea, was contaminated, too.
There were 10 tankers or more that had already sailed from the port by the time the contamination was spotted.  Combined, they were carrying about 1 million tonnes of oil.  That would normally be worth around $500 million at the prices at the time.
The Vitol trading house rejected Ust-Luga-based cargo, forcing the port to close for a full 24 hours. Though the port opened once again to load crude as of 26 April, by 29 April, the oil was still contaminated with high levels of chloride.  At that time, Russian officials were predicting that it wouldn’t be until 5 to 7 May before Ust-Luga would begin receiving clean oil again.

How Much Chloride is Too Much?

The highest amount of organic chlorides Transneft permits is 10 parts per million (PPM).  The Druzhba pipeline and Ust-Luga tanker levels were measured between 80 ppm and 330 ppm.
Surgutneftegaz, the Russian oil company, repeatedly failed to award two Ust-Luga-based Urals May cargoes at a tender shortly after the contamination was discovered, despite offering discounts for the high chloride levels.
The nearby Primorsk port’s Russian Urals crude prices spiked to the highest levels in twenty years as refiners scrambled to find alternative supply sources.

What is Being Done With the Dirty Oil?

Buyers already in receipt of the dirty oil are now obligated to store it until they can obtain enough crude with lower chloride levels that they will be able to mix the two together and dilute it to within allowable levels. Oil trading sources cited by Bloomberg said that this effort could be exceptionally costly.  Every tanker’s worth of contaminated crude could cost millions of dollars to dilute.
Ust-Luga’s tankers of contaminated oil may be gradually added to ships containing crude with lower chloride levels in order to use it up over time while keeping contamination within acceptable levels.
However, the challenge of cleaning the Druzhba pipeline will be a considerably more challenging one, said the experts. Neither Poland nor Germany have sufficient storage tanks available to set aside the contaminated oil for the length of time it would take to dilute it with higher quality crude.
As a result, the pipeline’s flow needed to be reversed in order to send the contaminated oil back to Russia or to the Gdansk port in Poland, where it can be flushed out of the pipeline.
The dirty oil received by Belarus may be shipped back to the Russian Novorossiisk Black Sea port via rail in order to dilute it there. Shipping crude by railway is a slow process as it maxes out at 300,000 tonnes of crude per month, say traders cited by Reuters.
Recent estimates are that the pipeline will take six to eight months to be fully decontaminated.  Oil output from Russia have reached a 12 month low.  Rosneft, Russia’s largest oil producer, accounts for the majority of the reductions, having decreased its cuts by 2.9 percent in May.

Not All Russian Oil Output Plummets

On the other hand, the country’s second oil producer Lukoil squeaked upward by 0.7 percent.  Similarly, Gazprom Neft was able to send its output skyward by 4.7 percent.  Both companies are not connected to the pipeline.  Instead, they each expert from their own Arctic terminals.