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Russia’s Dirty Oil Crisis Leaves Pipe Giant With a Few Scars


By Olga Tanas and Dina Khrennikova

As the biggest disruption to Russian oil flows in decades draws to a close the country’s European market looks remarkably unscathed, but its pipeline operator bears a few scars.For Transneft PJSC — the giant company that runs enough pipes to wrap five times round the Earth — the worst didn’t happen. There’s little sign that buyers are turning away from Russian crude, despite the crucial Druzhba supply network being shut down for weeks by chemical contamination.Yet the relief of retaining customers will be tempered by large compensation claims yet to be resolved, and potentially costly changes happening in Transneft’s domestic operations.The Druzhba incident “exposed weak links in the Russian oil transportation system,” said Vitaly Yermakov, senior research fellow at the Oxford Institute for Energy Studies. The way Transneft responds “will become a litmus test” for the company and Russian energy regulators, he said.

Tainted Crude

The Druzhba crisis started small, with warnings in April about high levels of organic chlorides in Belarus’s portion of the pipeline. But it rapidly morphed into an international incident. It emerged that Russia, which has always prided itself on being a reliable energy exporter to Europe, had pumped millions of barrels of tainted oil to customers.

The mistake brought the country “very serious damage” economically, financially and in terms of public image, according to President Vladimir Putin.

“It’s the first time we are facing such a situation,” Transneft spokesman Igor Dyomin told Bloomberg. “It’s still too early to make any wrap-up analysis but we’ll definitely do it.”

Compensation Costs

Responsibility for fixing the crisis fell on Transneft, which manages a network of almost 69,000 kilometers (42,900 miles) of trunk pipelines that link up to Europe in the west and China in the east. In the weeks since the contamination first emerged, it has scrambled to remove tainted crude, get clean oil flowing again and reassure customers that losses will be covered.

Transneft hasn’t yet given an estimate for the cost of that pledge. The sole benchmark for the potential financial fallout is an agreement between the pipeline operator and its counterpart in Kazakhstan. Some supplies from the Central Asian nation were also contaminated because it sends crude through the Russian network to the Baltic port of Ust-Luga.

Transneft estimates that 22.2 million barrels of oil were contaminated by across all affected countries. If the compensation rate paid to Kazakhstan of $15 a barrel were applied to all of this crude, it could amount to hundreds of millions of dollars.

Running Smoothly

While the costs of the crisis remain uncertain, the impact on the oil market has eased considerably.

Transneft started gradually resuming clean crude shipments in May, and from July 1 customers’ delivery requests were being “fully met.” That means Germany, Hungary, Poland, Slovakia and the Czech Republic should once again be receiving about 4 million tons of clean oil every month via Ukraine and Belarus, Transneft said.

The problem isn’t entirely resolved. Crude flows in Poland and the Czech Republic were briefly halted last month when excess organic chlorides were detected again. On Friday, Royal Dutch Shell Plc’s PCK Schwedt plant stopped taking Russian oil for the same reason.

Overall, the European market showed resilience to the Druzhba disruption, said the Oxford Institute for Energy Studies’ Yermakov. Affected countries were able to tap oil inventories to ensure refineries continued to work, he wrote in a June research paper.

In response to the incident, Polish refiner Grupa Lotos SA said it has explored “opportunities for diversification” of crude supplies and studied technical solutions that could limit the impact of low-quality oil in the future, but doesn’t currently see any reason to change its supply model.

“For decades, the Druzhba pipeline has been running smoothly with a few exceptions,” said Alexander von Gersdorff, spokesman for German refiner and fuel-supplier association MWV. “The nationwide supply of mineral oil products was ensured at all times. There is no reason for a change of strategy.”

Transneft has “not noticed any changes in attitude of our European counterparts to Druzhba supplies,” Dyomin said.

Cheapest Supplies

European customers “don’t consider Russia to be an unreliable supplier,” said Dmitry Marinchenko, a senior director at Fitch Ratings Ltd.

Refineries in eastern Europe were designed in Soviet times to process Russian Urals crude supplied via the Druzhba pipeline, Marinchenko said. For several years they’ve been trying to reduce their dependence, but the country’s export blends still account for 70% to 75% of the feedstock for facilities in Poland, the Czech Republic, Hungary and Slovakia, according to last year’s annual report and presentations from PKN Orlen SA, Lotos and MOL Group.

The continent’s refiners could put diversifying their suppliers “higher on the agenda” or seek to change the wording of contracts, but due to geography and logistics “it would be difficult for European consumers to find cheaper supplies,” Marinchenko said.

Home Turf

It’s within Russia that Transneft may need to make the largest changes.

The crude was contaminated with organic chlorides at a remote collection point of the pipeline network in central Russia, according to investigative authorities. Transneft doesn’t control that section, along with around 150 other collection points along its pipeline system. They are owned either by oil majors or third-party companies, Transneft President Nikolay Tokarev told Putin at a meeting at the end of April.

“We need to change the system,” Putin replied. Now Transneft aims to become the operator of all privately-owned points linked to its pipes.

The company has already tightened oil-quality control. Under Russian standards, Transneft has to check daily for sulfur and paraffin content in the shipped oil, but only once every 10 days for organic chlorides, according to the Oxford Institute for Energy Studies. Now the company has switched to monitoring 11 metrics for oil quality on a daily basis, including organic chlorides, Dyomin said.

These changes may come at a price for Russia’s entire oil industry. “Greater control and more checks may increase costs for Russian oil producers at a time when their low-cost legacy is already expiring,” Yermakov said in the June paper.

(Updates with Transneft spokesman comment in seventh paragraph.)


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