Druzhba's lasting impact
Oil contamination on a key Russian export pipeline that shocked the markets may echo long after the fuel has been cleaned up
The pollution of the Druzhba pipeline with organic chloride may impact future consumer demand for Urals blend, while Russia's image damage and reputation risk could also be reflected in a price discount, according to industry analysts.
The crisis began on 19 April, when oil contaminated with highly corrosive organic chloride reached Belarus through the Druzhba pipeline, causing an equipment failure at the Belarusian Mozyr refinery. Diluting the ‘dirty oil' with other grades supplied to the plant by rail was unsuccessful. Ukraine and Poland, the Druzhba system's other transit countries to Europe, stopped receiving oil on 24 and 25 April.
Built in the 1960s, Druzhba (or Friendship) is one of the oldest Russian pipelines, delivering to refineries in Belarus, Poland, Germany, the Czech Republic, Slovakia and Hungary. It transports around 25pc of Russian total 257mn t 2018 crude exports. Up to 5mn t of contaminated oil was pumped through Druzhba, according to estimates by Belarusian state-owned refiner Belneftekhim.
The first priority is to resolve the technological issues and start piping clean oil, says Alexei Kalachev, an analyst at Moscow-based investment firm Finam. The crisis is expected to be partially resolved by the end of May, when the ‘dirty' oil will be taken out, diluted and sold at a discount.
But Urals blend was already facing criticism for its high sulphur level, and its buyers may look anew at reduced purchasing and finding alternatives, agree Kalachev and Belarus-based economics writer Tatiana Manenok. While Urals consumers and suppliers have long-standing relationships, and refineries are set up to process the Urals blend, should the financial losses resulting from the Druzhba interruption outweigh the cost of refinery adjustments, the inertia that has previously impeded switching may be overcome, Kalachev says.
Russian government concerns
Russian president Vladimir Putin met with Nikolay Tokarev, the president of Russian state-owned pipeline monopoly Transneft, responsible for 80pc of Russia's oil transport, at the end of April. During the meeting Tokarev pinned the blame on private companies engaged in fraud, while Putin criticised monitoring of oil exports for quality and said that private entities' "cheating" had created economic, material and serious reputation damage for "us".
In the wake of the Druzhba incident, the Russian government may pass legislation to once again prohibit the use of organic chloride compounds in the oil industry, according to Russian energy minister Alexander Novak. The Russian authorities allowed usage of organic chloride to clean up oil wells in order to increase oil production in 2012.
"Active work continues to normalise the situation of oil quality for our partners and European consumers," Novak said in May. Two parts of the Druzhba pipeline were still filled with oil of poor quality in mid-May, deputy prime minister Dmitry Kozak, who oversees the fuel and energy complex, told the media following a meeting with Igor Lyashenko, his Belarusian counterpart, on 16 May. One part is expected to be cleaned in seven days, another in 22 days, he said, although the former target appeared to have slipped slightly as Petroleum Economist went to press.
Who will bear the cost?
The Russian government says that damage caused by the Druzhba contamination stands at around or below $100mn, but the president of Belarus Alexander Lukashenko counters that it could be "hundreds of millions of dollars," according to Manenok. As well as damaged equipment, Belarus has lost out on transit fees and reduced refined products exports. Poland had to unlock its oil reserves to keep its refineries running.
The difference in damage valuation is a usual part of negotiations, and a consensus will be reached, Kalachev says. Transneft rarely has problems with its oil transit routes, and it is unlikely, in Kalachev's view, that it was fully insured against such an incident. Thus, the large part of the bills is likely to be Transneft's responsibility, he concludes.