Published June 20, 2023
The U.S. and the Russo-Ukraine War
Issue
The Russo-Ukraine War dramatically threatens some of our vital national interests. We must either protect those interests by taking an active role in ending the conflict on favorable terms and shaping the post-conflict peace or allow Putin to shape them for us. Given Russia’s nuclear-saber rattling, the main challenge for the U.S., then, is shaping the path to that post-conflict peace without Russia blowing up the world.
Executive Summary
Two global struggles will define our world for decades to come. The first is China vs. the U.S. The second is Russia vs. the West. For the U.S. and the West, Russia made itself the most urgent of the two issues when it invaded Ukraine.
The U.S. has a number of vital national interests at stake in Ukraine.
– The U.S. has a vital national interest in upholding the principle that the world will not tolerate the changing of international borders by force. It is highly relevant in Ukraine specifically, because the U.S., UK, and Russia guaranteed the territorial integrity of Ukraine in the 1994 Budapest Memorandum.
– The U.S. has a vital national interest in ensuring that neither Europe nor the Pacific are controlled by a hostile power.
– The U.S. has a vital national interest in avoiding war with China, China’s President Xi is undoubtably using the Ukraine war to assess Western (U.S.) resolve, while Japan, Korea, Australia, and Taiwan are already arming in reaction to China’s increasing belligerence.
– The U.S. has a vital national interest in Ukraine unambiguously defeating Russia militarily and ejecting Russia from Ukrainian territory seized since 2014. This will leave Ukraine as a strong, Western-oriented democratic state uncorrupted by oligarchs and Russian infiltrators, enhance European security and allow 2 million Ukrainian refugees to go home. Conversely, any settlement which leaves Russia holding any Ukrainian territory will leave a festering, potentially violent flashpoint on the border of four NATO countries, leave Europe with a long-term refugee crisis, cement the artificial distortions in the world’s energy markets and trade finance system and stunt world GDP growth for decades to come.
– The U.S. has a vital national interest in ensuring that the post-conflict Russia does not become a subjugated or failed nation state.
– The U.S. has a vital national interest in protecting the U.S. Dollar as the world’s preferred reserve currency and the medium of international trade finance and all countries conducting the banking transactions via a transparent and well-regulated western banking system.
For its part, Ukraine has showed that it is determined to fight for its sovereignty. However, despite successes on the battlefield, Ukraine has limited manpower reserves and cannot pay for a long war. For its part, the myth of Russian military prowess has been destroyed and Russian industry has been hard-pressed to produce sufficient munitions to keep up with expenditure rates. However, Russia has vast manpower reserves, and its economy is growing slightly despite Western sanctions. It can fight a long war, but its system cannot respond to a sudden escalation.
The central questions for the U.S. right now are to define our vital national interests at stake, whether to play a decisive role in the war and, if so, how to do it, and how best to engage the American people to support U.S. participation, either de facto or de jure, in an armed conflict.
Background
Two global struggles are underway right now that will define our world for decades to come. The first is China vs. the U.S., a struggle between the Chinese communist dictatorship-oligarchy and the capitalist, democratic countries of the world. That contest involves the entire Asia-Pacific region, source of circa 75% of the world’s GDP, and is currently playing out in diplomatic, economic, technological, military, financial, and political spheres. The second issue is Russia vs. the West, with the West trying to maintain the rules-based international order and Russia trying to reestablish its old empire through intrigue, intimidation, and military force.
Russia forcefully became the most urgent of the two issues for the U.S. when Russia invaded Ukraine, openly flouting the post-WWII convention prohibiting changing of international borders by force and, for the first time in 80 years, making real the danger of a nuclear confrontation.
For the past year, the U.S. – and NATO -have been incrementally increasing its involvement in the war. This is increasing the chances that Russia could feel the necessity to escalate the war. If Russia does escalate, it will present us with the hard choice – for which we are not currently prepared – of whether to match the escalation and widen the conflagration or to capitulate. (See Tab A for background on how the U.S. chooses to go to war and the conditions under which it has made peace. See Tab B for details on the war’s impact on the U.S.)
The central questions for the U.S. right now are whether to play a decisive role in the war, if so, how to do it, and whether to engage the American people to support U.S. participation, either de facto or de jure, in an armed conflict. The U.S. also faces an issue of timing. Experience has shown that the U.S. must take a decisive role in the conflict now if it is to have a role in shaping any post-conflict peace. These questions need to be answered sequentially, and they need to be answered soon if we are to have a voice in the outcome or avoid just backing into the next conflict.
Our vital national interests that are at stake in Ukraine are easily discerned. We can also determine our desired end-states. In fact, the war has reached a point at which we can now start discussing the post-conflict peace, rather than the immediate tactical goal of helping Ukraine not lose a war. However, that statement of our vital national interests needs to come from the President, be delivered to the U.S. people via the Congress, and Congress needs to vote and approve it – if we are to be successful.
U.S. interests
At the international level, the U.S. has a vital national interest in upholding the post-WWII axiom that the world will not tolerate the changing of international borders by force. It is highly relevant in Ukraine specifically, because the U.S., UK, and Russia guaranteed the territorial integrity of Ukraine in the 1994 Budapest Memorandum. The immediate danger at that time was nuclear proliferation. However, the Memorandum was based on that principle that international borders cannot be changed by force. For its part, since the 1994 Budapest Memorandum, Russia has invaded its neighbors three times, unchecked by the West, to extend its influence and threatened several other invasions.
The U.S. has a vital national interest in ensuring that neither Europe nor the Pacific are controlled by a hostile power. The numerous American military cemeteries in both regions from the 20th Century are stark reminders of what happens when we ignore that need. For his part, Putin portrays the war as the West trying to destroy Russia. In reality, the Ukraine war is just another step in Putin’s effort to re-establish the Russian Empire and, through it, intimidate Europe, which we cannot allow.
The U.S. has a vital national interest in avoiding war with China, which would occur of China invades Taiwan. China’s President Xi is undoubtably using the Ukraine war to assess Western (U.S.) resolve, while Japan, Korea, Australia, and Taiwan are already arming in reaction to China’s increasing belligerence. Ukraine not prevailing in its war, despite U.S. support, could easily set us on the path to a much larger Sino-U.S. war – in which we might not prevail. The U.S. needs to disabuse China of any notion that the West lacks the resolve to defend its interests, thereby avoiding an exponentially larger conflagration in the Pacific.
The U.S. has a vital national interest in Ukraine unambiguously defeating Russia militarily and ejecting Russia from Ukrainian territory seized since 2014. A victorious post-war Ukraine would be a strong, Western-oriented democratic state uncorrupted by oligarchs and Russian infiltrators. That Ukrainian victory would enhance European security and allow 2 million Ukrainian refugees to go home. Conversely, Ukrainian failure to eject Russia or a ceasefire which leaves Russia holding any Ukrainian territory will leave a festering, violent confrontation on the border of four NATO countries. It would also leave Europe with a long-term refugee crisis, with the circa 2 million Ukrainian refugees now outside Ukraine. Finally, since U.S. sanctions would stay in place, it would cement the artificial distortions in the world’s energy markets and trade finance system and stunt world GDP growth for decades to come.
The U.S. has a vital national interest in ensuring that the post-conflict Russia does not become a subjugated or failed nation state. Rather, the U.S. needs to see a post-war Russia re-integrated as quickly as possible into the world economic, trading, and trade finance systems. Befriending a stable, pro-west Russia will dramatically lower the danger of a Sino- U.S. war with Russia as a Chinese vassal state.
The U.S. has a vital national interest in protecting the U.S. Dollar as the world’s preferred reserve currency and the medium of international trade finance. The U.S. also has a vital national interest in returning to an oil and gas market driven by market forces rather than clandestine sanctions busting. Too, the U.S. has a vital national interest in all countries conducting the banking transactions via a transparent and well-regulated western banking system.
Dynamics of the War
U.S. vital national interests and reasons for becoming involved in the Ukraine war have not changed since the war began. However, the conditions have changed dramatically as the war has progressed. Ironically, this has made our options more clear.
On the eve of the Russian invasion, Ukraine was a developing, increasingly western-oriented country beset by widespread corruption, weak governmental institutions, significant pro-Russian domestic sentiment, and a weak national identity. Fifteen months of war have acid-washed Ukraine, stripped away the corruption, dramatically strengthened the national identity, and built an effective government. It has also tied Ukraine physically to western Europe through road and rail networks, IT infrastructure, refugee flows, and military material. Unfortunately, it has also saddled Ukraine with immense debt that Ukraine will struggle to repay even if it prevails in the war. (See Tab C for key facts on Ukraine’s current situation.)
Concurrently, the war has destroyed the veneer of invincibility of the Russian armed forces and pushed Russian demographics and economy to the point of anarchy. It has also severed Ukraine’s physical links to Russia, forced Russia closer to China, and caused a significant number of Russia’s educated elite to flee Russia. Despite Western sanctions and adverse demographics, Russia has protected its civilian population from a declining economy, inflation, or falling standards of living. (In fact, Russian GPD will likely grow 1% this year.) Russia also has the monetary resources to maintain its war effort for years, if need be. However, its industry has been hard-pressed to keep up with the Russian Armed Forces’ weapons losses and munitions expenditure rates. In other words, Russia can sustain a long war, but not a rapidly escalating war. (See Tab D for key facts on Russia’s current situation.)
Outside the area of armed combat, the war has re-shaped key parts of the world economy. It has changed the flow of the world’s oil and gas resources and exposed the vulnerability of the world’s undersea commercial infrastructure. It has dramatically expanded NATO’s direct Russo-NATO border, which dramatically expands the possibility of direct NATO-Russia confrontation. Finally, it has encouraged huge trading blocs and trade financing to be set up outside the scrutiny of the Western regulatory and banking system and threatened the U.S. dollar as the medium of world trade finance. (See Tab E for key facts on the current direction of global oil markets.) Ultimately, if mis-managed, the end of this conflict could open the door to 50 years of conflict in Europe, truncate the world’s GDP growth, and set the stage for a Sino-U.S. war over Taiwan.
Goals vs. A Plan
President Biden clearly set out U.S. goals in Ukraine in a 31 May 2022 essay in the New York Times, writing that, “America’s goal is straightforward. We want to see a democratic, independent, sovereign, and prosperous Ukraine with the means to deter and defend itself against further aggression.” However, President Biden has never explained to the American people the vital U.S. national interests at stake, presented his plan for protecting them, or solicited their support. If the American people don’t know what our vital national interests are, they cannot decide what they will support. And, if we cannot say what we will do to defend our interests, Russia certainly cannot calculate whether any escalation it makes will spark another World War.
The essential tasks for the U.S. right now are for the President to clearly articulate our vital national interests in the new international context, explain them to the American people, and win the support of the American people via the Congress for any U.S. participation in the conflict. Failing to accomplish these tasks will likely doom our efforts there.
Policy Recommendations
We can and should help Ukraine bring the war to a rapid conclusion. However, any conclusion other than a decisive, unambiguous Russian military defeat and expulsion from all Ukrainian territory will likely just set the stage for the next war. Accordingly, we must shift from our current policy of restricting Ukraine’s combat abilities to one of rapid defeat of Russian forces inside Ukraine.
The U.S. must be clear about our policy goals. Continued U.S. ambiguity allows Russia to believe that it can create divisions inside the western alliance and cause support for Ukraine to collapse. Western resolve in dealing with Russia will likely moderate China’s behavior far more than any negotiated Russo-Ukraine cease-fire.
The U.S. should not allow post-war Russia to descend into chaos. We can push for regime change and for Russian war criminals to face justice. However, we must not allow post-conflict Russia to become a failed state or follow the path of 1930’s Germany into the abyss of fascism. And, announcing this will tell the Russian people and Russian military leadership that they have an exit from this conflagration that will save their position in the world.
We need to reintegrate Russia into the world economic system as quickly as possible after the peace in order to disrupt the development of alternative, secretive trade systems – especially for oil and gas – outside of western business norms and transparency.
We must reintegrate Russia into the western banking system as quickly as possible after a peace settlement in order to forestall the development of alternative trade finance systems, which are outside western standards of regulation.
Tab A: How the U.S. Goes to War and How it makes Peace
Armed conflict is the foreign policy option of last resort. It is the most intense, resource consuming, and unpredictable endeavor that a country can undertake. For a democracy, going to war is likely the hardest decision that it must ever make. If committing to that course of action, however, a country must have a clear vision as to why it is going to war and the desired end-state if it is to have any chance of achieving its war goals. And, despite having a certainty of purpose at the beginning of a conflict, the unpredictable, dynamic nature of war means a country must be prepared to re-evaluate that desired end-state.
For the U.S., the Founding Fathers deliberately vested the power to declare war in the Congress, not the President. In practice, declaring war forces the President to publicly solicit the support of the American people via the Congress – and gain their assent. Making the case requires the President to articulate publicly why the U.S. needs to go to war and what the end state needs to be. This process is what links the American people to any war effort.
Our Constitutional process has served the U.S. very well. Conversely, when the U.S. has failed to follow that process, as it did with the Korean War, Viet Nam, Somalia, Yugoslavia, Iraq and Afghanistan, the U.S. war effort has lacked strategic direction, our war aims drifted, the conflicts lost public support, and, ultimately, end results ranged from undesirable to disastrous.
War’s unpredictable nature also means that initial goals will change during the conflict. In every case in our own history, why the U.S. has gone to war has had little semblance to the conditions under which we made peace. The American Revolution started to force the British monarch to respect our rights as English subjects. A year after the initial combat, the U.S. declared its independence. A key grievance driving the U.S. to war in 1812 was the Royal Navy’s impressment of U.S. sailors on the high seas. That offense wasn’t even mentioned in the Treaty of Ghent. The U.S. war aim in 1941 was to defend the U.S. from attack. A year later, our war aim was the unconditional surrender of the Axis powers.
That pattern has held in every conflict in which the U.S. has engaged since 1775. In most cases, we could not articulate our final war goals until at least a year into the conflict. That pattern very much applies to the war in Ukraine. The situation in Ukraine that existed on the eve of the 2022 Russian invasion is far different than it is today. Accordingly, our desired end state must change, also. If anything, the wide-spread dangers for the U.S. have become more clear and the need to set forth a plan more compelling.
Tab B: Ukraine War Effects on the U.S.
U.S. military support for Ukraine has revealed severe shortages in the U.S. military logistics infrastructure. The U.S. and Europe are rapidly using up their stocks of various munitions, which we won’t have if a war breaks out in Asia. Perversely, U.S. efforts to keep China from supply war materials to Russia is allowing China to stockpile critical munitions while the U.S and Europe expend theirs in transfers to Ukraine.
Defense contractors produce only what munitions they expect that their governments intend to buy. At present, U.S. munitions manufacturers are sized to produce only what the U.S. will use in peace-time training. Limiting any flexibility, the limited industrial infrastructure built to produce munitions at peacetime rates cannot expand rapidly to meet sudden war time requirements.
Cannon artillery is one of the most effective and widely used weapons by both Ukraine and Russia. Ukraine is firing 4,000 to 7,000 shells per day. Russia is firing an estimated 20,000 rounds per day. For Ukraine, the 155mm round is most requested. So far, the U.S. has given Ukraine 1.5 million shells. In doing so, the U.S. seriously depleted its stocks of 1555mm rounds, which it cannot replace quickly enough.
Currently, the U.S. can make 180,000 155mm rounds per year; Europe can produce 300,000 155mm shells per year. If combined and sent exclusively to Ukraine, total U.S. and European manufacturing is 1315 rounds per day, less than 25% of Ukraine’s daily usage rate. The U.S. Army has set aside funds to expand 155mm shell production. However, it will not increase production until 2025.
We have seen shortfalls occur in other areas, too. In the 2011 bombing campaign against Libya, the Europeans ran out of precision-guided bombs in 3 weeks; the U.S. made up the shortfall. During the anti-ISIS campaign in Iraq, the U.S. ran very low on precision guided bombs. Rapid depletion of Stinger Anti-Air missiles and Javelin Anti-tank missiles portend future supply problems. According to Mark Cancian at CSIS, replacing the 8,500 Javelins already received by Ukraine will take seven years.
Tab C: Ukraine War Effects on Ukraine
Closer to Western Europe
Ukraine is now physically tied to western Europe through new road and rail networks, IT infrastructure, refugee flows, and provision of NATO-standard military material. Ukraine has also been given tariff-free access the EU.
Solidification of Ukrainian national identity
Many Ukrainians are paying their taxes early and are paying more than required. Many Ukrainians living ex patria have also started paying taxes. Astonishingly, Ukrainians living in Russia-occupied areas are paying Ukrainian taxes via on-line portals.
Stronger Government institutions
The need for tax revenue has also led to a crackdown on government corruption, including the dismissal of many tax collectors for corruption.
Refugee Situation
Circa 2 million Ukrainian refugees in Easter Europe, mostly in Poland
81% have said they intend to return to Ukraine as soon as it is safe.
Economic trends, forecast, and dangers
Ukraine’s GDP plunged by 29% in 2022, but tax revenues fell by only 14%. The war has saddled Ukraine with immense debt that Ukraine will struggle to repay even if it prevails in the war.
On March 21st the IMF announced Ukraine would receive the seventh-biggest bail-out in the fund’s 79-year history, $15.6bn over the next four years through an emergency program that may be approved by the IMF’s board (on which Russia has a seat) next week. (Economist, 30 March 2023)
Ukraine estimates that to continue financing the war this year, it will need $39.5bn more than it expects to receive from tax and aid, a shortfall equivalent to 9% of GDP. The IMF is expected to release at most $5bn this year. The rest, it says, should come from the likes of America, Europe and the World Bank. (Economist, 30 March 2023)
Even if Ukraine cobbles enough together to fill the gap, there is the matter of repayment. Borrowing from the IMF is expensive. (Economist, 30 March 2023)
Ukraine has to pay a basic interest rate of 3.5%. All told, Ukraine’s government could rack up rates of 7.5-8%. (Economist, 30 March 2023)
The IMF’s conditions typically revolve around restraining spending, which is not an option so long as Ukraine is at war. (Economist, 30 March 2023)
The nightmare would be crippling Ukraine with debts while it is still at war, or just beginning to recover. (Economist, 30 March 2023)
“There needs to be economic support for Ukraine but its allies should have borne the risk, not the IMF,” argues Mark Malloch-Brown of the Open Society Foundations, “and done so with grants instead of letting Ukraine rack up debt.” (Economist, 30 March 2023)
Tab D: Ukraine War Effects on Russia
Russia can sustain a longer war, but not a more intense war. Putin has successfully insulated the Russian economy and the Russian population from the economic effects of the war, but he has done so in a way that prevents Russia from winning the war quickly. In sum, Putin can sustain a long, drawn-out war, but cannot tolerate a sudden, rapid escalation.
Russia’s economy is starting to show the stresses of the war, but it is not crumbling.
The war effort right now appears to be costing Russia about 3% of its GDP, which is less than the U.S. spent during the Korean War.
The Ruble has lost 20% of its value relative to the U.S. Dollar.
Government revenues are falling, while military expenditures are ballooning. The gap between them in the first two months of 2023 was $34b, about 1.5% of the Russia’s total economic output.
In January and February, oil and gas tax revenue, which accounts for nearly half of Russia’s total budget revenue, fell by 46%. Meanwhile, state spending rose by 50%.
The IMF estimated in 2014 that Russia’s GDP would grow at 3.5%. Now, that growth looks to be around 1%.
A former Russian Central Bank official estimated that, for an economy like Russia, 1% growth was not enough to even just maintain the economy.
The IMF reported that Russia’s loss of human capital, isolation from Western financial markets, and impaired access to advanced technology will hamper the Russian economy.
The IMF projected the Russian GDP will now fall about 7% by 2027.
Russian war material manufacturing does have challenges.
Due to Russia’s 300,000-man military mobilization in late 2022, circa 200,000 battlefield casualties, and emigration of military-age men, Russia’s labor market is in the worst crunch since records started being kept 1993.
The Russian central bank reported that the Russian economy has 2.5 vacancies for every unemployed person, making the labor market twice as tight as the U.S.
By December 2022, according to FinExpertiza, the number of Russians under age 35 employed in Russia had fallen by 1.3 million.
As in Soviet times, Russia is trying to replace now-unobtainable Western technology, especially in the telecommunications and oil-drilling equipment and software, with lesser-grade domestically produced equipment. One Russia Central Bank official called the situation “reverse industrialization”.
Russia has not been able to replace the thousands of tanks, military vehicles, artillery pieces, drones, and aircraft that it has lost so far or munitions expended.
Russian arms exports have fallen dramatically as all weapons made are being sent to the Russian military.
To manufacture the high-technology weapons that it needs, Russia needs access to the Western-made high-end dual use items, such as computer chips and rocket motors.
However, Russian arms manufactures have not been able to keep up with the munitions expenditure rates or hardware losses of the Russian military.
The Consumer Sector
Russia has maintained its living standards, so far, and kept inflation under control.
According to Russian government data, retail sales fell 6.7% in 2022, the worst drop since 2015, while new car sales fell 62% in February 2023 over the same month in 2022.
Despite dire Western predictions, Russia’s GPD fell only 2-3% in 2022 and will likely grow a bit in 2023.
Putin recently said, “Of course, national defense is the top priority, but in resolving strategic tasks in this area, we should not repeat the mistakes of the past and should not destroy our own economy.”
Russia still does have options to fund the war
Its sovereign wealth fund has about $150b, about 10% of Russia’s GDP, even after spending $300bn last year. That said, Russia’s sovereign wealth fund assets are not very liquid. Russia can raise money, but not quickly.
Last year’s huge energy exports have left Russia’s energy sector siting on large amounts of cash. The Russian government could tap through a windfall profits tax or compulsory bond purchases.
Russian financial institutions hold assets sufficient to cover 10 trillion-ruble deficits, if the Russian Government should decide to tap them.
The West has frozen about $100bn in Russian assets, but $3bn are still liquid.
Moscow has become reliant on China
After being expelled from SWIFT, about 66% of the Russian banking system cannot process US Dollar or Euro transactions.
China’s economy is roughly 10 times larger than Russia’s.
China now sells twice as much to Russia as it did pre-invasion.
Average daily transactions using CIPS, the Chinese equivalent of SWIFT, have increased 50%.
In Dec 2022, 16% of Russian exports were paid for in Yuan.
Russia has Become Adept at Evading Western Sanctions
Parallel imports (to Russia from a third county) have soared.
Companies in Armenia and Serbia are suddenly major purchasers of Western telecom equipment.
Armenia’s imports from the EU mysteriously doubled after 2022.
Serbian exports of phones to Russia grew from $8,518 in 2021 to $37m in 2022.
Russian Challenges
If the war became more intense, Russia would have to dramatically increase defense spending. The only ways to ramp it up quickly – raising taxes or printing money – would likely cause extreme inflation. And falling standards of living.
Shifting public sector spending to defense- taking benefits away from families and the elderly – would be very unpopular.
The efforts won’t clear manufacturing bottlenecks or shortages of skilled workers.
Tab E: Ukraine War Effects in the World Oil and Gas Markets
Armed conflicts affect seemingly unrelated issues. The price of oil, natural gas and refined products like diesel in the U.S. is a prime example. President Biden, upon taking office in 2021, asserted significant pressure on the U.S. fossil fuel industry to reduce gasoline production. The refiners complied, reducing domestic U.S. refinery output of gasoline by 4 million bpd by the end of 2022. Consumption, however, did not fall, which resulted in an 85% rise in the price of gasoline in the U.S. by early 2022.
The February 2022 Russian invasion of Ukraine upended the global markets for oil, natural gas and refined products, super-charging the U.S. gasoline inflation problem and leading to largest shift in the global energy market since the 1973 OPEC oil embargo. At the beginning of the war, Putin stopped the flow of most natural gas to Europe, while the U.S. imposed deep sanctions on the Russian oil industry and Europe shut off Russian oil. In December 2022, the U.S. and Europe enacted the deepest energy sanctions ever directed at any country. Europe banned seaborne imports of Russian oil and barred its shippers, lenders, and insurers from facilitating the sale of Russian crude above a benchmark price of $60 per barrel. A second round of sanctions went into force in February 2023.
For Russia and its partners, the reaction has been the growth of the gray-area oil trade. Cut-rate Russian oil has flowed into other markets, principally India and China through channels that the West cannot observe. Russian exports of crude oil in Jan 2023 were 3.7m bpd, more than any four-week period in 2021. Russian oil imports to China increased 180% by January 2023. Purchases by Indian refineries, which began buying Russian crude oil in early 2022, now equal China in volume. According to Reid I’Anson of Kpler, 25% of Russia’s oil exports went to China and India in 2021. Now, they import 90% of Russia’s crude exports. In addition, Russian crude shipments to Fujairah, UAE, are breaking records.
Russia needs its oil to see at $100/barrel to break even. Right now, it is selling for about $50/barrel. If gas and diesel sanctions bite, Russia is likely to export less refined oil products and more crude, which India and China will refine, then sell to the West as refined products. The “system” now encourages gray-market traders and non-Western countries to lie. The shadow trade is building a sub-rosa financing, insuring, and shipping infrastructure. An entire eco-system of shadow trading, opaque to Western finance regulators, is growing especially in Dubai and Hong Kong. The share of the Russian oil trade handled by Western infrastructure dropped from 50% in December 2022 to 36% February 2023.
The lesson for the West is that the impact of sanctions will fade as malign actors adapt and that, the war is causing major realignments in the global flow of oil and its products, but shunning Russian oil will not win the war.
Global oil production and refining trends
The U.S. and Europe
The U.S. is seeing the renewal of a 2020-2021 trend that saw a flurry of closures and conversions, amounting to a loss of around 4 million bpd of refining capacity, predominantly in the Atlantic Basin. Crude oil extraction and refining in the West is rapidly reorienting from its traditional east-west axis to a north-south axis. Major U.S. oil producers are withdrawing from projects in Russia, Asia, and Africa and investing in projects in the U.S. or Latin America.
The two largest U.S. oil companies, Exxon-Mobile and Chevron, pulled back from big international oil projects and are concentrating on a handful of more lucrative assets closer to home. The two plan to spend most of their annual budgets in the Americas this year, with Chevron saying it will pour 70% of the capital allocated for production into oil fields in the U.S., Argentina and Canada, and Exxon saying it will spend a similar portion of its budget in the Permian Basin of New Mexico and West Texas, Guyana, Brazil and liquefied natural-gas projects. (WSJ 04 Jan 2023)
Chevron has kept some international assets close to home. The U.S. has granted it a new license to pump oil in Venezuela again, after years of sanctions. So far, it has said it will only maintain existing assets while it collects debt from its state-run joint venture partner. Chevron would have to contend with myriad technical issues in Venezuela’s aging oil fields and take on political risk to expand there.
For its part, Europe is looking to other Mideast countries for oil and places like Qatar and Algeria for natural gas. New fields are coming online in Africa, while new mega-refineries in Saudi Arabia and Kuwait are poised to become new, major sources of gasoline and diesel fuel as old refineries in the West will likely be converted into greener processing plants.
In Europe, Italy’s Eni is likely to convert its Livorno site to a biorefinery by 2025. France’s Grandpuits is on track to be converted to a zero-oil platform in 2024 and start producing sustainable aviation fuel. Finland’s Neste considering switching its Porvoo refinery to “non-crude oil refining” as far ahead as the mid-2030s. For their part, refineries in Japan are proceeding with planned closures.
The Middle East
The first phase of Kuwait’s new 615,000 bpd al-Zour refinery started in November 2022. The start-up of the first unit will be followed by the second and third units to reach full capacity next year.
The commissioning and ramping up of other refineries in the Middle East including Saudi Arabia’s 400,000 b/d Jazan refinery, Iraq’s 140,000 b/d Karbala refinery and Oman’s 230,000 b/d Duqm refinery will increase the region’s crude runs to 9.30 million b/d in 2023. (S&P Global)
Saudi Arabia’s Jazan refinery will fill the void in Europe left by Russian diesel exports.
Russian diesel is likely to travel to the Middle East, where it will be blended with regional material before being shipped back to Europe, analysts suggested.
China
Two new refineries in China will achieve full capacity in 2023.
China’s 320,000 bpd Shenghong Petrochemical complex commenced commercial operations in November 2022. In October, another greenfield refinery in China, the 400,000 bpd Guandong Petrochemical, started trial runs.
Over the next two years, China could see the start-up of two more refineries: the 400,000 b/d Yulong Petrochemical plant and the 300,000 b/d Huajin Aramco Petrochemical complex.
China’s Shenghong and Guandong as well as Malaysia’s 300,000 b/d Pengerang Integrated Complex in the Johor state, which finally resumed operations in May, following an incident in 2020, have also added to global refining capacity.
China will likely increase key product exports, particularly gasoline and kerosene/jet.
Africa
Nigeria’s 650,000 bpd Dangote refinery was expected to open in 2023, but the project has experienced delays. Also in Africa, a 40,000 bpd complex is getting close to being commissioned in Ghana.
