Rising energy costs: Can South Africa look to Russia for cheap oil?

Rising energy prices, driven in part by the Russian invasion of Ukraine, are putting enormous pressure on South African consumers and businesses. One short-term solution suggested is to import cheaper crude oil from Russia on the back of our relationship with that country due in part to our membership of BRICS. Those imports will however face challenges, firstly with regard to the insurance of the cargo, the ship and the cargo owners, and ship owners’ liabilities should there be a pollution incident. Secondly, should the conflict not be resolved, the imports will face challenges with regard to the extension of EU and US sanctions to countries normally outside their jurisdiction. The sanctions can exercise influence over these trades through the global oil, insurance and finance companies who have a presence in the EU and/or US. Given Europe’s heavy reliance on Russian energy, the imposition of full sanctions has been delayed, but if the conflict is not resolved by December, the window of opportunity for cheap Russian crude oil imports will probably close.

The EU’s recent round of sanctions contains a complete import ban on all Russian seaborne crude oil and petroleum products which covers 90% of the current oil imports from Russia to the EU. This ban will however only come into effect after a six month transitional period. The sanctions will also include a ban on EU companies insuring or financing the transport of Russian oil whether to the EU or to third party countries. The effect of this is that, although the EU sanctions do not prevent South African companies from purchasing Russian crude either now or after the transitional period, there will be reluctance from December to transport oil in uninsured tankers or purchase cargoes that cannot be insured.

The effect of the looming ban on insurance and finance does not, at first blush, seem to affect South African importers simply because they take delivery of the cargo on discharge from the ocean going vessel. The vast majority of crude oil cargoes are however purchased on an FOB, CFR or CIF basis which means that risk of loss of the cargo passes to the South African buyer on loading in Russia. FOB and CFR buyers would have to arrange their own insurance and with CIF transactions, the seller would have to arrange insurance for loss of or contamination of the cargo.

Given that a significant volume of insurance is either placed or reinsured directly or indirectly through the EU insurance markets, traders may encounter difficulty in insuring the cargo.

This difficulty will extend to those shipowners and charterers who have to insure not only the ship itself, but also all of its potential liabilities to cargo owners and other third parties. These liabilities are extensive given the risk of pollution from a collision, grounding or similar catastrophe involving large tankers carrying crude oil.

The vast majority of the liabilities are placed through P&I Clubs or fixed premium P&I insurers and, again, the majority of those are based in Europe. The only significant exceptions are some Clubs which are based in the Scandinavian countries, the Japan P&I Cub and the Russian P&I Club. Most of those Clubs are however members of the International Group based in the UK and the International Group provides insurance cover above the amount borne by the individual Clubs.

Assuming that the ship owner or charterer can insure its liabilities and the cargo can be insured, the cover provided under the global regime introduced by the International Maritime Organisation may also be at risk. The IMO has created a liability and insurance regime under several oil pollution liability conventions which have been extended from crude oil to other products.

This regime provides for three tiers of compensation, the first of which is paid by the P&I Clubs. The second tier is governed by the International Oil Pollution Compensation Fund of 1992. The third tier is governed by the Supplementary Protocol of 2003 which provides further compensation up to a total amount of SDR750 million (approximately US$1 billion). The top two tiers are paid from a fund financed by contributions levied on any entity or person who has received more than 150 000 tonnes of persistent oil after sea transport in any calendar year.

This compensation regime has worked well for several decades in responding to the increasing cost of crude oil pollution in the event of a major casualty. The Pollution Fund, although not established exclusively from contributions from EU companies, is run in part out of the UK where the International Tanker Owners Federation is based. It is not yet clear whether this compensation regime will be affected by the proposed EU and UK sanctions after the transition period. No doubt, the Clubs and the Fund will come under enormous pressure to continue to deal with catastrophic oil spills from tankers even if they are Russian-owned or carrying Russian crude mainly because that regime is designed to compensate, not the shipowners or cargo owners, but the victims of the pollution incident who, in most cases, will not be Russian.

The US, which unlike the EU does not rely on Russian crude oil, has also imposed a ban on imports of Russian crude. That has not yet been extended to third party countries such as South Africa, but may be in the future.

The reality is that the majority of the companies, whether in South Africa or elsewhere, who trade in crude oil, have a global footprint and a presence in the UK, EU or US. This means that those sanctions can be given effect to by the EU or US taking action against parent or subsidiary companies in the EU and the US who breach the sanctions regime even if the crude oil goes nowhere near the EU or the US.

The current US sanctions which included a ban on Russian banks financing crude oil contained a waiver until 24 June have now been extended to 5 December to bring it in line with the EU transition period.

The cumulative effect of the above is that if the conflict is not resolved and the sanctions are not extended, UK, EU and US sanctions against insuring and financing Russian oil and the ships that carry it, will come into effect. It is unlikely that the victims of pollution will not be able to claim from the three tiers of the pollution regime. That is however a possibility, particularly insofar as the first tier claim against P&I Clubs is concerned.

In addition, particularly if the conflict escalates or any other countries are drawn into it, it is possible that the UK, EU and the US will extend the reach of their sanctions to include any trade in Russian crude oil regardless of where it is headed. Those sanctions could be given effect to should any of the parties involved carry on business in the UK, EU or US or if the trade is in US Dollars or Euros which have to pass thorough a US clearing bank and European clearing bank respectively.

For now, South African importers are free to trade in Russian crude, but need to be very careful about entering into long-term agreements or future contracts relating to Russian crude oil and refined products.