Ukraine invasion: how much Russian oil will China soak up after the US, Britain announce embargo?

• China is expected to absorb incremental amounts of Russian oil following an import ban imposed by the United States and Britain
• However, uncertainty over shipping and fears of secondary sanctions mean the amount will be limited in the short term, analysts say

China’s ability to absorb more Russian oil is limited in the short term due to payment issues, but discounted crude shunned by other buyers could become increasingly attractive if inflationary pressure mounts this year, experts said.

Western sanctions on Russia have escalated following its invasion of Ukraine, with the United States and Britain announcing bans on Russian oil imports on Tuesday, though the European Union, which relies heavily on Russian energy products, has not followed suit.

The Kremlin said it would restrict exports of some goods and raw materials in response to the sanctions, without defining what would be included.

China is expected to absorb incremental amounts of Russian oil by circumventing financial sanctions, as it did with Iran and Venezuela in the past few years. But its ability and willingness to do so depends on the time frame, according to Michal Meidan, director of the China Energy Research Programme at Oxford Institute for Energy Studies.

“In the near term, the ability to soak up more crude is limited as demand growth is uncertain and the financial mechanisms are unclear,” Meidan said.

Russia was China’s second largest crude oil supplier in 2021, accounting for around 15.5 per cent of total imports, according to data from Chinese customs.

In February, while announcing their friendship had “no limits”, the two countries struck a 10-year agreement for Russia to supply 100 million tonnes of crude oil to northwestern China.

But since Russia’s assault on Ukraine started two weeks ago, Chinese spot buyers of Russian crude have refrained from closing deals temporarily due to uncertainty around shipping and fears of secondary sanctions, according to a note from S&P Global Commodity Insights on Wednesday.

“They will want to avoid being cut off from global markets and having their operations limited,” Meidan said.

“In principle, China will not cut itself off from Russian supplies. The reality, however, is more complicated given that most transactions are still settled in US dollars.”

The US and its Western allies have decided to exclude selected Russian banks from the Swift financial messaging system, leading some of China’s state-owned banks to stop issuing letters of credit for trading or buying Russian commodities, according to Bloomberg.

That has prompted some Chinese refiners to trade using cash transfers to maintain seaborne crude imports from Russia’s Far East, Reuters reported.

Chinese refiners will adjust their buying strategies again once it becomes clear if they are exposed to secondary sanctions and when they figure out workarounds for payment, Meidan said.

Some trade will shift to settlement in yuan using China’s Cross-Border Interbank Payment System (CIPS) as an alternative to Swift, though few oil market participants are familiar with the Chinese system.

“Using CIPS will take time to set up and it remains unclear to what extent Russian sellers are willing to move wholesale to the yuan,” she said.

But the discounted crude from Russia could be more appealing to Chinese refiners later in the year, especially if prices remain high, Meidan said.

Beijing has asked state refiners to consider suspending exports of petrol and diesel in April amid shortage concerns, according to a Reuters report citing anonymous sources on Wednesday.

Nevertheless, even though China has the appetite for more Russian crude, demand cannot grow indefinitely, experts said.

“In the long term we expect that the Russian economy can strengthen the links with mainland China, its largest trade partner,” said Jakub Kwiatkowski, a senior economist at IHS Markit.

“On the other hand, we believe that mainland China is not able to absorb the whole sanctions-related trade shift.”

Author: Ji Siqi, SCMP