Asian buyers shun Russian commodities as payment concerns mount

Many Asian buyers have been backing off from a wide range of Russian commodities like oil, gas, coal and the chartering of Russian vessels on growing uncertainty over payments and widening efforts to sever Moscow from the global financial system, traders said.

The uncertainty stems from an increasing number of Russian energy companies and banks getting entangled in international sanctions, forcing Asian banks to take precautionary measures and stop issuing Letters of Credit for trading or purchasing Russian commodities.

Market participants were worried restrictions on the Russian financial system could start to resemble the Iran sanctions that eventually led to secondary sanctions on any entity that entered US dollar trades with an entity designated by the US Department of the Treasury's Office of Foreign Assets Control, or OFAC.

A Singapore-based trader said that even with the US providing a general license to exempt energy payments, many buyers and importers are simply not willing to take the risk because of how rapidly the situation is evolving.

The US, Canada, and European allies on Feb. 26 agreed to impose new financial sanctions on Russian banks, including curbing access to the SWIFT messaging system, but the specific measures and names of Russian banks are yet to be specified.

Large risk-averse banks have started limiting trade finance for Russian commodities markets and compliance teams in banks, financial institutions and trading houses are working overtime to assess and limit exposure to Russian commodities, traders said.

They said if US dollar-denominated payments are blocked, commodity traders using alternative currencies, banks and clearing houses could find remaining channels close rapidly in coming weeks too.

During the Iranian sanctions, businesses preferred to avoid sanctioned entities entirely to avoid cumbersome compliance reviews and legal scrutiny.

Trade disruptions

OFAC has targeted Russia's large financial services sector. OFAC said that the sector, which is heavily dominated by state-owned actors, relies on the US financial system to conduct business activities both within Russia and internationally.

It named several energy-related state actors -- the world's largest natural gas company Gazprom, Gazprom Neft, one of Russia's largest oil producers and refiners, Transneft which manages Russia's network of petroleum-related pipelines, hydroelectricity company RusHydro which is also one of Russia's largest power companies and Sovcomflot -- one of the world's largest shipping fleet owners. It also included Russia's largest bank Sberbank.

Pushback against these state actors have begun to emerge.

Chinese independent refiners raised concerns that the sanctioning of Russian shipowners creates problems like opening Letters of Credit that prevent traders from supplying them with Russian crude.

This could make it hard for Shandong-based refineries to buy Russian crudes even if they wanted, and so for the time being, most independent refineries prefer to watch and see how the situation evolved.

Charterers were unwilling to use ships owned by Russia's state shipping company Sovcomflot for routes such as the Kozmino-North Asia route and from the Sakhalin-1 DeKastri Terminal in the far east, Singapore-based shipbrokers said.

Sovcomflot operates one of the largest Aframax tanker fleets, the most popular tanker size for far east ports to move ESPO and Sokol crude grades.

Shipping sources said charterers on this route were rushing to complete their shipments before more sanctions kick-in, while a VLCC broker said many shipowners were holding back their ships in anticipation that freight rates would surge as disruptions increase ton mile demand.

Other commodities such as LNG, coal and agricultural products were also facing similar pushback amid legal advisories warning businesses to scrutinize all counterparties for Russian entities, regardless of exemptions.

Secondary sanctions risk

In 2012, secondary sanctions imposed on the Central Bank of Iran were aimed at curbing oil exports, and the subsequent oil embargo specifically targeted Iran's tanker fleet, National Iranian Tanker Company, or NITC, that was rapidly cut off from global maritime insurance.

Over the years, the NITC fleet fell into disrepair as it could not access spare parts and yards for maintenance, with many VLCCs eventually being used for floating storage. Iranian banks were also cut off from the global SWIFT messaging service.

Russia has access to alternative messaging systems like its own System for Transfer of Financial Messages, or SPFS, and China's China International Payment System, or CIPS, but both have a much smaller share of payments. According to Barclays, only around 2% of SWIFT global payment messages by value were in yuan, while 40% were in US dollar and 35% in euro as of 2020.

Goldman Sachs said late Feb. 27 that the absence of SWIFT intermediation would result in slower payments and the rise in account receivables for Russian commodity exporters rather than a complete halt in financial transfers.

"Limiting access to foreign reserves for Russia's Central Bank could have a larger impact, as it could restrict trade to be conducted through Ruble or gold," the bank said.

"With 65% Russia's Central Bank foreign reserves mostly held at correspondent banks in the West, sanctions that would prevent their access could force a sharp contraction in Russia's foreign trade to a level that matches its current account debit, as the accumulation of G7 FX currencies becomes unattractive, or would likely require exporters to sell in RMB," GS said.

"While commodity exports would be prioritized as a source of foreign credits, such a measure could lead to potential energy export suspensions from Russia, although at the rapid cost of having to shut-in gas and oil production given the lack of export outlook, a costly and slow-reversed process," the bank added.