Drones hammer Russian, Ukrainian energy infrastructure amid push for peace deal

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Kelly Norways:

Hello and welcome to the Platts Oil Markets podcast, where today we're discussing the bitter drone war between Russia and Ukraine and its repercussions for the global oil market.

I'm Kelly Norways, an oil reporter based here in London, and today I'm joined by my news colleague, Nick Coleman and Elza Turner who specializes in refining and the Russian market. It's hard to escape news around the Russia-Ukraine war at the moment, at what feels like a key inflection point for the conflict as we've seen momentum build behind trilateral peace talks now potentially involving Vladimir Putin and Vladimir Zelensky after recent discussions in Washington involving the Ukrainian president and various European leaders.

But for all the positive mood music around talks in Washington and the best meeting yet over ending, the conflict, in Zelensky's words, talk of a ceasefire has been quietly sidelined, and drones have continued to fly across the border on both sides. And for Ukraine in particular, domestically produced drones have been one of the most effective tools that it has at its disposal to display a show of force and notch up pressure on Russia, particularly as the U.S. has pulled back on its sanctions threats to keep pressure up on Putin.

Nick, obviously we've seen a pretty significant escalation in drone attacks on Russian energy infrastructure in recent weeks. Can you qualify how we are seeing things look in the Russian market at the moment, or what the status is around drone attacks that we've seen in recent days?

Nick Coleman:

Thank you, Kelly. We've definitely seen an upsurge in Russia's oil infrastructure being a target in this conflict. Obviously, there's a wider context of Russian attacks on Ukraine, including on civilians in targets in Ukraine. But we are definitely seeing Ukraine targeting Russian oil infrastructure both locally or regionally in southwest Russia where you could perhaps see a direct connection to Russian military activity, but also an attack on the sector more widely. And this has got more ambitious.

It didn't start this year. Actually, it goes back to 2024, but we've also seen kind of displays of Ukraine's capability in long range drone attacks. We saw this the furthest, probably the furthest reaching drone attack on a refinery, just I think, last week this was the Ukhta refinery in the far north of the European part of Russia in the Komi Republic. So yeah, the gloves are off as far as Russian oil infrastructure is concerned, and also Russian oil pipelines, which are still used for getting some Russian crude oil into Europe, into Central Europe, not in the volumes pre 2022, but there are still a few countries using Russian crude oil that have exemptions from sanctions like Hungary.

One thing I think this shows, just to round off the answer, is actually Ukraine is feeling probably greater freedom in its choice of targets, ironically, in the era of Donald Trump than it did probably under the previous U.S. administration of Joe Biden, where certainly, I think there was a nervousness about knock-on effects for the global oil market for Russian exports. This could have a destabilizing effect on oil prices. And I think the message we heard back then was that the U.S. wasn't so keen on Ukraine attacking critical oil infrastructure from Russia to the outside world at least.

But perhaps there isn't that level of control being exerted. Perhaps Ukraine is experimenting a bit more. We did see an example of this probably in February when a critical crude oil pipeline from Kazakhstan going through southern Russia was actually hit by drones allegedly causing some short-term disruption to Kazakh oil exports through Russia, which is really a separate topic. It's quite complicated. But certainly, Kazakhstan was unhappy because they're not really a party to the war in Ukraine, and Kazakh oil production is supported by American and European companies.

Leaving that aside, I think it was an example where a lot of diplomacy then kicked in to try and say to the Ukrainians, if it was indeed them that initiated the attacks, "Let's keep away from the Kazakh infrastructure here." So yes, a long answer, but basically there's definitely an uptick in attacks on refineries and pipelines.

Kelly Norways:

Yeah, and it's a good point that you mentioned the politics behind all of this, because I suppose in any conflict with Russia, you often hear that energy exports account for something like a third of their revenues. That's what you might initially think that you'd go for if you were trying to wreak havoc on the Kremlin and really make them feel the economic pinch of attacks. And obviously, that's long been the fear of some of Ukraine's Western allies, fearing the inflationary price spikes that you might have in such a scenario. Which I guess is why you've had these drones really come into play, because a lot of the western arms that have been provided have had these strict requirements around initially only using munitions for defensive purposes. And that's why you've seen Ukraine really pivot to ramping up its own domestic production of these drones. So it's interesting how that's really become such an important tool for Kiev to utilize in recent years.

Nick Coleman:

It is an incredible kind of thing that has happened in Ukraine with the self, home-manufactured drones in Ukraine. So we are obviously not military analysts, but as you say, that's definitely been a big factor of Ukraine building up its defense capability.

Kelly Norways:

Yeah. And the timing is interesting. Obviously, you mentioned that CPC incident, which came on the eve of previous talks in Riyadh. This recent attack on the Druzhba pipeline system came on the night before Putin was due to meet Trump. So, clearly it's something that's very carefully thought out when you see these big escalations in the targets that they're going for.

Nick Coleman:

You could definitely speculate that there's not a coincidence. This upsurge, the latest upsurge happened just before the Alaska summit. Perhaps Ukraine attempting to send a message that they're not down and out at this point. They're still fighting.

Kelly Norways:

Definitely. And you hear that messaging around, peace through force. And actually, they've been quite vocal in publishing some of their numbers. I noted that Ukraine's military put something out saying it was just 10% of drone targets that have been pumping stations over the last year, whereas the vast majority have been refineries, which can typically be more domestic orientated, I suppose. And on that, I suppose that's a nice segue to move to you, Elza. Can you walk us through just how destructive these attacks have been for the Russian sector and potentially some of its export partners?

Elza Turner:

Yes, as you said, both of you, last year there was a big spate of drone attacks, which took offline a lot of Russian refinery capacity. However, unlike the pipeline, the crude oil pipeline, which still affects some European buyers like Hungary and Slovakia, the Russian refineries in the past, probably if they were offline, that was having an impact on the diesel market, because Russia is a big diesel exporter. Bt not any longer, because Europe is not buying Russian diesel. So this is felt quite a bit in the Russian domestic market. Typically, around that time of the year, we have a surge of diesel demand because of the autumn agricultural works, and diesel is the fuel which is used during the harvest and spring planting season.

But this year, we've had quite an ample supply of diesel. Diesel prices are not recording the expected, let's say, seasonal gains. They're moving slightly up, but everybody talks of sufficient supply. In previous years, for instance, we've had problems with very high prices affecting farmers, a lot of complaints, which eventually led to a diesel export ban. But this year, there's none of that. The government is reporting steady supplies to the farming sector, normal prices, everything runs smoothly.

But the situation is not like this in the gasoline market, because gasoline is the motor fuel of choice in Russia. The car fleet is using gasoline. Gasoline demand in the summer always goes up because it's a driving season, people go on holidays. However, this demand has become even stronger since the start of the war, because long-haul destinations are not readily available, let's say, and people drive a lot to domestic tourist holiday resorts. This is southern Russia, across Russia generally, and demand surges for gasoline. And Russia has invested heavily in refinery upgrades, but geared towards hydrocrackers and diesel output rather than gasoline.

So gasoline remains very balanced. Exports are very small, hardly have any impact on any international markets, even in times of normal export flows. But this year, Russia has introduced a gasoline export ban in March, which was enforced primarily on traders and small refineries with less than 1 million metric ton a year capacity. Last month, end of July, it extended it to the bigger refineries. And now, they've pretty much decided in principle that they'll extend the ban further. And part of the reason for this export ban is of course domestic demand and tight supply, which has been tight so far this year, even with very small unplanned outages.

Like last year, we had an enormous amount of refinery capacity taken offline by drone strikes. This year, after there was few attacks in the beginning of the year. And a notable example is the Astrakhan Gas Condensate Processing Plant, which is a big gasoline domestic supplier. It's been offline ever since. But otherwise, refineries have been operating normally apart from the plant maintenance.

However, now as both of you mentioned, there has been a surge of drone attacks in the last few weeks, and they have very quickly and efficiently taken offline, I think I've counted five refineries in southern Russia. This morning, there was yet again a strike on the Volgograd refinery, which is already offline after a previous drone strike. The prospects for those refineries coming back online in the short term are very slim. So maybe, they'll come back in September, but people, market sources, media, reports, they don't expect them earlier than September. At the same time, there is plant maintenance starting. And Russian refineries, they have two rounds of maintenance, spring and autumn.

So, those that didn't have maintenance in the spring and the spring maintenance notably was fairly light this year, they are starting now, their maintenance. August, has to last through September into October. So this is affecting domestic gasoline supply. Spot prices are surging on the St. Petersburg exchange. They're breaking record highs almost every day. There were few days of drops last week before a meeting chaired by Deputy Prime Minister Alexander Novak. But immediately afterwards, they resumed their upsides.

So, yes, the situation on the Russian market is very volatile. What happens is these spot price increases don't lead necessarily to retail price spikes, because retail prices are more or less controlled and monitored. But this is hurting very much retail margins. Probably the government hopes that the gasoline demand will subside naturally with the start of school in September and the end of the active driving season, and that should calm down the market. But for the moment, there are shortages, tight supply, people complain.

Kelly Norways:

Yeah, yeah. It's really difficult to capture just how long exactly some of these sites will be offline, isn't it? But having monitored this over the last year or so, sometimes it can be months and months. Sometimes they can bring on spare capacity. And it's notable that these are often very high precision strikes, which in some cases have gone for sophisticated units like FCCs, or they'll take CDUs offline.

Elza Turner:

Mostly CDUs. And once the CDU goes offline, you can't operate the FCCs, even if they are in perfectly good order. The latest attacks especially hit the Samara refinery hub, because Novokuybyshevsk was offline already. And after that, the Syzran refinery was attacked. So it's also offline. And this comes at a time when the third refinery in this key refinery hub, Kuibyshev is having plant maintenance. So it should be coming back shortly. But this is having enormous impact on Rosneft's ability to produce fuel.

Kelly Norways:

And I guess you've really seen them hone their strategy here. Nick mentioned that they're now able to stretch something like 2000 kilometers from the front line. That puts a lot of refining capacity in that strike radius. You're seeing some of the largest complexes like Volgograd, which you mentioned, being hit two, three times, really making sure that this capacity is kept offline and it's not easy to quickly ramp things up or sort of paper over the cracks.

Nick Coleman:

It's also about the precision of the targeting, right?

Kelly Norways:

Completely.

Nick Coleman:

I mean, these refineries sites, often they're very large, extended sites spaced out to prevent accidents or to prevent fires from spreading. But often, a refining column is a target that might be a couple of meters wide, and there's a lot of sophistication in the technology.

Elza Turner:

Most of the units that have been hit, especially now in the latest attacks, were CDU units, and big CDU units that are accounting for, in quite a few of the refineries, for more than half of their capacity.

Nick Coleman:

Correct me if I'm wrong, but I think when we first saw these attacks, probably the precision wasn't always as good. You'd see some fire or something, but the authorities would say usually they'd managed to extinguish the fire and carry on operating. Not always, but yeah.

Elza Turner:

In quite a few cases, the fire has been raging for the whole day before it was put out. So it's very hard to get information exactly on what's happening at the refineries because Russia first stopped publishing official information about the oil sector years ago, soon after the start of the war. And it's becoming harder and harder. But of course, it's also hard to hide information completely, so something manages to leak out.

Kelly Norways:

And it's worth underscoring, obviously from our perspective, we're particularly focused on looking at oil flows and supply and demand implications. But it is worth noting just how much of a headache this is for the Russian economy. Even if you are able to bring refineries back online as quickly as you can, it's still incredibly cost intensive at a time when you're looking at high interest rates. The economy's really struggling. We've already seen that materialize in 2024, and it's likely that that will really mount pressure on the regime and the economy.

Elza Turner:

And the other hurdle, as you know, Kelly, we've written several stories on this, is the access to western equipment, which has been very difficult because of the sanctions. So some repairs took months just because they can't have access to the necessary spare parts.

Kelly Norways:

And I'd like to throw it to you, Nick, in a moment, but just before we move on, it's interesting you talking about the gasoline export ban and the fact that you are starting to see perhaps some anxiety around Russian energy security. I suppose it's worth touching on there, the fact that they have in the past imposed a diesel export ban, which is much more market moving for the world refining market or fuel sector. It seems like they've kind of shied away from taking similar measures over recent years. I think I'm right in remembering that it was 2023, the last time that they did that. But that's certainly something to monitor to see whether this does start to trigger some more emergency responses.

Elza Turner:

As I said, diesel market is still very well-supplied. So there are no any indications that they could go towards a diesel export ban. But with the latest refineries offline, anything can happen.

Kelly Norways:

And Nick, obviously we've been looking mostly here at the Russian energy sector and the Ukrainian attacks, but this is a two-way conflict, and we're still seeing many Russian attacks fly across the border into Ukraine. Obviously, a recent counterparty that's been caught in the crosshairs of those strikes is Azerbaijan's state oil company, Socar. Can you talk to me a little bit more about what we've seen happening with their facility and potentially how this conflict could start to embroil some other regional actors if you are seeing perhaps more unscrupulous attacks on energy facilities specifically?

Nick Coleman:

So Russian attacks on, for example, gas infrastructure are nothing new, and I think we've seen another attack in the last 24 hours. But, there's an interesting subplot that may be developing into something significant with some attacks that have happened in the course of this month on infrastructure linked to Azerbaijan. So listeners will know, obviously, Azerbaijan is Russia's small, but very important, southern neighbor. In fact, Azerbaijan was the birthplace of the Russian oil industry itself in the 19th century with business people like the Nobel Brothers first developing the Baku oil fields before any commercial oil production was happening in present-day Russia. So they've had historical close ties. And Azerbaijan is not turning its back on Russia exactly, but there have been definitely some strains emerging in the last couple of years, which seem to be a little bit playing out in the Ukraine war now.

The strains I mentioned, obviously Azerbaijan has taken back territory physically from Armenian-backed forces in the Karabakh region, which was finalized basically in 2023. And that really sidelined Russia in the diplomatic process. Russia was trying to be a regional power and mediator between these two conflicting southern countries, Armenia and Azerbaijan, and then an Azeri airliner was actually shot down by Russian defense forces in December 2024, which really has soured ties.

So coming to the matter at hand, this month, we've seen a couple of apparent Russian attacks on infrastructure in Ukraine linked to Azerbaijan in the far southwest of Azerbaijan. So we've seen attacks in this month on infrastructure linked to Azerbaijan in Ukraine, specifically in the far southwest of Ukraine near the Romanian border. We saw an attack on a gas compression station earlier this month, which for the first time was meant to be bringing Azeri gas from the southern gas corridor into Ukraine in a kind of quite strategic start of trades. I mean, very early stages. So this gas compression center was damaged by a Russian attack. Behind that, this isn't really a gas podcast, but we could go into the competition between Russia and Azerbaijan now to still keep supplying gas to Southeastern Europe and the Balkans.

But anyway, also hit a couple of times now have been fuel depots belonging to Azerbaijan's state oil company in southwest Ukraine. So again, that's probably more of a local impact in the big picture. It's still perhaps early days to start drawing major conclusions about what this means for Russia. But I think it's a sign of, as you say, the regional balance of power slightly shifting. So as Azerbaijan has actually tried to maintain ties with Ukraine for many years, if you think back to Ukraine's former president, Yushchenko in the 2000s, Ilham Aliyev, the president of Azerbaijan was quite keen on ties with Ukraine back then. And as things move over time, Azerbaijan is judging which way the wind is blowing, but they have come out after this month's attacks, the Azeris have come out quite strongly to denounce the Russian attacks.

Ilham Aliyev had a phone call with President Zelensky of Ukraine in the immediate aftermath, and they issued basically a joint statement denouncing the attack. I think that's something to watch. In the biggest scheme of things, I think Ukraine has a lot more troubles on its mind, but it's an interesting side aspect of the energy story there.

Kelly Norways:

And no doubt something that we'll revisit as we enter this next phase of the conflict in likely what will be a long negotiation process between all the various counterparties. We could do a whole other episode on Russia's crude buyers, and you're already seeing conversations happen there with the Hungarians and Slovakians about energy risks associated with the Druzhba connection and all the rest.

Nick Coleman:

And the Hungarians who have quite close ties to Moscow, you're kind of denouncing Ukrainian drone attacks, right? So Hungary continues to take a slightly independent course in terms of EU politics.

Kelly Norways:

Yeah, you can definitely see how it could escalate, but as I say, it's something that no doubt we'll be following, and I'm sure there'll be plenty more podcasts to come from us. So thank you, Nick and Elza, for your time. And thank you to the listener for joining us. Keep up to date with Platts Live, the professional platform built exclusively for the energy industry. And have your say and join the conversation at PlattsLive.com.