Unmanned Disruption: The direct and indirect consequences of Ukrainian drone attacks on Russian refineries

Mass Ukrainian drone attacks have so far disabled between 15% and 20% of Russia’s oil refining capacity (the consequences of the attack on the Taneco refinery on 2 April are still not entirely clear). In the second half of March, petrol production was down 10% and diesel production was down 8% compared to the same period last year. Prices for petroleum products have increased by 12-20% since the beginning of the year. So far, the refining industry's losses and their likely consequences are not considered critical, as there are reserves to compensate for them. However, the prospects for repairing the equipment put out of operation under sanctions are uncertain. Companies are already facing difficulties replacing malfunctioning equipment. Russian oil refining underwent significant modernisation in the 2010s, and now, under sanctions, this has become a source of vulnerability. Besides, the peculiarities of the structure and regulation of the domestic petroleum products market have led to local crises in previous years, without any external force majeure. Therefore, the consequences of the 'petrol war' will almost certainly be very serious for both the prices of petroleum products and for inflation in Russia as a whole, as fuel prices carry significant weight. Today, it can be said that about two-thirds of Russian oil refining is in the affected area. Moreover, it appears that the Russian authorities do not have the ability to quickly build up means to protect refineries from Ukrainian drones. These attacks mark a fundamentally new stage in the war, where Russian infrastructure is almost as vulnerable as Ukrainian infrastructure was in the first two years of the war. The only question is the number of UAVs.

According to Reuters' estimates as of the end of March 2024, a series of attacks by Ukrainian drones on Russian refineries had disabled about 14% of Russia's oil refining capacities, which accounts for 38.5 million of Russia's 275 million tonnes of refining capacity. A similar estimate (more than 14% of annual refining) is given in a report by the pricing agency Argus. Analysts at JPMorgan Chase have estimated the volume of damage even higher at 16% (45 million tonnes per year). After these assessments were made, on 2 April, Ukrainian drones attacked the Tatneft Taneco refinery, which ranks third in terms of oil processing volumes (more than 17 million tonnes per year, or 6% of the country's total refining). The consequences of this attack are still unclear: Reuters claims that a drone hit one of the refinery units, while the head of Tatarstan, Rustam Minnikhanov, stated that there were no serious damages and the technological process was not disrupted.

There is information about damage to nine refineries, six of which are large and very important for both the domestic market and exports. The most serious damage was incurred by three large Rosneft refineries — in Tuapse (with a designed processing capacity of 12 million tons of oil per year), Syzran, and Ryazan (6 million tons each): they have either completely or partially halted the production of petroleum products. In Syzran, the situation is complicated by the fact that one refining unit was damaged by drones, while the second one was shut down in July 2023 for extensive repairs, which were supposed to be completed by April 2024. The Tuapse refinery was attacked two months ago, on 25 January, but remains non-operational.

According to a report by the Sinara investment bank, only a third of the affected refineries have managed to fully resume operations so far. According to forecasts by JPMorgan Chase and Argus, repairing the remaining refineries may require several more months. One of the reasons for the prolonged repairs is Western sanctions, which prohibit the supply of refinery equipment to Russia. For example, according to Reuters, the catalytic cracking unit at Lukoil's NORSI refinery in Nizhny Novgorod, which malfunctioned at the very beginning of the year, is yet to be repaired: its manufacturer, the US company UOP, has left the Russian market. The situation may become systemic: Russian oil companies had been modernising their oil refining (the corresponding programme was launched in 2011), without anticipating the war and a large-scale break in relations with Western producers. Now, it is likely that the refining industry will need to be de-modernised to adapt to the new reality. Therefore, it is difficult to accurately assess the scale of the problem today. The critical question will therefore be how much time is needed for repairs under the specific conditions of sanctions.

As can be seen in the diagram below, the downward trend in refining volumes has been observed since mid-February; in the second half of March, diesel production fell by 8% and petrol production by 10% compared to the corresponding level last year. The attacks on refineries has led to an increase in wholesale fuel prices on the stock exchange: since February, AI-92 petrol has risen by 12%, while diesel fuel has increased by 21%. However, retail prices remain relatively stable, according to data from Rosstat and the Moscow Fuel Association.

Weekly data on petrol and diesel production in Russia, 2024, % compared to the corresponding week of 2023

All of this is happening on the eve of the annual scheduled maintenance of refineries, the sowing season and the holiday period, when fuel consumption rises sharply. Pavel Sorokin, First Deputy Head of the Ministry of Energy, acknowledged that the volume of refining will be less than planned (as was the case last year, refining was expected to be 275 million tonnes, with total oil production at 520-530 million tonnes). However, the authorities and analysts are confident that the Russian market will not face a critical shortage of petroleum products. The six-month 'summer' ban on petrol exports (supplies abroad accounted for about 11% of its production) will help to cope with the situation. Moreover, the capacities of Russian refineries exceed the actual annual volume of oil processing by 24%. This allowed for planned maintenance work, which may be postponed this year. Thus, the temporary shutdown of production at affected plants may be compensated by processing at refineries that have not been attacked by drones. The accumulated reserves will be used (at the end of March, these amounted to 1.9 million tonnes of petrol and 3.4 million tonnes of diesel fuel). Finally, the potential shortage of petrol can be covered by imports from two large Belarusian refineries, the total capacity of which far exceeds Belarus's needs.

However, this will not save the Russian oil products market from instability. Drone attacks have already led to its unbalancing, as evidenced by the growth of wholesale prices, according to the Argus report. Retail prices for petroleum products in Russia are not formally regulated. The authorities influence them indirectly by setting maximum wholesale prices, if these are met, oil companies receive payments from the budget (the so-called 'damping surcharge'). However, the domestic market is periodically affected by seasonal crises. Artificially holding down retail prices while wholesale prices rise reduces the profitability of vertically integrated companies and particularly hits independent gas station owners who do not have their own refineries. As a result, this often leads to an explosive rise in prices at gas stations with a delay of several months.

Last year, for fiscal purposes, the Ministry of Finance decided to reduce compensation to oil companies for keeping wholesale prices down. But following the increase in exchange rates, retail prices for gasoline and diesel also rose: according to Rosstat, in January–September 2023, they jumped by 9.4% and 11.1%, respectively. These plans will have to be abandoned permanently, but the authorities' ability to curb prices is limited. Usually it is only possible to postpone the moment of their rise. In turn, fuel prices make a significant contribution to consumer inflation. For example, in the Tax Code, indicative prices used to calculate compensation to oil companies (damping) increase by 3% per year, and excise taxes on petroleum products increase by 4%. In addition, the redistribution of capacity and fuel flows will create additional logistical problems for Russian Railways, which is already overloaded due to the reorientation of trade flows. According to market participants, the reorientation of petrol volumes from exports to the domestic market will increase cargo delivery time by an average of more than four days and will require an additional fleet of tank cars for petroleum products. Another problem is how to dispose of crude oil that the attacked plants cannot currently process (Russia has no such oil storage facilities). The Ministry of Energy claims that it can be directed for export. However, there may be difficulties with this given the recent tightening of procedures for controlling compliance with the price cap on oil. Oil supplies to Turkey are at a record high level (in February 2024, they increased by a third to 434,000 barrels per day), and Ankara is unlikely to be able to increase its purchases even further. AAnd India, the new major buyer of Russian raw materials, has in recent months, on the contrary, been reducing its purchases (1.45 million barrels per day in January-February 2024, a quarter less than last year's records).

CNN's assertion that Ukrainian drones could potentially do more damage to the Russian economy than all the sanctions already imposed combined should be considered an exaggeration. However, the damage from the opening of a new 'petrol' front in the Russia-Ukraine war should be viewed as serious or very serious, depending on how long it will take to actually restore the lost capacity. Sergei Vakulenko, an expert at the Carnegie Berlin Centre for Russia and Eurasia Studies, estimates that 60% of Russia's oil refining capacity is in the area affected by Ukrainian drone attacks. According to Sinara, all major Surgutneftegaz and Tatneft refineries are at risk: the refineries of both companies have already been attacked, although without significant damage. Lukoil has 67% of its refining volumes at risk of systematic attacks from Ukraine, while Rosneft and Gazpromneft, which own refineries in Siberia and the Far East, have just under half of their refining volumes at risk. Moreover, judging by the remark of the head of Tatarstan Rustam Minnikhanov that missile defence 'solves other problems' and enterprises will have to defend themselves, it is unlikely that the protection of plants and other infrastructure will be established in the near future.