Tempest in a teapot: Putin and Orbán's staged political play over oil and sanctions

Content

• Why Ukraine's new sanctions do not affect oil transit
• How Lukoil circumvents Ukraine's sanctions
• Why oil transit continues despite EU sanctions
• How real are Budapest's threats to Kyiv
• What caused transit scandal

In the second half of July, a scandal began to emerge concerning Ukrainian sanctions against Russia's Lukoil. The company’s oil, along with that of other Russian suppliers, is transported for processing to Hungary, accounting for about half of all Russian oil deliveries through Ukraine. The rest goes to Slovakia, where the Hungarian company MOL operates a refinery.

Hungary's Foreign Minister Péter Szijjártó was the first to report problems with transit after a meeting with Russian Foreign Minister Sergey Lavrov. "A legal situation has developed in Ukraine that currently prevents 'Lukoil' from supplying products to Hungary," Szijjártó was quoted as saying by Bloomberg on July 18.

The problems with supplies were attributed to sanctions imposed by Ukraine against Lukoil at the end of June, under a decree by President Volodymyr Zelenskyy following a decision by the National Security and Defense Council. These sanctions include a ban on Lukoil oil transit through the Druzhba pipeline.

Interestingly, the announcement of supply problems was made nearly three weeks after the sanctions, which indeed include transit restrictions or bans on Lukoil, came into effect. And it came right after the meeting with the Russian Foreign Minister.

Why Ukraine's new sanctions do not affect oil transit

The first sanctions against Lukoil were introduced back in 2018 and didn't include any transit restrictions. The first transit-related sanctions appeared on July 1, 2023. They affected not only the main company - PJSC Lukoil, but some of its subsidiaries, such as Lukoil-Volgogradneftepererabotka, Lukoil-Permnefteorgsintez, and others. However, these measures were practically ineffective as these companies did not operate in Ukraine.

Oil transit through Ukraine to Hungary and Slovakia continued without interruptions over the past year, according to a 10-year contract signed between Ukrtransnafta and Russia's Transneft.

Druzhba oil pipeline (photo: Getty Images)

About 12-13 million tons of oil transit through Ukraine annually. Hungary receives about 5 million tons, which accounts for nearly 70% of its imports. According to Bloomberg, "Transneft" earns about $6 billion a year from oil supplies to Europe through Ukraine.

In July, the list of restrictions was adjusted, and the transit ban was extended to the central company, PJSC Lukoil. Previously, such restrictions weren't applied to allow neighboring European countries to continue receiving essential raw materials until they found alternative supply sources.

But since late last year, Hungary began to actively obstruct Ukraine, blocking financial aid, and forcing Kyiv to take retaliatory measures. It’s worth recalling that hints from the Ukrainian side about possibly halting oil transit reached Budapest as early as 2022. The first public mention of this was made by Lana Zerkal, who at the time was an advisor to Ukraine's Minister of Energy. Her words caused serious concern in Budapest. However, until recently, Kyiv had refrained from taking drastic steps against its neighbors, whose policies were hindering Western support for the fight against the aggressor.

But this summer, Ukraine grew tired of tolerating the antics of Hungarian Prime Minister Orbán and decided to extend the sanctions to affect Budapest. Sources familiar with the decision-making process confirmed that the transit restrictions were Kyiv's response to Budapest's behavior, including attempts to block military aid. However, the Office of the President officially stated that sanctions against Lukoil should not be viewed as a tool against Hungary. This was echoed by the head of the President's Office, Andrii Yermak, in an interview with European Pravda.

At first glance, the oil transit ban appears to be a harsh move, but in reality, it was carefully executed and has not significantly impacted the process of Russian oil supplies. Oil continues to flow through the Ukrainian branch of the Druzhba pipeline. However, in July, supply volumes slightly decreased for a few days due to "some technical issues," according to an industry source. Thus, this sanction can be seen not as an economic measure, but as a clear political warning to Budapest.

How Lukoil circumvents Ukraine's sanctions

Ukrtransnafta has no direct contracts with individual Russian oil extraction companies. It provides transit services for oil supplied by Transneft, regardless of the seller. "In turn, Transneft contracts transport services with Lukoil, Rosneft, Surgutneftegas, and others. So Ukrtransnafta has no legal relations with Russian oil extraction companies," said Volodymyr Omelchenko, director of energy programs at the Razumkov Center, in a comment to RBC-Ukraine.

The only inconvenience for the Russians due to the new sanctions is that Lukoil now has to re-register the oil under traders, such as Litasco SA, an international marketing and trading company founded by Lukoil in Switzerland in 2000, to maintain clean legal conditions for the process. Essentially, Lukoil is using this mechanism to bypass sanctions.

Screenshot from Linkedin

Litasco SA operates not only in Europe but also in the US It has not been sanctioned in any country, including Ukraine. Therefore, Lukoil is not formally the owner of the transit oil, and there are no real obstacles to its passage through Ukraine to Hungary. This is confirmed by Ukraine's Ministry of Energy.

"NSDC sanctions apply only to 'Lukoil's' commercial activities in Ukraine and do not interfere with the exemption established for Hungary and Slovakia (for oil transit via pipeline transport)," said Deputy Minister of Energy Svitlana Hrynchuk.

Why oil transit continues despite EU sanctions

EU oil sanctions against Russian oil were introduced at the end of 2022. At that time, sea shipments of oil were banned, but as an exception, Hungary, Slovakia, and Czechia were allowed to receive oil from Russia via pipeline transport. They had blocked the implementation of sanctions for over six months, demanding to maintain supplies.

These countries managed to secure concessions. Czechia was granted the right to receive Russian oil via the "Druzhba" pipeline until June 2024, while Hungary and Slovakia were given until the end of 2024. Later, Czechia's ability to receive oil through Ukraine was extended until mid-2025. However, it is now actively exploring a new route through the TAL pipeline (Italy-Germany). The oil transit through Ukraine to Hungary and Slovakia is set to end in 2025. So far, RBC-Ukraine has not found any confirmation that the preferential period will be extended.

After loud statements about the alleged cessation of oil supplies, Hungary and Slovakia, which would have to reduce production at the refinery in Bratislava in the absence of oil, complained to the European Commission. But their complaints were essentially dismissed.

Prime Ministers of Hungary and Slovakia Viktor Orbán and Robert Fico (photo: Getty Images)

Budapest and Bratislava were informed that Ukrainian sanctions do not affect the transit of oil unless it is owned by Lukoil. Furthermore, the European Commission reminded both countries that they were supposed to secure alternative supply sources, citing the example of Czechia. However, in this regard, they have done practically nothing. In response, Szijjártó stated that Croatia is not a reliable supplier, which sparked outrage in Zagreb.

It is difficult to predict what Hungary and Slovakia's next moves will be. However, it is clear that these countries are highly interested in securing Russian oil supplies. This is primarily because Russia offers such significant political discounts that purchasing oil remains profitable even after Ukraine nearly doubled the oil transit tariff in April last year.

How real are Budapest's threats to Kyiv

For now, Hungary has decided to move to threats. Budapest has promised to block the allocation of €6.5 billion from the European Peace Facility for weapons and ammunition to Ukraine until Kyiv allows oil transit again. However, in reality, the transit continues, so the grounds for such a blockade are not entirely clear. Moreover, Hungary had blocked this aid even before the Lukoil issue began.

Additionally, Hungary has hinted that it may stop exporting electricity. But this is absolutely unrealistic, several energy market sources told the publication. "First and foremost, electricity supply is not a decision of any individual country but of the European network of operators, ENTSO-E. And in this matter, the position of a single country cannot change the situation with electricity supply," one of the interlocutors said. But even if we assume that some technical problems suddenly arise on the line with Hungary, the supply will still continue through other routes (Slovakia, Romania, Poland).

Another step Hungary might take "in retaliation" is to restrict the supply of oil products. But, firstly, this is unlikely, and secondly, it is completely safe for Ukraine, says Serhiy Kuyun, director of the consulting company A-95. "I believe that (the restriction of oil product supply) would be nothing but a bluff. We buy fuel from them at market prices, and sometimes even higher. For Hungarians, this is good money. And even if there are some supply restrictions, we can easily replace them," he said in a comment to RBC-Ukraine.

According to A-95, in the first seven months of this year, diesel supplies from Hungary and Slovakia accounted for only 7% of total imports. "It will not be difficult for us to replace these volumes. The contract with Hungary is quite expensive, so we will not feel any discomfort in terms of price or volume," Kuyun said. He also noted that it is profitable for Hungary to supply diesel to Ukraine, even if their refineries switch to oil supplies through Croatia.

The third step could be to limit gas supplies. But Ukraine is planning to go through a second winter without imports. And if purchases are necessary, the volumes will be insignificant (according to experts, up to 1 billion cubic meters). In this case, Hungary, which has not been the main route for gas supplies to Ukraine, will be less important than Slovakia, through which most of the imports have passed.

With Slovakia, by the way, there is a "constructive" dialogue, including on oil transit. This is how Ukrainian Prime Minister Denys Shmyhal described the outcome of several telephone conversations with Robert Fico. He assured his Slovak colleague that Ukraine remains a reliable transit country for all nations that value freedom and the rule of law. Ukraine also considers Slovakia a reliable partner and does not expect "blackmail or threats" from it.

There is currently no information about negotiations with Hungary. But in recent days, Budapest has not raised the issue of transit.

What caused transit scandal

Volodymyr Omelchenko from the Razumkov Center believes that the Kremlin inflated the entire oil transit scandal to create an imagined conflict and thereby justify the blockade of military aid to Ukraine. "I think Putin and Orbán staged this theatrical performance for this reason," he said.

However, as a result, Hungary may end up in a losing position with the help of Russia. The European Union seems to have lost patience—it is no longer willing to tolerate Budapest's antics. The last straw was Hungary's decision to simplify entry conditions for Russian and Belarusian citizens planning to work in Hungary. The European Parliament has already demanded that the country be excluded from the Schengen area.

Orbán has calmed down a bit for now. However, there are no guarantees that Budapest will not return to the issue of oil transit in the future, especially since the possibility of supplying oil through Ukraine will cease at the end of 2024. So far, there are no agreements for alternative supply routes for Budapest, and the only alternative could be Croatia, with whom relations have already soured. Thus, Orbán will have to seek an extension of the right to receive oil through the pipeline via Ukraine, which, under current conditions, seems practically impossible.

Part of Hungary's and Slovakia's oil supplies has already been shifted to the Adria pipeline, operated by the Croatian company Janaf. However, the volumes are not yet significant enough for this route to become an alternative to the Druzhba pipeline by the end of the year. According to unofficial data obtained by the publication, Slovakia received 30% of its oil through this route in 2023. Slightly more is planned for the current year, and over 60% is expected in 2025. Hungary's figures are somewhat higher.

However, relations between Budapest and Croatia have already soured. This means that Orbán, and likely Fico, will have to push for the extension of the right to receive oil through the Ukrainian pipeline, which under current conditions seems practically unrealistic.