COMMODITIES 2025: Russian refining resilience faces new threats

This is part of the COMMODITIES 2025 series where our reporters bring to you key themes that will drive commodities markets in 2025.

Russian refining operations emerged remarkably unscathed from a wave of Ukrainian drone attacks in 2024, but economic headwinds and sanctions pressure could leave the sector newly exposed as it weathers ongoing attacks.

Russia's refining sector became a prominent target for Ukrainian military efforts through 2024, as drone strikes picked off key units across some of the country's largest plants. By early 2024, the attacks had left around 1 million b/d of capacity impacted, according to analysts with S&P Global Commodity Insights.

While attacks on refineries have slowed in recent months, expansions in Ukraine's proven strike range have left more plants at risk. In first-quarter 2024, attacks reached no further than around 1.1 km from the Ukrainian front line.

By May, the strike radius had expanded close to 1,500 km, and refineries that previously avoided attacks, including Ufaneftekhim and Moscow, became targets in the autumn.

As a result, at least 60% of Russian refining capacity is at risk of attack, according to Commodity Insights analysts, which have warned that expansions of "just a couple of hundred kilometers" would leave only refineries in the Urals, Siberia and Far East out of reach.

Damages after drone attacks were one of the reasons Russian enforced an export ban on gasoline, but growing confidence in domestic supplies prompted the government to lift it Dec. 1. Analysts have cautioned that energy security risks prevail.

Sergey Kaufman, an analyst with Finam, a Moscow-based financial firm, said that a new program of mass drone attacks or major equipment failures could easily trigger renewed gasoline shortages next year.

Repair costs, expansion uncertainty

Western sanctions complicated Russian efforts to bring damaged refinery units online swiftly, putting also additional strain on maintenance and expansion plans.

US and EU sanctions have limited Russian access to equipment and spare parts, driving up costs and downtime as refiners have been forced to source from alternative suppliers, such as China.

Throughout 2024, difficulties obtaining spare parts extended the repair times following equipment failures and routine maintenance. It took Lukoil's Nizhny Novgorod refinery six months to repair an FCC unit after a technical incident in January, while several CDUs targeted by Ukrainian drones suffered delays before returning to operation.

While damage to units and infrastructure proved manageable in 2024, further along the line repairs and upgrades will become more challenging, said Igor Yushkov, a senior analyst with the National Energy Security Fund and a specialist at the Russian government's Financial University.

"So far, Russian refineries have dealt primarily with the replacement of relatively simple details and equipment. In the future, problems are expected to affect more advanced equipment," Yushkov said.

The record-high key interest rate, which the Central Bank is likely to raise again in order to deal with inflation, will make repair costs more painful.

Alexander Kotov, head of consulting at NEFT Research, a Moscow-based think tank, said that the combined impact of sanctions pressure and high borrowing costs could pause refining expansion plans, suggesting that no major increase in production capacity for gasoline, jet fuel and other products is likely to materialize over the next three years.

Commodity Insights analysts estimated in the spring of 2024 that "only about 232,000 b/d of conversion capacity will be added over the next four years, while approximately 604,000 b/d of announced conversion capacity remains speculative," noting that the modernization will be "significantly reduced" and project timelines extended. They expect to revise downwards this estimate due to current delays and the sanctions' impact.

Russia's official plans promise to upgrade or commission 50 units by 2028 and increase gasoline output by 4 million mt/year and diesel by 30 million mt/year, although recent delays have sparked speculation over whether targets will be met.

Margin pressure

Refiners are expected to endure falling profits in 2025 due to less generous state subsidies, logistics challenges and demand-side concerns.

Revised state subsidies could impact Russia's 'damping mechanism,' which compensates refineries for selling on the domestic market below export prices, risking upward price pressure and falling demand, said the National Energy Security Fund's Igor Yushkov.

According to Commodity Insights forecasts, Russian domestic gasoil demand is on course to hit a seven-month low in January, but remains 9% above previous year's levels. Gasoline demand has also remained above the five-year range.

Commodity Insights analysts have maintained a conservative growth forecast for oil products in 2025, but warned that any halt to the conflict with Ukraine could sharply curb consumption of gasoil and diesel.

Meanwhile, internal logistics bottlenecks have also eaten into margins, with refiners relying heavily on railway infrastructure and suffering heavy rail delays as export flows have been redirected from West to East.

Russia's Transport Minister Roman Starovoit projected that Russian railway throughput is likely to fall 3% on the year in 2024 due to logistical constraints on the Far East route. The minister forecast a 4% rebound in 2025, although sources have flagged ongoing disruptions as a key strain on profits.

Pressure on margins coincides with wider refining downswing that has put pressure on producers globally. According to Commodity Insights forecasts, light sweet hydrocracking margins in Northwest Europe are set to drop from an average of around $3/b in 2024 to 70 cents/b in 2025.

Despite challenging headwinds on all fronts for the Russian refining industry, activity is expected to stay resilient. With energy security concerns still front-of mind, Commodity Insights forecasts reflect expectations that the government will strive to keep key plants running in the short-run.

But in the long-term, Russia will likely be forced to lower refinery runs, though the rationalization "will be gradual, extending over several years if not decades," Commodity Insights wrote.