A new, four billion dollar a week gray market is casting a shadow across energy desks around the globe. The sanction-skirting gray market trading for crude, intermediates and finished products has increased seven-fold in the past 24 months and now accounts for approximately 15 percent of global waterborne crude and product flows. The impact of this emergent market is increased risk, less efficient markets, and a long-term shift in the global energy trading system that will render future sanctions largely ineffective.
The origin of this gray market is, of course, Russia’s 2022 attack on Ukraine which provoked wide-ranging Western sanctions on Russian crude and products. Fears of energy shortages, particularly in Europe, led to an attempt by Western allies to create a sanctions system that would keep Russian barrels flowing but at a discounted price.
The West’s approach to sanctions quickly gave rise to a global “crude-laundering” industry in which “dirty” sanctioned barrels were blended, upgraded and otherwise cleaned to become sanction-free barrels that could be exported to the West. Refiners and blending facilities in countries like India and China found themselves with a once-in-a-lifetime arbitrage opportunity: Buy cheap Russian barrels, launder them through blending and upgrading, and resell them onto the global trading markets.
The Russian government helped facilitate the rapid growth of the gray market, with a Russian sponsored “shadow tanker fleet” that is moving gray market barrels. Russian-supported financial backers increasingly buy and sell the gray crude and blend stock on a non-dollar, local currency basis, while a shadow insurance industry underwrites the voyages.
Sanctions barrels trading on the gray market is, of course, nothing new. But, even at the previous height of sanctions against Venezuela and Iran, these barrels represented just two percent of global oil flows. Today, they are large enough to threaten oil market stability. They are certainly sophisticated enough to represent a structural challenge to traditional oil trading.
While the gray market brings much-wanted barrels back into the market, its lack of transparency is also injecting hidden volatility into the energy markets and increasing the risks of an unforeseen black swan event because the traded markets react too early or too late to rebalance supply and demand and that can occur both structurally and on a short-term basis.
For instance, over the past several months, Brazil has relied on discounted diesel imports from Russia for nearly 80 percent of its import requirements, displacing supplies from the traditional traded market in the region. Since Ukrainian drones began striking Russian’s oil refineries, directly impacting diesel exports, the impact on traded markets remains opaque.
The market is striving to assimilate the gray market because global markets depend on transparency to make real time adjustments in price to solve for supply/demand imbalances.
Sophisticated tools like AI can help interpret the bits of data available from the gray markets but the interpretation of scarce data risks further amplifying a future disruption in the gray market and having greater spillover effects in the traded markets. Companies are also hiring old fashioned wetware to assimilate information from diverse sources around the gray market to back into crude flows, trading strategies, and likely bilateral agreements, to interpret and trade around the gray market.
There may be good and urgent reasons for governments to take actions that push supply into the shadow markets, but it affects markets across the industry and makes everything less predictable, more volatile and more prone to unexpected shocks.
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