Russian Oil Transit Brings Only Tiny Profit to Ukraine – Why is Only Lukoil Banned?

The Soviet regime often affixed “friendship” or “brotherhood” to many of its projects to instill a sense of (albeit artificial) unity. That’s why Kyiv had a “Friendship of the Peoples Arch,” “Friendship of the Peoples Boulevard,” and a “Friendship of the Peoples Metro Station.”

But the pretense of friendship no longer exists between Russia and Ukraine. The Friendship of the Peoples Street, in Ukraine’s second largest city, Kharkiv, is located in the district of Saltivka – now a region under almost daily Russian shelling.    

One other example of Soviet Friendship was the Druzhba Pipeline which stretches across Russia, Belarus, Ukraine, and Poland was opened in 1964. It still operates.

The gas transit contract between Ukraine and Russia expires at the end of this year and the oil transit contract expires on Jan. 1, 2030.  Both deals were signed in 2019, five years after Russia’s illegal annexation of Crimea and parts of the Donbas and three years before the 2022 full-scale invasion.

Kyiv has stated that it will not extend the gas transit contract, telling Europe to find alternatives to Russian gas, but has yet declare its intentions towards Russian oil.

Giving up payments for the transit of both Russian oil and gas would be no big loss for Ukraine. Yearly profits from the transit of both are estimated at Hr.10 billion ($250 million) - a drop in the ocean compared with this year’s estimate for revenues to the state budget of about Hr.1.78 trillion ($43.7 billion) and expenditure of about Hr.3.35 trillion ($82.3 billion).

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The annual profits from oil and gas transit are close to Kyiv’s income from bonds’ sales over a couple of weeks.

Ukraine has also to consider the possible effect on its partners.

No Oil on Troubled Water

The Czech Republic, Germany, Slovakia, and Hungary were granted exemption from the Russian oil import embargo, imposed in June 2022 and allowed to receive Russian oil through the Druzhba pipeline because of difficulties in finding alternative sources due to a lack of access to the sea.

The European Union banned the purchase, import, or transfer of Russian crude oil into the EU as a part of its sixth package of sanctions.

The Czech Republic has plans to replace Russian oil by 2025 after expanding the Transalpine Pipeline which will allow the import of crude from Kazakhstan via the Italian port of Trieste and southern Germany.

Germany’s finance minister Christian Lindner told the BBC that Berlin had already “diversified its energy infrastructure” and was no longer reliant on Russia in January 2023.

Though Hungary and Slovakia could also use alternative pipelines to import crude oil but decided to retain their ties with Russia.

“The Adria oil pipeline can be expanded and help get oil from Kazakhstan, Kuwait, and other OPEC countries. But for two years they did nothing,” the former head of Ukraine’s Gas Transmission System Operator, Serhii Makohon, told Kyiv Post.

On July 17 Ukraine banned the use of the southern Druzhba’s pipeline to Slovnaft by Lukoil – the Slovakian subsidiary of Hungary’s state-owned oil company MOL Group.

Over the next fortnight, the two countries kicked up a storm.

Hungarian Prime Minister Viktor Orbán’s chief of staff said that “Ukraine is blackmailing the two countries that are standing for peace and ceasefire,” according to Reuters.

Slovakian Prime Minister Robert Fico said he had spoken to his Ukrainian counterpart Denys Shmyhal about “a technical solution” to restore the transit.

Slovakia and Hungary also requested open consultations on the matter inside the European Commission, but other members declined support to the two countries, in response to Orbán’s visit to discuss a “peace plan” with China and Russia without the EU’s permission, the FT wrote.

Hungarian Foreign Minister Peter Szijjarto, after a meeting of EU foreign ministers in Brussels on Monday, July 22, said that Budapest and Bratislava were ready to take Ukraine to court to resolve the issue absent an agreement, Bloomberg wrote.

“It takes time to file a lawsuit, so Slovakia and Hungary decided to take a shortcut, pressing on Ukraine through the European Commission. But it only highlighted that there is no unanimous support on this issue – Orbán’s losses are also political,” DiXi Group energy security expert and general manager Olena Lapenko told Kyiv Post.

To raise the stakes, Fico threatened to stop the supply of diesel fuel to Ukraine if Kyiv did not resume the transit for Russia’s Lukoil, Ukrainska Pravda reported on July 29. Later Interfax-Ukraine reported that Shmyhal denied such threats had been made.

Is the outcry worth the deal?

Financially, it doesn’t seem like it. 

Ukraine has not stopped transit, in fact it increased by 30 percent between June and July, ExPro oil analyst Mykhailo Svyshcho told Kyiv Post. This is the first increase in volume since the start of 2024 – which had previously been decreasing.

Russian oil also flows to Slovnaft and other MOL refineries which, for Slovakia, oil makes up 35-40 percent of its input, according to the FT.

“Transit has increased this month, including to MOL refineries, but Slovakia is talking about a threat to energy security - this is illogical,” Svyshcho said.

Ukraine has only expanded de-jure sanctions against Lukoil, essentially affirming its right to stop oil transit, but hasn’t actually stopped it, Forbes Ukraine reported quoting Naftogaz CEO Chernyshov. “Ukraine could have deleted the Lukoil name from its waybills and that’s it,” Makohon told Kyiv Post.

However, MOLʼs direct contracts with Russia are now jeopardized – Hungary and Slovakia received oil with a discount and prices lower than the market rather than market hub-based pricing, a source in the energy market told Kyiv Post.

Lower profits of MOL can also impact lower taxes paid to Hungary’s budget – in 2023, Orban imposed a 95 percent special tax rate on the Brent-Ural spread, compared with only 25 percent in 2022.

Orbán’s fight is not only for the hearts of the voters, but also against inflation and increased budget deficit. In 2023, Hungary’s annual average inflation reached 17.6 percent and its public debt was estimated at 73.5 percent of GDP, with general government deficit at 6.7 percent of GDP – “well above the original target of 3.9 percent,” Fitch reported.

Strategic move?

It may be that Lukoil oil is still flowing through the pipeline since Ukraine does not see the data on which companies are transiting oil. Russian companies can swap their oil and still export it, using the name of another enterprise.

“Ukraine cooperates with Russian Transneft which does not provide the data on which companies export their oil using Ukraine’s pipeline, only the volumes exported,” Svyshcho told Kyiv Post.

This is what happened on the northern Druzhba pipeline flowing through Belarus, Poland, and Germany – Russian oil was switched with Kazakhstan oil and is transported to these countries.

But Ukraine’s transit sanctions only refer to Lukoil, while the country has a long list of other larger players in the Russian oil market including Rosneft, Tatneft, Gaspromneft, Transneft.

Motors pumping oil transit also require electricity – a scarce resource in Ukraine after Russia hit electricity generation, causing a loss of more than half its pre-war energy capacity.

Unlike the relatively humble $250 million profits of Ukraine per year, “Russia earns at least $6 billion from oil transit,” according to Makohon’s estimates.

For the so-called world’s second army, this is also a drop in the ocean – Russia’s defense budget for 2023 was estimated as being $109 billion, according to the Stockholm International Peace Research Institute.

It is still bigger than Ukraine’s transit profits.

Kyiv Post asked why Lukoil was the only company receiving the transit ban, but the President's Office, Ukraine’s intelligence services and the parliamentary energy committee declined to comment or failed to respond.

“It is better to ask the ones who implemented the decision,” MP and parliament energy committee head Andrii Herus told Kyiv Post.