CHAPTER 4. CORROSIVE EFFECT OF THE RUSSIAN FEDERATION ON THE OIL REFINING INDUSTRY OF UKRAINE

4.1. Soviet heritage that depended exclusively on Russian raw materials

Ukraine's oil refining industry inherited from the former USSR was represented by six oil refineries and a trunk pipeline system built to pump oil from fields located in the former USSR.

The total nominal capacity of primary refining in Ukrainian refineries was more than 51 million tons of oil per year, which exceeds the combined similar capacities in Poland, Hungary, the Czech Republic, and Slovakia (Fig. 4.1). The refineries were able to produce 50 types of petroleum products.

The provision of raw materials to Ukrainian refineries was carried out by a system of three main oil pipelines that pumped oil from the Russian Federation, Belarus, and domestic fields39 (Fig. 4.2, Table 4.1). The pipelines were operated by Ukrtransnafta. Secondary methods included supply by rail, sea, and road.

39 http://www.irbis-nbuv.gov.ua/cgibin/irbis_nbuv/cgiirbis_64.exe?I21DBN=LINK&P21DBN=UJRN&Z21ID=&S21REF=10&S21CNR=20&S21STN=1&S21FMT=ASP_meta& C21COM=S&2_S21P03=FILA=&2_S21STR=aprer_2011_7%282%29 24

Transit to Ukrainian oil terminals on the Black Sea (Odesa), 4 Ukrainian refineries in Kremenchuk, Lysychansk, Kherson, and Odesa

It was meant to transit Caspian oil to Europe, bypassing the Russian Federation, but construction thus far ended at the city of Brody, in western Ukraine. With the exception of in 2007 the pipeline has not been used at full capacity, and since August 2010 it has not been used at all

Thus, Ukraine inherited Soviet-era oil transportation infrastructure but with Russian retained control over the oil import routes to Ukraine

Looking ahead, we would like to note that for some time Ukrainian refineries responsible for 52% of the nominal capacity were controlled by Russians.

In order to create alternative routes for oil supply to Ukraine and transit to Europe in 2001, the Odesa-Brody oil pipeline was constructed (No. 4 in Fig. 4.2). It could not fully provide an alternative to the transportation of Russian raw materials in terms of capacity. Throughput capacity was 9 million to 14.5 million tons per year.41

4.2. Elements of negative dynamics for the strategic oil refining industry in Ukraine, and signs of hybrid impact from the Russian Federation

Analysis of indicators of consumption and production of petroleum products obtained by the project analysts for two periods of time, 1998 to 2005 and 2012 to 2021, indicate a crucial change in the situation between these time periods (Fig. 4.3, 4.4).

Dynamics of domestic production and consumption of petroleum products in Ukraine during 1998-2005

Dynamics of domestic production and consumption of petroleum products in Ukraine for 2012–2021

41 https://www.pravda.com.ua/news/2004/05/27/3000165/

42 http://www.ukrstat.gov.ua/

43 https://map.ua-energy.org/uk/resources/41a1e792-ff7e-4819-a04d-f9083286cdb0/

During 1998–2005 the average level of production was more than 14.1 million tons with consumption of about 10.1 million tons, which allowed Ukraine to accumulate strategic stock and export products. In the second period of time there was a sharp decrease in the production of petroleum products from about 4 million tons to almost zero.

This trend (after 2012) took place under the following conditions (the list is not exhaustive):

• The dominance of the Russian Federation in the control of oil import routes to Ukraine (specified in section 4.1).

• Russia waging a hybrid war against Ukraine without the use of a military operational line. An undisguised sign is Vladimir Putin's statement on Ukraine during the NATO summit in 2008 regarding the interests of RF in the southern and eastern regions of Ukraine. Particularly, he mentioned that a third of Ukraine’s population is ethnic Russians living in territories “illegally” transferred by the USSR to Ukraine.44

• The preparation for the use of troops to occupy Crimea and Donbas in late 2013 and early 2014.

• The oil refining industry is a strategic industry to ensure the defensive capacity of the victim country, so its destruction was one of the goals of the aggressor country in the economic (hybrid) war.

The above factors provide grounds for the statement about the involvement of the Russian Federation in the elimination of the oil refining industry of Ukraine, and cause to investigate the use of the Russian corrosive investments or other methods of economic warfare.

The analysis of oil imports to Ukraine from the Russian Federation and other countries (Fig. 4.5.) shows that the first significant decrease in the import of Russian oil occurred in 2008, the same year Ukraine became a member of the WTO, that pro-Western authorities declared Euro-Atlantic intentions, the Russian war in Georgia, and Putin's speech at a NATO summit. Before that, the Russian Federation was almost the sole importer of oil to Ukraine, in which the economy still had pro-Russian orientation of the economy since the USSR time and the presidency of L. Kuchma.

Dynamics of raw oil market structure in Ukraine

Fig. 4.5. Summary diagram of the structure and dynamics of the oil raw materials market in Ukraine from 2006 to January 2022 (primary data received from the State Statistics Service: own production; and the State Customs Service: total imports, imports from the Russian Federation, imports from other countries, exports; estimations: oil raw materials for processing by Ukrainian refineries)45

44 https://www.unian.ua/politics/110949-vistup-volodimira-putina-na-samiti-nato-buharest-4-kvitnya-2008-roku.html

45 https://map.ua-energy.org/uk/resources/?ordering=-publication&paginate_by=20&subject=14&energy_resource=24&coverage_ date_range_start=&coverage_date_range_end=&cost=; https://trendeconomy.ru/data/commodity_h2?commodity=2709&indicato r=TV&trade_flow=Export,Import&time_period=2005,2006,2007,2008; http://www.ukrstat.gov.ua/

Such a state of affairs in 2008 had a negative impact on the production (and, among other things, export) of petroleum products and, accordingly, on the profits of the refineries. The exceptions were refineries owned by Russian oligarchs, the profits of which increased significantly.

This challenge to this strategic industry of Ukraine prompted the pro-Western government of Ukraine during the presidency of V. Yushchenko to make certain efforts to find alternative importers of raw oil. Oil from Azerbaijan, Kazakhstan, Turkmenistan and the Middle East appeared on the Ukrainian market.46

This allowed, against the background of a gradual decrease in Russian imports and a drop in domestic production by 2010, an increase in the volume of raw oil for the refineries and, as a result, more oil refining in Ukraine.

With the arrival of pro-Russian President Viktor Yanukovych and Prime Minister of Ukraine Mykola Azarov in 2010, there was a decrease in the volume of alternative oil imports against the background of a gradual cessation of imports from the Russian Federation.

The final collapse of import volumes of Russian raw oil for Ukrainian refineries took place in 2012. The main alternative suppliers and importers were Kazakhstan, Turkmenistan, and Azerbaijan. And the total volume of imports did not exceed 2 million tons, which, in combination with its own production (no more than 4 million tons), did not allow Ukraine to supply the country with refined products. The small sized of imports were due not only to the terms of supply contracts but also to the condition of the transport system, the destruction of which was also associated with Russia.

In fact, at the beginning of the military aggression of the Russian Federation against Ukraine in 2014, Ukraine was unable to produce strategic goods like fuel, including for military needs.

General information on the artificial reduction of imports of Russian raw oil, the activities of the pro-Russian authorities are the preliminary signs of the hybrid influence of the Russian Federation. What specific methods did Russia then apply?

The operation to destroy the refining industry of Ukraine, according to analysts, was comprehensive and included several stages, each of those being a lower-level operation by itself.47

46 https://map.ua-energy.org/uk/resources/829a72bd-1bf2-4463-b819-692a81417d37/

47 These are preliminary stated stages. An in-depth study of all aspects of destruction of the oil refining industry (including the presence of miscalculations of the Ukrainian authorities) requires expansion of the study that is planned to be carried out during the next stage of the project.

4.3. Stage 1 – Use of dumping by the Russian Federation to destroy the oil industry of Ukraine

In 1995, Ukraine adopted the government's “Oil and Gas Program of Ukraine until 2010”, which provided for an increase in oil production to 7.5 million tons per year by 2010. But its implementation was disrupted, and Ukraine's production has been decreasing since 2007 (Fig. 4.6).48

Oil production in Ukraine (including gas condensate)

At the same time, a comparative analysis of data on the prices of Russian oil for Ukraine from 2004 to 2007 and the market price of oil produced in Ukraine indicates a worsening situation for the country.

For example, on August 18, 2004, Russia and Ukraine signed a long-term oil transit agreement, under which oil from the Druzhba oil pipeline was delivered to the terminals of the Ukrainian port of Pivdennyi. In accordance with the signed agreement, TNK-BP took the responsibility to pump about 9 million tons of Urals oil annually through the pipeline from 2005 to 2007. Ukraine's profit from these supplies was estimated at $92 million. In addition, TNK-BP provided Ukrtransnafta with a commodity loan 450 thousand tons of oil worth $108 million at 8% per annum.50

Under the terms of the contract, the average price of Russian oil was about 1212 UAH/ton.

Such a pricing policy of the Russian Federation for oil is also confirmed by data from Russian sources51 (Table 4.2)

48 https://www.epravda.com.ua/news/2011/10/14/301924/

49 http://www.ukrstat.gov.ua/

50 https://www.kommersant.ru/doc/552952

51 http://lib.ieie.nsc.ru/docs/buren%26neft.pdf

At the same time, the price of Ukrainian production oil in 2006 was at the level of 1890 UAH/ton.52

As can be seen from the above examples, the price of Russian oil was lower than both the world prices and the Ukrainian oil production prices.

Such a dumping policy made it commercially attractive for Ukrainian refineries to buy oil from the Russian Federation because of the lower price, and to keep the profits from Ukrainian production at a level close to cost. The volume of production was reduced and the exploration of promising oilfields was not carried out.

The abandonment of Ukrainian oil production was facilitated by the fact that during this period 52% of the refining industry was owned by Russian oil companies, which naturally worked on their own raw materials produced in Russia.

4.4. Stage 2 – Shutdown of refineries controlled by the Russian Federation: Corrosive investments

Studying the fate of Ukrainian refineries shows that three of them were owned by Russian structures before the shutdown. The sequence was as follows:

• 2005 – Kherson Refinery. From 1996 to 2006, the facility was under control of the Ukrainian branch of Alliance Group, a Russian company owned by Chechen businessman Musa Bazhaev, who was close to V. Putin. The official reason for its shutdown was reconstruction, which was not really carried out. Although in 2006 the shares of the non-operating enterprise were bought by the Ukrainian businessman I. Yeremeyev, the enterprise was not launched due to the absence of the main technological installations decommissioned by the former owner before the modernization, which never took place.53

• 2010 – Odesa Refinery. From 1999 to 2013, the facility was under control of Russia’s Lukoil, and from 2013 to 2017 by the pro-Russian oligarch S. Kurchenko, who is currently hiding in the Russian

52 https://www.epravda.com.ua/eng/publications/2012/12/18/351426/

53 https://nashigroshi.org/2021/05/31/vid-al-ians-enerho-treydu-do-putina/ http://ruporzt.com.ua/ukraina/1879-xersonskij-npzvidklav-zapusk-virobnictva.html; http://www.liga.net/infografica/76177_koroli-benzokolonok-komu-prinadlezhat-ukrainskie-npz. htm; https://www.academia.edu/38485641/СУЧАСНИЙ_СТАН_ПРОБЛЕМИ_І_ПЕРСПЕКТИВИ_СТВОРЕННЯ_В_УКРАЇНІ_НАФТОВОГО_ТА_ЕНЕРГЕТИЧНОГО_РЕЗЕРВІВ

Federation. Since 2017, it has been owned by the state. In 2019, the State Property Fund of Ukraine established that production would not resume as a result of equipment failure.54

• 2012 – Lysychansk Refinery. From 2000 to 2012, it was under control of TNK – BP, an entity 50% owned by Russian oligarchs and sanctioned in Ukraine, the EU, the U.K. and other jurisdictions. Since 2012 its owner has been Russia’s Rosneft, which stopped the enterprise immediately after the acquisition of shares.55

Thus, the Russian owners stopped half of Ukraine's refineries, which had a total nominal capacity of 26.7 million tons per year, or 52% of total capacity, using the corrosive investment method.

4.5. Stage 3 - Stopping the oil supply

The shutdown of half of the refineries between 2006 and 2013 drastically reduced the production of petroleum products, while three other refineries could potentially produce fuel. Therefore, the Russian Federation stopped pumping oil to other refineries – Drohobych, Nadvirnyansky, and Kremenchuk.56

The first two refineries were shut down, while transit to Europe by the Druzhba oil pipeline continued, which may indicate that the halted flow to Ukraine’s three remaining refineries were due to non-technical reasons.

Production was resumed only at the Kremenchuk refinery, with imports from Azerbaijan and Kazakhstan supplied by sea, and then by rail and road transport.57

4.6. Stage 4 – Impossibility of diversification of supply by oil pipelines from other countries

Although the Russian Federation stopped pumping its own oil to Ukraine, theoretically there remained a possibility of using 3 entrances to the Ukrainian oil transportation system (that go through the territory of the Russian Federation) to transport oil from Azerbaijan, Kazakhstan, Turkmenistan.

In order to make such supplies physically impossible, Russia in 2012:

• filled the branch of the Michurinsk-Kremenchuk oil pipeline (No. 2 in Fig. 4.2) with substandard technological oil that led to Azerbaijan's refusal to supply oil by this route58

• after the cessation of oil supply to the Lysychansk refinery, it dismantled a part of the Samara –Lysychansk pipeline (No. 3 in Fig. 4.2) on its own territory.59

There were also Russian measures taken to block Ukraine's receipt of alternative oil through the Odesa-Brody oil pipeline, reserving its capacity for Russian raw materials and for use by Belarus.60

Thus, the Odesa-Brody oil pipeline was idle from the moment of construction until 2004 due to the lack of guarantees for the supply of Caspian oil. Russia sought to use this area in reverse mode for the supply of

54 https://web.archive.org/web/20210514233123/https://www.2000.ua/v-nomere/derzhava/resursy/speckonfiskacija-bezdarnajaibespowadnaja.htm; https://web.archive.org/web/20220528134413/https://zn.ua/ukr/energy_market/odeska-intriga-_.html

55 https://web.archive.org/web/20220622140031/https://file.liga.net/companies/lisichanskii_npz

56 https://biz.censor.net/resonance/3075515/tamnits_kremenchutskogo_npz_chomu_kompanya_kolomoyiskogo_hova_nformatsyu

57 https://biz.censor.net/resonance/3075515/tamnits_kremenchutskogo_npz_chomu_kompanya_kolomoyiskogo_hova_nformatsyu

58 https://neftegaz.ru/news/incidental/252274-28-km-arestovannogo-v-ukraine-nefteprovoda-michurinsk-kremenchug-mogutvzorvatsya-v-lyuboy-moment-ek/; http://oilnews.com.ua/news/article11173.html?hl=0YPQutGA0YLQsNGC0L3QsNGE0YLQsA

59 https://sd.ua/news/13101

60 https://focus.ua/economics/152928

Russian oil to the Mediterranean ports. On August 18, 2004, a long-term oil transit agreement was concluded between Ukraine and Russia, under which oil from the Druzhba oil pipeline would be delivered to the terminals of the Ukrainian port of Pivdennyi. This deprived Ukraine of the opportunity to receive oil from alternative sources of supply through the Odesa Maritime Terminal and to supply it to Ukrainian refineries.61

The oil pipeline operated until 2010, when the Ministry of Energy of the Russian Federation officially reported that there were no guarantees of oil transit due to the lack of cost effectiveness.62 Oil transit was stopped.

Since 2011, the pipeline has been operating in reverse mode for the supply of Venezuelan oil to Belarus (Mozyr). However, this contract for 8 million tons per year for the period 2011–2013 was prevented by Russia, which offered Belarus more favorable terms for oil supply within the Customs Union (in fact, the capacity was reserved but the volumes were minimal). Since the end of 2011, deliveries under this contract have been discontinued.63

In 2011, Ukrtransnafta failed to ensure pumping from the Odesa terminal of an experimental batch of oil purchased from Azerbaijan for a refinery in the Czech Republic. This was due to blocking from Rosneft in Slovakia. As a result, oil was processed in the territory of Ukraine with losses of about 400 million hryvnas.64

Conclusions to Chapter 4

1. The refining industry of Ukraine, inherited from the former USSR, was represented by six oil refineries. During 1996–2000, Russian structures established control over three refineries, in Kherson, Lysychansk, and Odesa.

2. Ukraine took over Soviet oil transportation infrastructure with 100% control of oil import routes to Ukraine by the Russian Federation.

3. Before the arrival of pro-Western political forces after the “Orange Revolution” in 2005, the dynamics of the prevalence of a high level of oil production over the level of consumption is traced. Since 2008, there has been a sharp decrease in the supply of oil from almost the only source – the Russian Federation. Meanwhile, measures of pro-Western governments to establish the supply of alternative raw materials were curtailed in 2010 after pro-Russian forces came to power in Ukraine.

4. The oil refining industry is a strategic industry to ensure the defense capability of Ukraine, so the goal of its destruction by the Russian Federation is quite natural.

5. Analysis of the processes with regard to the enterprises of the industry, the volume of supply of raw materials to Ukraine and the fate of oil pipelines provided grounds to believe that the industry was being purposefully destroyed by Russia in stages by conducting successive operations:

• Stage 1 – Dumping Russian oil at low prices to stunt Ukrainian production

• Stage 2 – Shutdown of refineries controlled by the Russian Federation using the corrosive investment method

• Stage 3 – Stopping Ukraine’s oil supply via trade embargo

• Stage 4 – Blocking alternative routes for supply of raw materials to Ukraine by supplying low-quality goods, sabotage, and reserving pipeline capacity for Russian needs).

61 https://zn.ua/ukr/energy_market/budemo_pratsyuvati_mozhlivo,_nad_pomilkami.html

62 https://www.epravda.com.ua/news/2010/06/19/239123/

63 https://web.archive.org/web/20200930230518/http://news.tut.by/economics/311617.html

64 https://web.archive.org/web/20160829040215/ http://delo.ua/ukraine/speshka-ukrtransnafty-stoila-goskompanii-400-mln- grivenubytkov-169115/

6. In fact, at the beginning of the military aggression of the Russian Federation against Ukraine in 2014, Ukraine was unable to produce strategic goods including fuel for military needs. The minimal production at the Kremenchuk refinery, which was set up in 2016, is no longer available because of repeated missile attacks by the Russian Federation after February 24, 2022.

7. The obtained data can serve as a basis to develop a recovery strategy for the industry after the end of the open phase of war of the Russian Federation against Ukraine. The main pillar of that strategy is to avoid dependence on the aggressor country.