The Shadow Fleet in Crisis (highlights from an upcoming report)
Beset by mixed economics and perilous sanctions, shadow fleet growth has stalled. OFAC is well positioned to downsize the fleet and undercut Moscow’s main price-cap evasion strategy should it choose.
Note
The following are highlights from an upcoming report to be published on Navigating Russia.
Report Highlights
The crisis of the shadow fleet: expansion has stalled and is at risk of reversal as the fate of the fleet slips out of Moscow’s control.
Russia’s shadow fleet has been slipping into a crisis over the past year, buffeted by challenging economics and increasingly perilous sanctions. That’s the picture emerging from extensive analysis of the relevant shipping and financial data.
These forces have stalled the growth of the shadow fleet and threaten to reverse it. A diminished fleet would undermine Moscow’s main price-cap evasion strategy and weaken Russia’s incentives to adhere to OPEC+ cuts.
Shadow fleet expansion began to decelerate sharply in mid-2023…
The crisis began in Q2 2023, when the number of tankers bought quarterly for Russia’s shadow fleet dropped off sharply, following three quarters of aggressive expansion (see Figure 1). By Q4, purchases were down some 70% off Q1 highs.
The main driver of shadow fleet expansion since June 2022 has been the acquisition of aging, second-hand tankers—mostly from mainstream operators—that are then repurposed for Russia’s shadow trade. These bought-for-purpose vessels account for some 90% of growth (see Figure 2). By contrast, tankers hired in from other shadow trades, like Iran’s, have contributed only marginally. This fact is often overlooked in analysis but critical for understanding fleet dynamics.
… as many newly purchased tankers failed to generate sufficient benefits to the state to justify their record-high purchase costs.
What accounts for last year’s sharp slowdown in quarterly growth? It’s not that Moscow had satisfied its tonnage requirements—far from it. Shadow fleet capacity remains below 50% of what Russia needs for a stand-alone fleet (see Figure 1 above). (The actual shadow shipping capacity active in Russia today is equivalent to some 270 Aframax class tankers—a figure far smaller than commonly reported.)
Challenging economics were likely to blame for the initial slow down. Fleet expansion has been costly. An estimated $8.5 billion—largely financed by the Russian state it appears—has been spent acquiring aging vessels at record prices, most with only 2 to 3 years of expected service life remaining (see Figure 3).
Assembling a stand-alone shipping capability—able to keep Russian exports whole—would likely take several more years and cost upwards of $25 billion (1.3% of 2023 GDP) in total for initial acquisitions. Additionally, maintaining fleet strength in the face of high attrition would require billions more each year, rising to some $7 billion per annum (2% of Russia’s 2023 federal budget) at full fleet strength.
But for much of 2023, many newly purchased shadow tankers failed to unlock enough additional revenues above the cap to justify the heavy draw on state resources needed to acquire them. Economically, the state would have been better off relying more heavily on the mainstream fleet.
What’s more, routes with low economic returns—those with long voyage times and cargoes priced at deep discounts, like western-ports-to-India—required far more tankers to service them than high-return routes like Pacific-ports-to-China (see Figure 4).
With capacity needs on the high-return routes already satisfied by mid-2023 (see Figure 5) and Russia’s budget deficit widening, enthusiasm for continuing to fund a high rate of fleet expansion appears to have slackened.
Growth was further impeded last October, when OFAC launched an effective campaign of measured tanker blockings. It reduced incentives for further investments…
Moscow’s buy-to-grow fleet strategy suffered a further setback after October, when OFAC began imposing blocking orders on select shadow tankers, rendering them unusable for normal export operations. To date, 40 vessels representing some 15% of fleet capacity have been blocked (see Figure 6).
And then there are negative knock-on effects arising from the market’s perception of rising risk around the fleet, such as recent reports of major Indian importers refusing any deliveries on Sovcomflot tankers (20-25% of shadow fleet capacity), for fear of sanctions “contagion.”
…and placed control over future fleet size largely in OFAC’s hands.
Now, the fate of the fleet depends largely on OFAC’s next step—specifically, on whether it continues to block more tankers and at what pace. Coalition enforcement authorities have expressed an interest in downsizing the fleet. A moderately stepped-up blocking program could significantly reduce fleet size with little risk to shipping and energy markets (see Figure 7).
Significantly downsizing the shadow fleet would shift more export barrels back to the price-cap constrained mainstream fleet (where price-attestation rules appear in need of further tightening).
If OFAC acts to downsize the fleet, it would expose more revenues to price cap restrictions and incentivize Moscow to pursue a volume-over-value export policy.
If the shadow fleet does get downsized and mainstream compliance is tightened, it would incentivize Moscow to revert to a volume-over-value export strategy. This, in turn, would reduce Moscow’s incentive to coordinate cuts with OPEC in support of higher prices.
By contrast, a prolonged pause in OFAC’s blocking campaign could encourage Moscow to push harder for higher oil prices and accelerate fleet expansion.
Conclusion: distress is rising across the Russian oil and gas sector.
The shadow fleet crisis is part of a broader pattern of mounting distress across the Russian energy sector, as sanctions—compounded by Kremlin incompetence—take their toll:
oil field productivity is falling;
Arctic LNG 2 has just been mothballed for lack of ice-class tankers;
Gazprom—deprived of its main source of revenue by Putin himself—now struggles with insolvency;
and Russia’s sprawling refining capacity is fast becoming a casualty of war.
The trajectory is clear: Russia’s hydrocarbon strength is fading.
About the author
The author is a former vice chairman at a global investment bank. He holds a doctorate in Russian and Middle Eastern History and is writing a history of the Russian oil industry and its impact on civil society.
Disclaimer: No Advice
The author of this substack does not provide tax, legal, investment or accounting advice. This report has been prepared for general informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, investment or accounting advice. The author shall not be held liable for any damages arising from information contained in the report.
© Copyright 2024, by Craig Kennedy. All rights reserved.
Looking forward to the full report, Craig.
Excellent work you are doing Craig