The backdoor that keeps Russian oil flowing into Europe

When is a cargo of Russian diesel not a cargo of Russian diesel? The answer is when Shell Plc, the largest European oil company, turns it into what traders refer to as a Latvian blend.

The point is to market a barrel in which only 49.99% comes from Russia; in Shell's eyes, as long as the other 50.01 percent is sourced elsewhere, the oil cargo isn't technically of Russian origin.

The maneuver underpins a burgeoning and opaque market for blended Russian diesel and other refined petroleum products, one of the many that oil companies and commodity traders are using to keep Russian energy flowing into Europe while at the same time satisfying public opinion that demands an end to subsidizing Vladimir Putin's war machine. 

As Europe has stopped short of applying any limits or penalties to the purchase of Russian oil, gas or coal, selling the novel blend is perfectly legal. If Shell and others followed European rules to the letter, they could buy cargoes of 100 percent Russian origin.

But blending is a convenient tool for companies to publicly say one thing (phase out Russian molecules) and do another (buy lots of Russian molecules). 

In the case of Shell, the company has amended the so-called general terms and conditions of its contracts to allow for Russian blending. The new terms say (my emphasis):

"It is a condition of this bid and shall be a condition of any resulting contract that the goods sold and delivered by Seller shall not be of Russian Federation ('RF') origin and shall not have been loaded in or transported from RF. Goods shall be deemed of 'RF origin' if produced in RF or if 50% or more of their content (by volume) consists of material that was produced in RF."

In the oil market, traders whisper about a "Latvian blend" – a new origin for diesel that looks like a workaround to supply Russian product mixed with something else. The typical trade goes from Primorsk, a Russian oil export town near St Petersburg, into Ventspils, a port in Latvia that has a large oil terminal and tanking capacity. That's where the blending takes place. There are many other locations where blending is happening, including in the Netherlands, and on the high seas, in what traders call ship-to-ship transfers. For many in the market, the Latvian blend is simply shorthand for any blend that contains Russian molecules, regardless of where the mixing took place. 

The Latvian blend is a reminder of similar backdoors to trade in sanctioned Iranian and Venezuelan crude, which for years had been offered in the Far East as "Malaysian blend" or "Singapore blend." For Shell, the strategy is not risk free. The company was forced to issue a rare apology last month after its traders bought a single cargo of deeply discounted Russian Urals crude, triggering an outcry that included the Ukrainian foreign affairs minister accusing the company of profiting from Ukrainian blood. 

In a subsequent statement, Shell said it had started a "phased withdrawal from Russian petroleum products" and announced it "immediately stopped buying Russian crude on the spot market."

While Shell has taken the route of accepting shipments containing up to 49.99% of Russian diesel, others haven't. France's TotalEnergies SE stipulates that no cargo "in all or in part" shall originate in Russia, according to the company's updated general terms and conditions. Repsol SA of Spain has similar rules banning any Russian molecules, according to its general terms and conditions.  

There are other loopholes – again, all legal. For example, the Intercontinental Exchange Inc. allows traders to deliver Russian diesel against its popular European gas-oil contract. In a circular on Wednesday, the exchange reminded traders that "product of any origin shall be deliverable" in the region of Antwerp, Rotterdam and Amsterdam. So a trader can take a position on the contract, and be able to deliver Russian diesel, all while remaining in compliance with EU rules.

The loopholes and backdoors are a reminder of why sanctions are hard to implement. And when sanctions aren't imposed but actually self-sanctions, it opens the door for companies to do as they see fit. The result? Russia keeps selling its fossil fuels, and making money. Europe, too, benefits from higher diesel supply, and lower energy prices. The moral question awaits its reckoning.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.