G7 price cap on Russian crude oil- The impact assessment

The sanctions and price restrictions weaken the Russian government's capacity to fund its operations against Ukraine. The G7 and the European Union Member States have adopted a decision that will hurt Russia's income even harder and diminish its capacity to conduct war in Ukraine. This statement was presented by European Commission President Ursula von der Leyen. It would also help stabilise global energy costs, which will assist nations worldwide that are now dealing with high oil prices. The limit was created to lower Russia's income while keeping global energy markets steady. As a result, it will also assist in managing inflation and keep energy costs steady when high expenses, notably high gasoline prices, are a worry in the EU and throughout the world.

THE PRICE CAP 

The initial price impact has been minor. So far, the embargo and price restriction have achieved one important goal: enormous institutionalising discounts for Russian oil. According to Argus price assessments, Urals, traditionally Russia's main crude mix shipped to Europe, sold below $40 per barrel at the Baltic port of Primorsk on January 9. Russia's ESPO mix, often transported to Asia, was trading over the $60 per barrel price limit. Because Russia will now be compelled to export quantities from Baltic or Black Sea ports across considerably longer distances, mostly to Asian clients, the discount for Urals is likely to persist. All members of the Price Cap Coalition will implement the cap, which will be adjustable to respond to market changes through their domestic legislative processes. While the EU continues to prohibit importing Russian seaborne crude oil and petroleum products, the price cap will allow European operators to transport Russian oil to third countries as long as the price remains firmly below the cap.

IMPLEMENTATION OF THE PRICE CAP

It is difficult to say how broadly the attestation method has been used. Because there is no public disclosure mechanism, evaluations are based on investigations utilising insurance and shipping records. The first price-cap-compliant Russian oil shipments arrived in December, indicating that certain market participants, including Indian refiners, were adhering to the price limit criteria. Tankers shipping this oil looked covered by Western insurance, and at least one ship operator indicated that the required attestation paperwork had been produced. However, later reports indicate that some of these cargoes may have included Russian fuel oil or crude of Kazakh origin, which would not be subject to the price restriction.

It will be vital to watch Russia's dark fleet's expansion, but for the time being, Russia cannot divorce from G7 support services for its oil exports. The G7 countries offer around 90% of the key marine oil trade services, including insurance and reinsurance. Instead of avoiding all G7 services, Russia will most likely ship its oil autonomously instead of avoiding all G7 services as much as possible while satisfying risk-averse purchasers' requests. For months, US Treasury officials have maintained that this would be a victory for the price cap alliance. Russia's biggest importers, India and China, will have more bargaining power. They will likely either comply with all price cap attestation requirements or demand lower prices, limiting Russia's oil earnings.

PROBLEM WITH THE PRICE CAP

The fact that it took nearly six months for the EU and the US to reach an agreement on the cap indicates the proposal's complexity and the internal squabbling with the groups to get at a figure. As a remedy, the price cap aims to balance two opposing goals: how to reduce Russia's oil and gas revenues while also limiting world oil supplies, which may exacerbate runaway inflation further? That is the source of the problem. When the EU originally suggested the embargo in May, the implication was that it would devastate Russia's oil cash flows. The fact that European shipping lines and insurers have long maintained a stronghold on global energy markets added to their clout. However, although a ban is designed to put pressure on Russia, it cannot be allowed to become a chokehold on Russian crude: if Russian oil does not enter the global oil market, crude prices may skyrocket, affecting consumers in the EU and the US as well as the rest of the globe. The threat of a surge in inflation is extremely serious. As a result, the floor price formula was chosen.

Analysts believe that if the price ceiling had been set at $50, it would have begun to cut into Russia's oil profits, but even that amount would have been more than Russia's cost of production. Even at $45, experts believe Moscow has the incentive to keep exporting oil in order to avoid having to cap wells that can be difficult to restart economically. In fact, the price cap will only operate if service providers request confirmation that their consumers purchased Russia-linked petroleum at a cap-compliant price. The US Treasury Department's Office of Foreign Assets Control (OFAC) published a determination to pursue the cap in late November, stating in its guidance that shipping and insurance firms may not have complete information about how much their clients pay for each shipment and urging the industry to request attestations that the cap has been respected through simple, already standard contract provisions. The biggest issue for the EU and the US would be routing Russian oil through non-European shipping lines to countries such as China, Turkey, Indonesia, and India that are not covered by the price ceiling. Moscow has already stated that it will refuse to utilise tankers signed on to the oil cap system and may reduce its oil shipments by depending on a smaller number of non-Western tankers and insurers.

IMPACT ON RUSSIA AND OTHER ECONOMIES

Russia has stated that it will not adhere to the limit and will suspend supply to nations that comply. Russia might react by halting supplies with the intention of earning from a much higher global oil price on whatever it can sell in the absence of sanctions. Buyers in China and India may object to the cap. Russia or China may attempt to establish their own insurance providers to replace those blacklisted by the United States, United Kingdom, and Europe. Russia, like Venezuela and Iran, might sell oil off the books by employing "dark fleet" vessels with dubious ownership. To conceal its origin, oil might be transported from one ship to another and blended with oil of the same grade. Even under these conditions, the cap would make it "costlier, time-consuming, and inconvenient" for Russia to export oil around the constraints. The longer distances required to carry oil to Asia necessitate up to four times the tanker capacity, and not everyone will accept Russian insurance. Russian producers are unlikely to be able to redirect all of their oil from Europe, formerly their largest consumer, and some will likely be lost to the global market – at least initially. According to Commerzbank analysts, the EU embargo and cap may result in "a considerable tightening on the oil market in early 2023," with the price of international benchmark Brent expected to return to $95 per barrel in the next weeks. The EU embargo may have the greatest impact not on Monday but on February 5, when Europe's further prohibition on oil-refinery goods, such as diesel fuel, goes into force. Many automobiles in Europe still operate on diesel. Because the fuel is also used for truck transportation to deliver a wide range of commodities to customers and agricultural power machines, the higher prices will be disseminated across the economy.

INDIA'S STANCE

The $60 per barrel price restriction is important for India since Russia has emerged as a major supplier of crude oil this year. India will keep importing crude oil from all sources. The price cap is likely to benefit nations like India, China, and other large customers who have been acquiring inexpensive Russian barrels. The price cap would provide them with the power to reduce the price they pay to Russia. As the battle continued on, the world's third-largest oil importer increased imports of the flagship Urals crude, which ships from Russia's West, and is now competing for ESPO, a distillate-rich grade. According to the statistics, Russia's percentage of India's oil imports increased to an all-time high of 23% from 19% the previous month, while the Middle East's share fell to 56.4% from 59%. Iraq remained India's largest supplier, but Russia surpassed Saudi Arabia as the second largest. As a result, Indian refiners already receive Russian oil at or near price caps. As a result, when the price limitations are implemented, they are unlikely to negatively influence India's oil imports. India intends to use the present global oil issues caused by the Ukraine conflict to obtain inexpensive energy. Because Russia has curtailed crude oil discounts recently, India is increasingly moving to Africa and the Middle East instead of Russia owing to higher freight charges.

After the West imposed sanctions on Russian oil following the commencement of the Ukraine war, China and India, two of the world's top three importers, became Russia's largest clients. Reduced purchases by both Asian behemoths would compel Russia to seek new consumers. Even if Moscow provides better terms in the future, India and China are unlikely to buy much more Russian crude since they have many long-term contracts with competitor suppliers like Saudi Arabia and the United Arab Emirates (UAE).

CONCLUSION

Russia's reaction to the EU embargo and price cap has been subdued. On December 27, President Vladimir Putin threatened to shut off supplies to nations whose supply contracts directly or indirectly employ the price limit mechanism directly or indirectly. In contrast to an explicit need that all contracts indicate actual transaction costs, EU and US advice demands an attestation from various organisations engaged in transactions that purchasers did not pay more than the price cap. Russia's decree will similarly go into effect on February 1 and will be in effect until July 1. This implies that Putin's edict is not the last word and that Russia would seek a stronger reaction over time, but it also has limited options. 

The market appears to be uncertain about Russia's production prospects and the long-term impact of the EU embargo and price restriction. The December shipment reduction has fueled concern that Russia may be unable to find enough customers for its crude, particularly Urals, and will be forced to shut in significant supplies. According to the International Energy Agency, by late March, Russia may have to shut down 1.8 million b/d of crude oil, condensate, and natural gas liquids. A significant interruption is undoubtedly possible. It will be difficult for Russia to find new consumers for the 3.1 million barrels per day of crude oil and feedstocks sold to Europe before the war. However, Russian exports are more likely to recover from a short drop in December as weather-related problems fade and buyers gain confidence in new shipping routes and arrangements.

Long-distance oil exports to a diminishing number of clients would reduce Russia's earnings per barrel, yet some nations may push for an even lower price ceiling to increase the pressure. Russia, its purchasers, and different intermediaries will almost certainly discover methods to circumvent the price restriction over time, especially if oil prices increase. However, sanctions architects appear to have the upper hand for the time being.

REFERENCES-

1.         “G7 Sets Price Cap for Russian Oil at USD 60 Per Barrel.” 2022. Sanctions & Export Controls Update. https://sanctionsnews.bakermckenzie.com/g7-sets-price-cap-for-russian-oil-at-usd-60-per-barrel/

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8.       Shan, Lee Ying. “The G-7 May Cap Russia’s Oil Price — but It Won’t Dent Moscow’s War Chest.” CNBC. https://www.cnbc.com/2022/11/25/g7-price-cap-on-russia-oil-wont-have-strong-impact-on-moscow-analysts.html

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(The views expressed are those of the author and do not represent views of CESCUBE.)