On 27 December 2022, Russian President Vladimir Putin signed a decree on countermeasures against the introduction of a price cap on Russian oil and oil products. These are in response to the G7 agreement on a US$60 per barrel cap for Russian seaborne oil. The decree bans the sale of oil and oil products if the sales contract is based on a price cap for Russian oil, although the decree allows Putin the right to make exceptions to the application of this rule. The ban will become effective as from 1 February 2023 and will apply ‘to Russian oil shipments to foreign legal entities or individuals under any contracts envisaging, directly or indirectly, any application of the price cap mechanism’. The ban relating to the sale of Russian oil products uses the same terminology and will take effect on a date determined by the Russian government but not earlier than 1 February 2023. The current oil price factors in this supply risk scenario to varying degrees but is any meaningful price adjustment for it truly justified? As with all matters relating to the global oil market there are two basic versions of ‘reality’ to consider: the official version and the unofficial version: spoiler alert – people with a lot to lose or a lot to gain frequently lie. Officially, some pricing in of the supply risk attached to the aforementioned ban and Russia’s reaction to it would appear to be justified. Russia’s own Deputy Prime Minister, Alexander Novak, said on 23 December 2022 that Russian oil output may fall 5-7 percent because of the G7’s sanctions on the sector in the aftermath of Russia’s invasion of Ukraine in February 2022. OPEC expects Russian liquids output to decline by 850,000 million barrels per day (bpd), to average 10.1 million bpd in 2023. The International Energy Agency (IEA) forecasts Russian production to drop by 1.4 million bpd in the period.
The unofficial version is that there is no reason to expect any meaningful drop in Russian oil or oil products output in 2023 for several reasons. A key one of these is that Russia is still making a lot of money from each barrel of oil it produces, whether it is sold at a discount to the benchmark or not, and consequently it is in its interests to keep production going at the usual pre-Ukraine War levels to maximise its government revenues. For a very long time, Russia had a budget breakeven price per barrel of Brent oil equivalent of around US$40, about the same as the best of the U.S. shale oil producers, and this figure is still about right. With the
US$60 pb cap in place, this is a very healthy profit.
It is apposite to note here that the 30 percent or so discount demanded by some major buyers since the Ukraine War began – most notably, China and India – is a discount from the market price of oil, not from the price cap. Therefore, with Brent currently around US$80 pb, Russia is receiving around US$56 per barrel of its oil from these buyers, which is still a healthy profit. Ironically, as the astute readers of this website will immediately have deduced, the G7 price cap price is higher than the current market price minus hefty discount that Russian oil is being sold at to some other buyers around the world.
Another element to factor into the unofficial reality of the global oil supply/demand mix is that Russia can still work around any price caps or sanctions that G7 or any other group cares to put into place through the myriad of sanctions-avoiding mechanisms put into place by Iran since it came under various sanctions in 1979. As analysed in depth in my previous book on the global oil markets, to get more oil into Europe at better prices than the price cap allows would be no problem for Russia by utilising the basic shipping-related sanctions-stepping method of just disabling – literally just flicking a switch – on the ‘automatic identification system’ on ships that carry Russian oil. Simply lying about destinations in shipping documentation is another tried-and-trusted method, as boasted about by Iran’s former Petroleum Minister, Bijan Zanganeh, when he said in 2020: “What we export is not under Iran’s name. The documents are changed over and over, as well as [the] specifications.”
For oil going into Europe, Iran used this method repeatedly and successfully. The method involved initially shipping crude oil loads into some of the less rigorously policed ports of southern Europe that need oil and/or oil trading commissions, including those of Albania, Montenegro, Bosnia and Herzegovina, Serbia, Macedonia, and Croatia. From there, the oil was easily moved into Europe’s bigger oil consumers, including through Turkey. For Asian-bound shipments, the reliable methodology for Iranian sanctioned oil, also available to Russian oil, has involved Malaysia (and to a lesser degree Indonesia) in forwarding oil exports to China, with tankers bound ultimately for China engaging in at-sea or just-outside-port transfers of Iranian oil onto tankers flying other flags.
So, how many ships does Russia have access to move its oil in such a fashion? Several senior sources in the oil industry in the U.S. and European Union energy security spheres, spoken to exclusively by OilPrice.com in recent weeks, believe that Russia could secure in very quick time at least three quarters of the shipping needed to move its oil as usual to established buyers, and up to 90 percent within a few weeks after that. Before the invasion of Ukraine, according to IEA figures, Russia was exporting around 2.7 million barrels per day (bpd) of crude oil to Europe, and another 1.5 million bpd of oil products, mostly diesel.
More broadly, as at the end of January 2022, also according to the IEA, Russia’s total global oil exports were 7.8 million bpd, two-thirds of which were crude and condensate. Therefore, using the likely scenario range above, the global oil markets would only lose between 0.78 million bpd and 1.95 million bpd of pre-Ukraine invasion levels of Russian oil, even with the cap in place, regardless of all other factors. However, even this amount of supply loss is extremely unlikely, as Iran has a huge fleet of tankers, part of which could be made available to Russia, as do China and Hong Kong, and India, among others. The commonly cited ‘problem’ of shipping and cargo protection and indemnity insurance is also spurious as such insurance could be easily enough covered from all the countries mentioned, as it was when such shipping insurance-related sanctions were placed on Iranian oil tanker fleets by the U.S.
So, why is Putin firing off verbal warning salvos about the US$60 price cap, then? It seems clear enough that he is doing so in order that no one gets it into their heads to bring the price cap down to the levels originally mooted – of between US$20-30 per barrel of Brent equivalent – which would put Russian oil sales into a loss. The bottom line is that Putin, and Russia’s oil firms, are perfectly content to have an oil price cap of US$60 per barrel of Brent equivalent. So are all the buyers who can get Russian oil at this level.
Moreover, the U.S. is perfectly content for India – one of the two biggest buyers of Russian oil since February 2022 – to continue to do so, including at prices above the G7-imposed price cap mechanism if necessary, according to comments from U.S. Treasury Secretary Janet Yellen in November 2022. After all, it suits the U.S. and its developed market allies to have oil and gas prices much lower in order to ease their upwards pressure on inflation and interest rates and to alleviate fears of recessions in those countries. Oil traders as well can make as much money short selling oil and gas as they can from buying it, so they are equally content. The only people it does not suit are the oil companies, despite them still being in huge profit around these price levels.