Oil prices rose on Tuesday as the European Union (G7) and Australia proposed a price cap on Russian offshore oil took effect on Monday.
Global oil benchmarks – Brent and West Texas Intermediate crude – rose 60-70 cents a barrel in early trade on Tuesday, according to Reuters data.
How does price cap work?
From December 5, the EU said it would implement the plan first introduced in May.
The G7 and Australia also signed a deal to impose a price ceiling on Russian crude exports, currently set at $60 a barrel.
The price ceiling is set in place to prevent companies in signatory countries from extending shipping, insurance, brokerage and other services to Russian crude oil exports.
Since it came into effect on December 5, it applies only to shipments “loaded” on ships after that date and not to shipments in transit.
What are the issues with this price range?
The fact that it took almost six months for the EU and the US to reach an agreement reflects the complexity of the proposal and the infighting among groups to come to one. The problems lie in two aspects:
As a solution, a price ceiling seeks to balance two conflicting objectives. How can Russia’s oil and gas revenues be reduced without simultaneously shrinking global oil supplies, which could further fuel inflation? And therein lies the problem.
When the EU first proposed the ban in May, there was speculation that it would be a major blow to Russia’s oil liquidity. This is reinforced by the fact that European shipping liners and insurers have long held a stranglehold on global energy markets.
But the catch here is that even if the embargo is intended to put pressure on Russia, it cannot be allowed to be an embargo on Russian crude oil.
Because if Russian oil doesn’t enter the world oil market, crude prices may be possible. The spike affects consumers in the European Union and the United States, as well as the rest of the world.
The concern of rising inflation is very real.
Why is it that at $60, the price range is unlikely to make any difference?
Robin Brooks, chief economist at the Washington-based Institute for International Finance, tweeted about this last week.
“A $30 cap would give Russia a well-deserved financial crisis,” he said.
Also, countries including Poland and the Baltic states have noted higher prices, which is broadly in line with current market prices for Urals crude, Russia’s main export variant.
So basically, the embargo and price cap program was a minor issue as it was slightly below the current market price for Russian crude oil. Russian oil is already trading at a discount of about $68 a barrel compared to $85 for Brent crude, according to Vortexa data.
Also, the price range of $60 is higher than the cost of production of Russia’s main crudes, such as the Urals.
The Economist estimates that it will be in the region of $20-$44 per barrel.
Because the $60-a-barrel price ceiling includes a significant cash cushion, Moscow will continue to have a business case for pumping crude and delivering it to customers who want to buy it.
EU leaders have been quoted as saying after the decision that this $60 threshold could be lowered over time.
But the problem lies in the optics. It took nearly six months for the group to reach the $60 price range, and the figure hasn’t made a dent in Moscow’s oil profits, which President Vladimir Putin is using to sustain a war with Ukraine.
According to analysts, if the price range had been around $50, it would have started to eat into Russia’s oil margins, but even that figure would have exceeded Russia’s cost of production.
Even at $45, analysts think Moscow will be motivated to continue selling crude to avoid shutting down wells that would be difficult to restart from an economic viability point of view.
Also, in an article by Reid Blakemore, deputy director of the Atlantic Council’s Global Energy Center, “It is possible for the shipping industry to misrepresent or cover up. “The origin of its goods” and that it has historical precedents.
And they noted that exemptions for parts of the Russian production complex (including the heavily Japanese-funded Sakhalin-2 project) meant that “un-capped” Russian barrels would still be on the market.
The price range does not fully address blends that include Russian crudes, suggesting there may be additional opportunities to divert Russian barrels “with refined or partially refined products.”
In practice, the price cap will only work if service providers ask their customers for proof that they have purchased Russian-linked crude oil at cap-compliant prices.
In late November, the US Treasury Department’s Office of Foreign Assets Control (OFAC) issued a resolution to continue the cap.
Also, shipping and insurance companies do not have complete information about how much their customers pay for each shipment, its guidance said.
The industry was called upon to request certifications that the agreement was honored through simple, and already standard, contractual provisions.
A major concern for the EU and the US is the shipping of Russian oil through non-European shipping routes to countries such as China, Turkey, Indonesia and India, beyond the price ceiling.
Moscow has already said it will refuse to use tankers that are part of the Oil Cap program, relying on a small group of non-Western tankers and insurance companies to reduce its oil exports.
How does this affect Russia?
Russia’s export earnings have declined since the second quarter of 2022 due to easing global oil prices and lower gas sales due to Russia’s decision to reduce flows to Europe through the Nord Stream 1 pipeline.
But despite all this, Moscow’s current account surplus is forecast to exceed $250 billion this year.
It is second only to China. And the price cap at $60 doesn’t really hurt its earnings, crude prices are where they are right now.
If crude oil falls and the price ceiling persists, it could be a completely different story.
What is India’s position?
Despite the US-led sanctions on Russia after its invasion of Ukraine, India has decided to double its trade with Moscow “in the foreseeable future”, not continuing it.
New Delhi’s position, for now, is non-committal on such a price ceiling arrangement.
Meanwhile, on November 9, External Affairs Minister S Jaishankar and Russian Foreign Minister Sergey Lavrov met in Moscow.
It also clarified that India will continue to procure from Moscow.
But as the world’s third largest consumer of oil and gas, with income levels not very high, it is our fundamental duty to ensure that Indian consumers get better access on more favorable terms.
International markets. In that sense, quite frankly, we have seen the India-Russia relationship work in our favour. So, if it is in my favor, I would like to pursue it,” Jaishankar said in Moscow.
The increase in trade volumes between the two countries has mainly come on the back of heavy imports of discounted Russian crude oil by India.
India, which imported less than 1 percent of its total crude oil from Russia before the Russia-Ukraine war, now imports 20 percent of its total demand.
Crude oil imports from Iraq and Saudi Arabia, the top two suppliers of crude oil to India, accounted for 21 and 16 percent of India’s total imports, respectively.
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