A Price Cap On Russian Oil Could Cause A Supply Catastrophe 

• The G7 appears to be intent on implementing its price cap plan designed to reduce oil prices, reduce Russian revenues, and maintain a steady supply of Russian oil.
• In reality, there is a strong chance that the price cap would send oil prices soaring, with the risk that Russia retaliates by halting energy exports altogether.
• Russian oil will have to sail on non-Western tankers if it is to avoid the price cap, and there simply aren’t enough tankers available.

The G7-led idea of putting a price cap on Russian oil may look brilliant in theory, but it would likely be very messy in practice, potentially sending oil prices soaring. Surging oil prices are exactly what the price cap is meant to avoid, as it aims to keep Russian oil flowing but at a lower price.

For weeks now, the G7 has been discussing exempting Russian oil from the maritime insurance and financing ban only if that oil is sold at or below a certain price that the group has yet to agree to.  

This would require a lot of coordination with EU, UK, and U.S.-based providers of maritime insurance and financing. But it would be the easiest part of implementing the price cap. Russia could intensify its already ongoing efforts to have non-Western tankers and insurers agree to ship Russian oil and products. Or Putin can simply make good on his promise to halt all energy supply - including crude, fuels, natural gas, and coal - to the countries that sign up to cap the price of Russian oil.

In any case, oil prices will likely go much higher as the EU embargo on Russian oil - which excludes oil sold at or below the price cap - enters into force at the end of this year.

Russia will continue selling its oil to Asian buyers such as India and China using non-Western fleets of tankers and maritime services while choking supply to the West. Russia is also expected to increase its covert oil exports, taking a leaf out of Iran's playbook of below-the-radar exports by switching off transponders and/or hiding the origin of the oil, analysts say.

Still, the non-Western fleet of tankers that Russia can rely on is not enough, Energy Intelligence's John van Schaik and Emily Meredith write.

If Russia refuses to use any maritime services associated with G7 countries, "Russian oil will have to sail on non-Western tankers - and there aren't enough vessels to handle Russia's millions of barrels," they argue.

"The result: less oil, higher prices, and less pain for Russia."

According to Energy Intelligence, Russian oil going to Asia from Russia's Far East is already shipped there on Russian or Asian tankers. But Russia is estimated to be exporting 4.45 million barrels per day (bpd) from its ports in the Arctic, the Baltic Sea, and the Black Sea - and this is done mostly on EU-linked vessels. Finding tankers and insurance coverage not linked to the EU, the G7, or other countries that may join the price cap mechanism for that amount of oil could be next to impossible.

The G7 reiterated in early September that they would finalize and implement "a comprehensive prohibition of services which enable maritime transportation of Russian-origin crude oil and petroleum products globally – the provision of such services would only be allowed if the oil and petroleum products are purchased at or below a price ('the price cap') determined by the broad coalition of countries adhering to and implementing the price cap."

In guidance on the upcoming price cap, the U.S. Department of the Treasury said last week that the price cap policy has three objectives: "maintain a reliable supply of seaborne Russian oil to the global market; reduce upward pressure on energy prices; and reduce the revenues the Russian Federation earns from oil after its own war of choice in Ukraine has inflated global energy prices."

While clever in theory, the price cap plan could actually lead to much higher oil prices because trade flows will be upended again, tankers are in short supply, and Russian oil exports – still remarkably resilient – would plunge, analysts say.

The global oil market will have to prepare itself for a loss of 2.4 million bpd supply when the EU embargo kicks in, the International Energy Agency (IEA) said in its Oil Market Report this week. An additional 1 million bpd of products and 1.4 million bpd of crude will have to find new homes, which could result in deeper declines in Russian oil exports and production. The IEA expects oil production in Russia to fall to 9.5 million bpd by February 2023, which would be a plunge of 1.9 million bpd compared to February 2022.

Then there is the very real threat from Putin to simply stop selling oil – and all other energy products – to countries that join the price cap on Russian oil.

"We fully believe that Putin/Russia will follow through on this statement and curb exports rather than to accept any price cap regime. This will leave Russia with a severely reduced set of oil-clients and with a big problem of shipping it out," Bjarne Schieldrop, chief analyst commodities at bank SEB, said earlier this week.

"The price cap-regime which now seems close to a certainty will highly likely end up having a very, very bullish impact on oil prices," Schieldrop added.

Despite concerns on the demand side, due to China's Covid lockdowns and a global economic slowdown, the price cap mechanism "could turn out to be catastrophic to supply and totally overshadow any demand weaknesses for oil," the analyst noted.

By Tsvetana Paraskova for Oilprice.com

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