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Simon Watkins

Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…

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Predicting Russia's Next Move Against The Oil Price Cap

  • Russia’s President Vladimir Putin signed a decree on countermeasures against the G7 oil price cap at the end of 2022.
  • Even at $55 per barrel, Russia continues to make a healthy profit on the crude it sells.
  • Russia could secure in very quick time at least three quarters of the shipping needed to move its oil as usual to established buyers.

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.

Related: Europe’s Warm Winter May Not Be Such Good News For Energy
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.”

Related: Russian Lukoil To Sell Strategic Italian Refinery To Trafigura-Backed Company

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.


By Simon Watkins for Oilprice.com

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  • Mamdouh Salameh on January 10 2023 said:
    The Western price cap on Russian oil exports is futile and irrelevant. It will have no impact whatsoever on Russian oil exports since Russia has a sizeable oil tanker fleet to take its oil exports to destinations around the world, important customers who ignored the cap and markets. If needed, Russia could avail itself to additional tankers from India, China, Turkey, Iran and scores of countries around the world.

    President Putin’s decree to ban the sale of oil and oil products based on the price cap and even to consider cutting Russian production by 5%-7% if needed merely aims to add the seal on the irrelevancy and futility of the cap.

    And while Russia could easily balance its budget with a Brent crude price of $40 a barrel compared to $100 for the overwhelming majority of OPEC+ members, its lifting cost per barrel is estimated at $2.8 compared with $3.5 for Saudi Arabia. The reason is that Russia pays in ruble for its oil industry’s exploration, production and maintenance while it has been paid in dollars and euros. Since the sanctions, it has been paid in ruble which has appreciated significantly against other major currencies.

    For budget purposes, Russia makes handsome profits as long as the Brent crude is above $40. A price cap of $70 gives Russia a profit of $30 a barrel.

    To all appearances the Western cap is aimed at Russia as a test case but the long-term target isn’t Russia but OPEC. Since the founding of OPEC in 1960, the United States has been harbouring the thought of destroying it and planning ways means of destroying it to no avail.
    The fact that the cap has so far failed miserably doesn’t bode well for US plans for OPEC.

    Dr Mamdouh G Salameh
    International Oil Economist
    Global Energy Expert
  • Jesus Rodrigo on January 10 2023 said:
    The latest data today suggests Urals is actually below $40 a barrel which is below estimated production cost. There is no doubt that this artificial price cap has seriously hurt Russian revenues. The cost of shipping for them is increasing, the buyer's pool is small and the demand for steep discounts by those buyers is irresistible. In 2022 the average price of Urals was $76, in December after the price cap it went to $50, for this month of January it will doubtless be even lower. The World Bank today stated that global recession is now very close. Russia is in trouble.

    Not least when you look at their daily gas pipeline revenues since October as well, which have been less than one quarter what they were in June. Germany has completely eliminated Russia as a pipeline gas supplier. Incredible. Natural gas prices continue to drop, the mild European winter thus far means storage is barely being depleted across the continent. There is a very high chance that it will still have significant capacity by the end of the heating season in March, leading to a glut in production. Forcing prices even lower in the summer when it is time to refill.

    Europe is winning this energy war, no doubt about it.

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