Russian Oil Price Cap & New Ecosystem
Efficacy of the Oil Price Cap and an Ecosystem Independent of Western Services
Dear Subscribers,
“Barbershop Whispers….Russia” begins with “My Takeaways”on the main topic followed by the main topic discussion. The last two sections of “Barbershop Whispers…Russia” will be follow-ups from previous publications and emerging events.
In the previous issue, I discussed Russia’s relationship with Israel, Iran, and the Arab world in light of the murderous Hamas attack on Israel.
In this issue I will explore the price cap on Russian oil products enacted by the west. Has it been successful in its original goals, and what have been its consequences?
My Takeaways:
SANCTIONS EFFICACY: In the past nine months since it has been enacted, the price cap on Russian oil products has achieved its objectives better than many experts expected;
PRICE CAP TIME VALUE: Russia is quickly developing an immunity to the sanctions by applying innovative evasion techniques and building an ecosystem independent of western support services. This is being done in collaboration with its new customers – China and India – who are exploiting the market distortion arbitrage opportunities created by the sanctions;
MARKETS: Global oil supply is sufficient partly due to selective enforcement and/or removal of sanctions – Iran and Venezuela are cases in point;
ENVIRONMENTAL RISK: The growing shadow fleet of old tankers is a costly environmental risk to the coastal territories along the tankers’ routes. It is only matter of time before a major oil spill occurs and the newly established insurance writers of the shadow fleets will be called to pay up for a spill.
Price Cap Background
In June 2022, the EU adopted its 6th package of sanctions against Russia, which include two major measures against Russia’s oil industry. The first was a ban on the import on Russian seaborne crude and oil products, commencing in December 2022-February 2023. The second was a ban on EU operators from financing or insuring the maritime transportation of Russian crude and oil products. Then, in September, G7 finance ministers announced plans to impose a comprehensive prohibition on services that enable Russia to transport crude and oil products globally, unless the price was below a specified price cap. And thus the “Price Cap Coalition” was born. In December 2022, the price cap on Russian crude oil was announced, at $60/bbl. (The caps on high- and low-value refined products (e.g., diesel and fuel oil) were announced in February 2023.) In combination, these measures took Australian, Canadian, EU, Japanese, UK, and US companies out of the market for Russian oil, meaning Russian exporters would in any case need to ship their oil longer distances to sell their products. It also meant these companies were out of the market for shipping and related services (e.g., tankers, insurance, reinsurance) unless the price of oil was below $60/bbl for crude, $100/bbl for high-value products, and $45/bbl for low-value products.
It’s important to understand that the price cap was set out to achieve two objectives: 1. reduce Russia’s oil revenues, and 2. ensure an adequate supply of oil in global markets. Achieving both objectives would deprive Russia of revenues that would otherwise be directed towards supporting Putin’s war in Ukraine, but global oil markets would remain relatively stable despite the restrictions on Russian oil trade. The latter is important, given that Russia represents nearly 11% of the global oil supply. The price cap is designed to incentivize Russia to supply product to global markets despite the cap, because it would still earn a (small) profit on the sales.
Russian Oil Revenues:
According to the Russian Ministry of Finance, oil and gas revenues in January-June 2023 were 47% lower year-on-year: ₽3.4T ($37B) vs ₽7.4T ($86B) in 2022.
As illustrated below, despite relatively stable crude export volumes, revenues collected by the Russian government have declined steadily since May 2022.
A key assumption behind the price cap was that Russia would not be able to weaponize the export crude oil and refined products as it had done with natural gas exports to Europe. There are several reasons for this assumption, beginning with Russia’s heavy reliance on the tax revenues generated from oil exports. These revenues represent 11% of Russian GDP – ₽11.6T ($145B) in 2022 – and are critical to funding not just the war, but government services in general. Secondly, the age and complexity of the Russian oil wells network requires specialized equipment and maintenance to keep them operational. A large-scale production shutdown of these wells would damage the pumping and distribution network, and in the absence of western technology, the cost of restarting wells would be costly. Lastly, the selective relaxed enforcement of sanctions and the lifting of sanctions on Iranian and Venezuelan oil could create additional supply on the market (as well as reduce Russia’s market influence and leverage).
Building an Ecosystem from Scratch:
Russia has been forced to devise and build a new ecosystem for its oil exports because of the price cap and associated sanctions. This new ecosystem, built outside of the traditional G7/western system, is being built with the cooperation of Russia’s new customers, such as India and China. This includes the development of product delivery systems in the form of expanded seaborne tanker fleets, global insurance platforms, financial settlement platforms in various currencies, and banking services outside of the traditional western network for the oil trade.
The Kremlin’s development of this new ecosystem to facilitate its oil exports is an added cost to Russia and directly related to the price cap system. Russia’s relationship of convenience with Iran may help reduce construction costs, given Iran’s decades-long experience with sanctions. In fact, some of the product delivery system is being built on top of the shadow tanker fleet that Iran and Venezuela have created over the past decade. (Not addressed in this issue of BWR, is how this new ecosystem may facilitate the trade of other goods and services such as grains and fertilizers, a key issue that contributed to Russia’s exit from the Black Sea Grain Initiative (BSGI). While exempt from sanctions, western services providers had little economic incentive to underwrite Russian grain and fertilizer exports given the war and other sanctions against Russia).
New Markets:
Russian oil export markets have quickly shifted towards China, India, and Turkey. The chart below from the Center for Research on Energy and Clean Air illustrates the dramatic shift in physical volume and revenues from the west to these new markets.
The charts also illustrate the impact of the price cap, as revenues earned per thousand tonnes is significantly less than what it was prior to the price cap and change in markets.
Both India and China are taking advantage of discounted Russian oil, importing it in lieu of some imports from OPEC+. Since neither country recognizes Western sanctions, they are paying a price above the $60/bbl price cap but still getting a discount on the market price.
India is now the biggest importer of Russian seaborne crude oil. Since 2017, India has been diversifying its oil imports away from the Middle East, and as illustrated in the graph below, OPEC imports represent less than 59% of India’s imports today. This is a significant drop from the 2017 level of 80%.
Prior to the price cap, Russian crude represented less than 2% of Indian oil imports; today it is more than 32%.
Transaction Settlement:
For most, if not all, transactions above the $60/bbl price cap, Indian and Chinese importers – primarily refineries – are settling the transactions in CNY, INR, or AED. As a result, there are large amounts – several billion USD – of Russian-owned INR deposits in India, and Russian exporters are unable to repatriate all of their export revenues due to Indian currency controls.
Reuters recently reported Russian oil exporters are now demanding Indian oil refineries to settle the transactions in CNY and this has held up payment of at least seven shipments. From Moscow’s perspective, payment in CNY is more practical, given Russia’s shift to CNY due to expanded trade with China and the reduction of USD and EUR settlements. Furthermore, the large trade imbalance in favor of Russia with India implies Russia has less need for the Indian currency. For the Indian government, having state-owned refineries settled in CNY is a bitter pill to swallow given India’s lukewarm relationship with China. The aforementioned highlights one of the challenges of a common BRIC currency, but that is also a topic for another issue of BWR.
Shadow Tanker Fleet:
The sudden eastward shift in Russian oil markets has forced Russia to expand its tanker fleet, because the pipeline infrastructure that delivered oil to western markets do not have the capacity to satisfy the demand coming from eastern markets.
Since the second invasion of Ukraine, Russia has expanded its “shadow fleet” of tankers for crude and refined oil products. The fleet is estimated to be between 300 and 600 ships, which are typically 15 years old or more. The fleet is characterized by opaque ownership structures and questionable insurance coverage.
Country Origin of Tanker Ownership Carrying Russian Crude Oil
As can be seen by the illustration above, the ownership of the ships carrying Russian crude oil are increasingly domiciled in the United Arab Emirates, China, or other jurisdictions. Meanwhile the illustration below illustrates the change in domicile of the insurance underwriters for Russian oil shipments — shifting from nearly 80% located in G7 in January 2021 to 73% located in “other” domiciles in July 2023.
Country origin of tanker insurance Underwriters carrying Russian crude oil
What do these changes in shipping services mean for Russia, the global oil markets, and the efficacy of the price cap system?
For Russia, expanding the seaborne fleet is an additional but necessary cost of business imposed by the price cap system; it enables the continued generation of export revenues to fund the government and the war. The Kremlin may also view these changes as an unavoidable investment in securing independence from the western financial ecosystem. For the global oil markets, it represents a non-market distortion and arbitrage opportunities to be exploited. This is evidenced by the extended lifespan of old oil tankers and establishment of new domicile insurance underwriters. For the price cap system, it exposes leakage (intended or unintended) in the structure of the sanctions, and the need to monitor and adjust the terms of the sanctions as the markets change and evasion becomes more sophisticated.
There are other consequences to be considered, such as environmental safety and insurance underwriter solvency. For example, on May 1 an environmental disaster was narrowly averted off the coast of Malaysia. The Pablo, a 27-year-old oil tanker with a capacity of 700,000 barrels of oil, experienced an explosion, resulting in a fire that lasted for days and significant damage to the hull. Fortunately, the tanker was empty and had just unloaded highly pollutant Russian fuel oil to a port in China three days prior. The Pablo is well beyond its useful lifespan and is a danger to the coastal territories. One must also question whether the tanker was insured and if so, by whom? A clean-up of this size would cost at least $1.0B.
Follow-ups & Quick Bites:
Follow-Ups:
Armenian Prime Minister Berates Russia in Strasbourg Speech
In a speech to the European Union Parliament, Prime Minister Pashinyan criticized the security alliance with Russia and Russia’s interference with Armenian politics:
“When hundreds of thousands of Armenians were fleeing from Nagorno Karabakh to the Republic of Armenia, not only did our allies in the security sector refuse to help us, but they also made public calls for a change of power in Armenia, to overthrow the democratic government", he said. "But the people of Armenia united for their own independence, sovereignty, democracy, and another conspiracy against our state failed."
He also expressed the need to move towards peace with Azerbaijan.
Quick Bites:
Xi Calls for New World Order with Putin at his Side
President Putin and Chairman Xi met in Beijing for the annual celebration of the Belt & Road initiative. With Putin were the titans of Russian finance, energy, and agriculture, e.g. Sberbank, Gazprom, and Rosneft.
With Putin at his side, Xi called for a new world order, an alternative economic system not dominated by the west. Putin supported Xi in this initiative and touted the “no limits” friendship between Russia and China.
Diamonds are Forever, Russian Diamonds that is
G7 countries discussed four plans to ban Russian diamonds from G7 markets starting from 1 January 2024. The four proposals were prepared by Belgium, India, and the World Diamond Council.
Vol 1, No 16 - BWR 22.10.2023
Thank you for reading “Barbershop Whispers....Russia” written by Adam A Blanco! “Barbershop Whispers…Russia” is a product of e8Q Technologies, a consultancy with insights on all things Eurasia. Subscribe for free to receive new posts.