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Dec 4, 2022Liked by Peter Nayland Kust

"Russia is not saving any money by using its own tanker fleet. "

I wouldn't be so sure. I own a business. There are functions I outsource that I could do myself for less, but I don't, because I'd rather not be bothered handling all those details. Now if I were cut off from the vendors who are capable of doing those things for me, I'd find a way to do them myself, and it would probably cost me less.

But let's assume you're correct and that it costs more. How much more? $10/barrel? $20? If it's less than the spread between the $60 "cap" and the whatever Russia can sell the for in markets that aren't abiding by the cap, then using her own fleet of ships would still be net win for Russia, no?

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The price of oil having always been highly variable, and given that oil price vs the overall costs of production have been a major determinant of investment in oil discovery and production, it is reasonable to presume that this existing economic pressure to minimize costs would have compelled Russia (and other oil exporting countries) to have established and maintained their own tanker fleets long before now.

Instead, in Russia we have seen quite the opposite effect: reliance on the revenues from hydrocarbon export has hollowed out Russia's industrial base, such that even Russian officials have had to acknowledge that Russian industry is in several regards reliant on imports. Tanker maintenance and repair, while a cost to Russia's oil industry, would be revenue to other industrial sectors, and so the net benefit of internalizing that cost would be significant to Russia's overall economy. Despite that, Russia has never taken on that cost burden, which implies that the costs, at least to Russia, outweigh the overall economic benefits.

That is, of course, an extrapolation from Russia's prior reliance on foreign tankers to export its oil. Still, Russia's economy has always been in a rather parlous state, and the need to capture every ruble of revenue possible from its oil exports is quite significant, which makes the extrapolation a reasonable one.

Also, as Russia will have to maintain a rather large tanker fleet to fully evade the cap, it is highly unlikely it has the full shipyard facilities with which to do so at this time, and so there are ramp-up costs which also come into play that, a few years hence, will drop off but which for now will be fairly significant.

Any cost savings Russia will obtain from running its own tanker fleet are likely to be realized several years from now, not this year nor next.

Recently, Urals crude has traded as low as $66 per barrel, and is currently running at a $15-$20 discount from Brent, all of which is the result of the war in Ukraine and the attendant sanctions on Russia (prior to February Urals crude traded at more or less the same price as Brent). The cap adds another $5-$10 per barrel to that discount. If the costs of maintaining the tanker fleet exceed $10 per barrel then the cap will accomplish everything it set out to do, as at that point Russia will be losing money trying to evade the cap.

But even if the increased marginal costs of shipping are as little as $1 per barrel--and to be clear there is no data on how much the marginal costs of Russia's sovereign tanker fleet strategy will be, which makes all of this hypothetical--that would be $1 per barrel effectively added to the existing discount being applied to Urals crude.

The stated purpose of the cap is to deprive Russia of oil revenue to fund its war in Ukraine. If Russia takes on increased marginal costs of transport to evade the cap, Russia is still effectively being deprived of oil revenue that can be used to fund its war in Ukraine. Russia's best case scenario even with the sovereign tanker fleet is to minimize its revenue loss as a result of the cap. Barring a sea change in the price of Urals crude, there is no scenario where evading the cap increases Russia's oil revenue.

In fact, the existence of the cap is likely to increase the discount sought by India and China on Urals crude, as the price for Urals crude above the cap now represents something of a price premium to the purchaser.

The cap is unlikely to result in the magnitude of revenue loss to Russia the dollar amount of the cap itself would suggest. However, the cap is likely to result in at least some revenue loss. While a successful strategy to minimize that revenue loss arguably is a technical "win" for Russia, economically it's a fairly specious and even Pyrrhic sort of win, as Russia is still losing oil revenue (more precisely, oil income, which functionally amounts to the same thing) in every scenario.

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Dec 4, 2022Liked by Peter Nayland Kust

Question for you: Where does Urals crude trade? I don't mean on what exchange or the location of that exchange, but where is the physical hub (the equivalent of Cushing, OK for WTI) for Urals crude? If it's physically in Russia, the price there probably isn't very indicative of what Russia can sell its oil for in other markets that don't abide by the cap if they use their own tankers.

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Not sure which city is the physical hub, but the most likely location is the Novorossiysk end of the Baku pipeline, which puts it on the Black Sea.

Even if the final recipient is able to sell Urals crude for more than $60 per barrel, oil coming out of Novorossiysk sold for more than $60 is going to attract maximum attention.

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