The Russian Oil Cap Takes Effect

Is It Working? Quite Possibly

As of December 5, oil tankers carrying Russian crude sold for more than $60 per barrel are no longer able to obtain financial services or maritime insurance from western firms.

When the price cap on Russian oil took effect, the spot price for Brent crude rose slightly,

The price of Brent crude oil rose by almost 2% on Monday to $87.25 a barrel.

However, this price point did not hold and by day’s end the price of Brent crude was $83.01 per barrel, a 0.4% increase on the day.

Yet while the price of Brent rose slighly on the first day of the price cap, the price for the Russian benchmark Urals crude actually fell, from $63.85 per barrel on December 2 to $61.94 at the close of trading on December 5.

The EU price cap is having at least this much effect: it is reducing the market price for Urals crude, as purchasing countries have little reason to buy at above the cap price, pushing the Urals crude price towards the cap with or without enforcement.

At a minimum, the price cap has apparently already succeeded in depriving Russia of $2 per barrel in oil revenue.

However, the immediate effect of the cap appears to bite deeper than just that minor reduction in the spot price of Urals crude. Presumably because of the cap, the cost of shipping Russian oil has doubled thus far in December.

The cost of shipping Urals from Russia's ports to China and India, the key grade's consumers in Asia, doubled in December to $18 million and $15 million lump sum (full price for the tanker voyage) respectively, the traders said.

These lump sum costs work out to roughly $20 per barrel for India, and $25 per barrel for China. As Russian oil is generally sold Free On Board¹ Primorsk, Ust-Luga, and Novorossiisk, these lump sum shipping costs are deducted from the initial sale price, thus reducing the net revenue realized from Russian oil sales to India and China to the $40-45 per barrel range.

As a result Urals sellers' revenues may go down to $40-45 per barrel on FOB (free-on-board) Primorsk, Ust-Luga and Novorossiisk basis, which is well below the price cap level of $60 per barrel, Reuters calculations showed.

It may very well be that these shipping costs are what are motivating Russia to acquire its own shipping fleet. If Russia and Russian firms own the oil tankers, that lump sum shipping cost is captured and retained by Russia.

Russia's Workaround To The EU Oil Cap: Its Own Tanker Fleet

However, with the increased shipping cost in the range of $20-25 per barrel, even with its own fleet Russia is still unlikely to avoid shipping costs slighly below $10 per barrel, and with benchmark Urals crude trading very close to the cap price, Russia’s net revenue per barrel is still highly likely to end up below the price cap.

Some of the revenue loss is being mitigated by Russia's eastward oil infrastructure, as oil sent through the East Siberia Oil Pipeline is trading substantially higher than the price cap.

Russia's ESPO oil blend from the Far Eastern port of Kozmino was selling for around $79 a barrel in Asian markets on Monday - almost a third higher than the price cap imposed on Russian oil by the G7 and European Union - according to Refinitiv data and estimates from industry sources.

However, the ESPO blend has always traded higher than the benchmark Urals, so the practical impacts of the higher spot price are limited.

As I have observed previously, Russia's pipelines are heavily weighted in favor of European ports.

Russia Has A Pipeline Problem

Russian Press Secretary Dimitry Peskov reiterated on Russian media that Russia will not recognize the price cap and will sell oil for above $60 per barrel to whomever is willing to buy.

"The decision is being prepared," the Kremlin spokesman replied to the question of when Moscow's response could be expected. "One thing is clear - we will not recognize any ceilings," he stressed.

Additionally, Russian Deputy Prime Minister Alexander Novak, the government official in charge of Russia’s energy sector, has even hinted that Russia will trim production rather than accept a price cap.

"We will sell oil and petroleum products only to those countries that will work with us under market conditions, even if we have to reduce production a little," he added.

However, despite Russia’s determination to avoid the price cap, the current economics of shipping Russian oil may make avoiding the economic impact of the cap all but impossible. So long as Urals crude trades at a $20-25 per barrel discount to Brent crude, Russia is effectively stuck with the cap, in terms of realizable revenue. The imposition of the price cap does nothing to change the market environment which has imposed the steep discount on Russian oil; if anything, the cap makes steeper discounts attainable by purchasers of Russian crude.

To avoid the price cap and its consequences, Russia needs to drastically reduce shipping costs to well below $10 per barrel, needs to possess a tanker fleet of sufficient size to handle current production volumes, and needs to eliminate as much of the discount to Brent crude as it can. Only the second objective is realistically attainable in the short term.

Russia may yet find ways to evade the cap and its economic consequences, and certainly that possibility cannot be ruled out. That possibility might even be highly likely given enough time. However, in the immediate future, the price cap appears well-positioned to achieve most of its overall goal of denying Russia oil revenue with which it can fund its war in Ukraine.

1. Free On Board is a term used in shipping to determine when and where title and liability for goods passes from buyer to seller. FOB Origin, or FOB Shipping Point, transfers title to the buyer at the originating shipping point, while FOB Destination postpones title transfer until the final destination port is reached. While FOB Primorsk would suggest title passes to the purchaser Russian oil at the originating Russian port of Primorsk, the reporting indicates that the shipping costs are being netted against the sale price of the cargo. Certainly it is unlikely that buyers are going to simply absorb $20+ per barrel of shipping cost, as that would eliminate any economic benefit to purchasing Russian crude.