Cyprus Mail
CM Regular ColumnistFeaturedOpinion

What is the effect of the cap on the price of Russian oil?

file photo: the maltese flagged crude oil tanker minerva baltica sails in istanbul's bosphorus
Oil tankers in the Bosphorus

Western governments have agreed to cap Russia’s oil export price at $60 a barrel in a bid to curb profits that support its budget, military and invasion of Ukraine. This week, for the first time this year, the Brent price fell below $80/barrel, but the reasons are mainly economic.

The cap came into effect on Monday, December 5, the same day the European Union imposed an embargo on Russian oil shipped by sea.

The effect on the price of oil is uncertain. Bloomberg said: “It remains uncertain whether [the cap] will ensure the smooth flow of Russian barrels to Asian markets or whether there will be material disruption. “Any clear indication that Russia is ready to cut oil exports could send prices higher in the coming days.”

The EU, US and G7 imposed a price ceiling on Russian oil that is above the level at which it is now trading in the markets. Bloomberg’s conclusion is that if there was any doubt about what the criteria for selecting the cap were, it is now clear: the US and its allies want Russian oil to keep flowing, to avoid large increases in the price of oil.

President Putin has already warned that he will stop exporting oil to countries that appy the cap. Russia’s position is that it will sell oil and oil-products to those countries that will cooperate with it under market conditions, even if it has to reduce production.

Russia, the world’s second largest oil producer, already exports much of its oil to India, China and other Asian countries at about one-third discount to the Brent price, around $50-$55/barrel. Initial indications are that these countries do not apply the ceiling. As long as the price remains at around that level, it will not be affected by the ceiling.

A $60 cap could not have much of an impact on Russia’s finances. It will “go almost unnoticed” because it is close to where Russian oil is already being sold. The cost of producing Russian oil ranges between $30–$40/barrel.

The cap, however, could prevent Russia from benefiting if oil prices suddenly rise and the cap comes into effect. But if non-Western buyers don’t act, then Russia could benefit from a sharply higher global oil price.

The embargo is the biggest intervention in the world’s oil flow in decades, and no one knows exactly what will happen. Market players, including buyers, refiners, traders and the shipping industry, are skeptical that the new regulations can be implemented effectively. Politicians backing the effort admit it will not be perfect, but their view is that any reduction in Russia’s oil revenues is a win for the West.

Difficulties will increase after February 5 when, as planned by the EU, a similar embargo on the shipping of Russian oil-products by sea comes into effect. Europe has made little progress in replacing products such as Russian diesel, and tight global markets could make such replacement difficult and expensive. Cyprus should expect this to happen, with the price of diesel increasing in February.

Russia is banking on its growing “dark fleet” to ship its oil. After the Russian invasion of Ukraine, many tankers have been sold to unknown owners or newly established companies.

Oil price

The price of oil has fallen significantly this week mainly because of fears that economic economic slowdown is weakening demand:

  • economic data from China and Europe show economic weakness and reduced economic returns, leading to a decline in oil demand
  • there are also concerns about rising interest rates in the US, that are affecting the market negatively
  • US oil inventories rose more than expected, fueling fears about demand in a market already worried by an uncertain economy
  • also, investors are cautious due to recession warnings and prospects for further interest rate hikes in Europe and the US in 2023 impacting energy use.

But, all this is likely to be short-lived. The International Energy Agency predicts that there will be a reduction in Russian oil production and exports due to the cap and embargo, by up to 1-2 million barrels per year.

Also, in another development, Opec+ decided last Sunday to maintain the reduced oil production targets announced in October. Thus, oil supply to markets in early 2023 is expected to be below normal levels. The result will be an increase in prices.

Demand may fall if Europe or the US fall into a severe recession, but this will be offset by rising demand from China as it recovers from coronavirus and its economy bounces back. China is the world’s largest oil importer, so recovery of its economy could have a bigger impact on oil prices than a cap on Russian oil.

The outcome will be that by early 2023 prices will start to rise and perhaps return to $100/barrel.

How will the cap work?

The US proposed the cap with its G7 allies as a way to limit Russian profits while keeping Russian oil flowing into the global economy. The goal is to damage Russia’s finances by avoiding a sharp rise in the price of oil, which will be a consequence of a significant reduction in Russian oil on world markets. Easy in theory but difficult in practice – markets are not controllable.

The EU also imposed additional restrictions on insurance companies and other companies needed to transport oil. They will only be able to trade Russian oil if its price is at or below the ceiling price.

Most insurance companies are based in the EU or the UK and are expected to apply the cap.

This is the reason for the overcrowding of ships in the Black Sea, most of which are loaded with oil from Kazakhstan, not Russia. Turkey insists they must prove they are insured before letting them cross the Bosphorus, even though the US says this is unnecessary.

The risk is that a blanket ban on insurance could remove so much Russian oil from the market that prices would skyrocket, Western and other economies would suffer, and Russia would profit more from oil that can be exported by ship regardless of the embargo.

The EU and US position is that “the cap can be lowered over time if we want to increase pressure on President Putin.” They are determined to “cut Putin’s oil profits.” But, based on developments so far, this may prove to be more of a “moral stance”, difficult to implement, rather than an effective measure. So far, the cap and the embargo have had only limited effect.

Dr Charles Ellinas, @CharlesEllinas is a senior fellow at the Global Energy Centre of the Atlantic Council

Follow the Cyprus Mail on Google News

Related Posts

Disparity in gaming commission board allowances raises concerns

Elias Hazou

Larnaca port and marina developer renewing financial guarantee

Jonathan Shkurko

Cyprus plans expansion of firefighting air fleet

Elias Hazou

Keravnos: No threat to Cyprus’ economy amid Middle East tensions

Nikolaos Prakas

Migrant centres to house Syrians waiting for asylum (Updated)

Nikolaos Prakas

Fear that petrol will hit €2 a litre

Iole Damaskinos