FACTBOX: G7, EU keep markets guessing over price cap on Russian oil - S&P Global

Highlights

US-led move designed to hit prices, not supply of Russia's vital oil exports

Control of global tanker insurance key to enforcing price cap

EU still discussing adoption of price cap into existing Russian oil sanctions

As the G7 group of rich nations continues to hammer out the fine print for a price cap mechanism on Russian crude and products exports, oil markets and shippers have been left guessing how and when the measures will be structured, implemented, monitored and enforced.

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Designed to keep Russian oil flowing into global markets while curbing Moscow's ability to fund its war in Ukraine, the US hopes the price cap will be agreed upon at least a month before the EU's sanctions kick in on Dec. 5 and Feb. 5 for crude and products, respectively. As envisaged, the price cap would prohibit shippers, insurers and insurance brokers in compliant countries from providing services to oil buyers in other countries trading Russian oil above a specified price level.

"The US-proposed price cap continues to gain momentum," Paul Sheldon, chief geopolitical adviser at S&P Global Commodity Insights, said. "Our reference case assumes a complicated enforcement process and the need for Russia to willingly sell into the cap would mute the desired impact of keeping more oil on the market, at least initially."

The following is a roundup of the key market movements and implications for the price cap plans so far:

Prices

The value of Russia's flagship Urals export-grade crude took a tumble in the wake of the Ukraine war, hitting record lows of $40/b below physical Dated Brent, as many Western buyers shunned Moscow's oil. But the discounts for Urals began to shrink sharply in August as global supplies tightened and China and India stepped up imports of cheap Russian oil. The falling spread for Russian crude propped up Moscow's oil revenues even as benchmark oil prices slipped back from June highs. Some market watchers see the renewed impetus for the G7 price cap initiative as a direct response to the narrowing discounts for Russian crude.

• The US has said it doesn't expect or need key importers such China, India and Turkey to join the G7 price cap but hopes the impact of the mechanism on trade flows and its use as bargaining leverage to negotiate cheaper Russian oil will depress the value of Russian crudes globally.
• Indeed, the Urals crude discount to Dated Brent stood at $23.19/b Sept. 27, according to S&P Global Platts data, after widening by $3/b from a postwar low of $19.05/b Aug. 25.

US Treasury officials have said the proposal aims to set three separate price caps for imports of Russian crude and higher and lower value oil products such as jet and fuel oil.

• According to US officials, the yet-to-be-decided price caps will be set between the marginal cost of production for Russian oil and pre-pandemic prices for Russian oil in the global market in order to incentivize Russia to continue producing and exporting.
• Seven out of 11 major Asian refiners and trading companies surveyed by S&P Global Commodity Insights anticipated the cap for Russian crude to be around $48/b-$55/b.
• Several Southeast Asian refiners, including Pertamina, have said they are tempted to buy Far East Russian sweet crudes, including ESPO and Sokol, but it will depend on Russia's willingness to accept the price cap.
• Many Asian buyers, especially in India and China, have been snapping up Russian cargoes due to sharp discounts, and tanker rates out of Russia remain at elevated levels.
• The dirty Black Sea-to-Far East shipping route for a 135,000-mt cargo remained more than double prewar levels at $43.70/mt Sept. 27, as assessed by Platts.

Trade flows

Before the war, 60% of European imports of diesel came from Russia, a dependency that rises to 70% for Northwest Europe, while in the Mediterranean 25% of diesel imports were coming from Russia, according to tanker tracking data provider Kpler. Russia's seaborne oil exports fell 6% to a new post-Ukraine war low in the first half of September, according to Kpler. As Russian volumes fall ahead of sanctions, growing US imports mean the US is set to become Europe's biggest supplier of oil in the coming months.

• The G7 estimates that about 95% of the global oil tanker fleet is covered by shipping insurers in G7 countries, namely Canada, France, Germany, Italy, Japan, the UK and the US.
• Shipping insurance providers in all EU member states are also expected implement the cap when finalized.
• Russia has said it will not sell any oil or products to countries imposing the price cap mechanism on its exports.
• Some analysts fear Russia could retaliate further by shutting in swaths of its production to trigger higher global oil prices.
• Most market watchers, however, believe Russia will be able to maintain oil revenues and not jeopardize its global oil market share.

Some oil supply losses from Russia are seen as likely even if the EU reworks its existing sanctions to incorporate the price cap mechanism before year-end.

• S&P Global Commodity Insights forecasts Russian disruptions peaking at 1.5 million b/d in Q1 2023 due to the EU import bans, which could be tempered by the price cap.
• Goldman Sachs estimates that the world can expect to lose about 1 million b/d of Russian supply versus prewar levels due to incomplete redirection to alternative non-NATO buyers under a price cap.

Oil importers, refiners and traders looking to buy Russian crudes after December will find it difficult to access G7 finance and insurance services. Europe is heavily reliant on Russian oil, meaning it will take time to diversify supply, but new dynamics are emerging.

• Europe's imports of seaborne Russian crude stood some 1 million b/d below prewar levels at just under 1 million b/d in the first half of September, according to Kpler data.
• The EU has said it is looking to incorporate the G7 price caps into its existing sanctions on Russian oil imports due to kick in from Dec. 5. The trade bloc requires unanimous support from all 27 members to implement the price cap.
• If approved, the EU would need to create an exception to its ban on services for Russian seaborne oil, thereby prohibiting Russian oil imports unless the oil is purchased at or below the price cap.
• "Even so, several headwinds would persist," Sheldon said. "These include opaque pricing for many transactions, confusion over implementation and enforcement details, and the need for Russia to willingly engage under Western-induced constraints. However, if the alternative is shuttered production, the US does not shift to secondary sanctions threats, and the cap is set as high as a reported $60/b, over time Russia and some remaining buyers may choose to utilize the option to receive Western shipping services under the 'price exception' policy."

Infrastructure

With the main leverage of the price cap directed at the provision of tanker shipping insurance in compliant countries, market watchers expect some buyers of Russian crude to use a growing source of alternative insurance services offered in Russia and China.

• Russia's ability to sidestep the price cap by using domestic or non-G7-regulated shipping and tanker insurance from countries not imposing the price cap, however, is seen as limited due to a shortage of spare tanker capacity.
• The Druzhba pipeline -- which transported up to 1 million b/d of Russian Urals crude to Central Europe before the war -- remains a supply route for Russian oil to some European refiners. Ukraine ships Russian oil to Slovakia, Hungary and the Czech Republic via the southern leg of the Druzhba line.
• But flows via the route will dwindle further by year-end as Germany cuts off imports to comply with EU sanctions.
• Germany and Poland are preparing to end their imports through the northern Druzhba route by end-2022 despite sanctions exemption for pipeline flows.
• Some 300,000 b/d of remaining Russian crude could continue flowing to landlocked Hungary, Slovakia and the Czech Republic, which are exempt from the ban.
• Bulgaria, which imports Russian crude via the Black Sea to supply the Lukoil-owned, 190,000 b/d Neftokhim refinery in Burgas, is allowed to buy Russian crude for another two years until December 2024.
• These remaining Russian flows to the EU, however, could still be subject to price caps if the EU adopts the G7 proposal.

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