The State of the Russian Oil Price Caps

At the G20 Meeting in February, U.S. Treasury Secretary Janet Yellen took a victory lap for the two rounds of oil price caps imposed on Russia since December last year. Yellen argued they had “sharply” reduced Moscow’s income while ensuring deep discounts for emerging markets. This assessment was echoed at last month’s CERAWeek conference by Torbjorn Tornqvist, CEO of Gunvor, the world’s 4th largest crude oil trading company. Counting himself among the initial sceptics, Tornqvist observed that “the cap is […] effective” with Russian “oil flowing but at a lower price.” 

These appraisals have been bolstered by economic assessments coming out of Russia in recent weeks. Not only have last year’s warnings from wary sceptics – myself included – not yet materialised, the Kremlin’s previously resilient finances have come under great pressure. Last year’s massive export-fuelled budget surpluses have swiftly turned into steep deficits since December, with surging defence expenditure parallel to a plummeting energy income. Nevertheless, it is imperative not to grow overconfident. The hitherto smooth price cap rollout is no guarantee against volatility ahead, and a miscalculated escalation could still backfire, potentially worsening the cost-of-living crisis.  

Sanctions Taking Their Toll 

The official price of Russian Ural Crude Oil fell swiftly in early December below the imposed price cap of $60 per barrel, with a widening price differential to the European Brent Crude benchmark (Here are two primers on the price caps). Already in January, the Centre for Research on Energy and Clean Air approximated the dual embargo and crude price cap to cost the Russian state $172 million per day – rising further with the February 5 price cap extension to refined petroleum products. Kremlin spokesman Dmitry Peskov cautioned against drawing premature conclusions, although more indicators have since emerged. Russia’s oil product export volumes slumped 20 percent in February, with a precipitous 48 percent year-on-year decline in overall energy-related tax revenues – levels not seen since mid-2020 when the global economy was at a standstill. While the Russian 2023 budget projects an overall 23 percent oil and gas revenue decline, the Kyiv School of Economics has estimated it could be twice as much. 

These losses have come even as Russia’s oil exports to its top consumers – India, China, and Turkey – have surged to new highs. China has overtaken the entire EU as Russia’s leading buyer of fossil fuels, while India has emerged as the top destination for seaborne cargoes. As noted by Rosneft CEO Igor Setjin, Russian oil prices are now entirely set by Asian markets. Though critics had cautioned that price caps could become impotent with major consumers opting out, the new buyers have secured the growing volumes at steep discounts, with long-distance shipping costs eating further into Moscow’s profits. Moreover, Russia’s substantial March production cut indicates it has proven challenging to find sufficient alternative buyers. 

The Institute of International Finance (IIF) has assessed that oil shipments have been sold significantly above the $60 price cap, although this was always to be anticipated. As the price caps are indirectly imposed through Europe’s near-monopoly on shipping insurance, Russian traders could always use third-party insurance and shipping providers, albeit at greater logistical costs. The Russian National Reinsurance Company (RNRC), the Russian Sovcomflot PSJC tanker fleet, and some Chinese supertankers have thus taken on a sizeable share of shipments from Russia’s European ports. Meanwhile, there has been a record increase in suspected ship-to-ship (STS) transfers to obfuscate the oil shipments’ origins, fuelling an intuitive suspicion of commodity traders’ substantial incentives to under-report price attestations to reduce insurance and tax liabilities. 

Still, these efforts are far from offsetting the Kremlin’s lost revenues, and more importantly, most oil contracts have continued to rely on Western insurance. Russian shipments using Western tankers even increased in January, suggesting that Russia’s $2.2 billion fuel tanker spending spree has yet to deliver, with the long-rumoured shadow fleet of tankers falling short.  

Challenges Ahead 

Not only has this been a hard blow to the Kremlin’s finances, but there has also not been any significant turmoil in global energy markets, putting some wind in the sails of those who favour lowering the price caps further. Ukraine, Poland, and the Baltic states have long complained that the current caps are far too lenient. However, the U.S. and other G7 member states have wisely erred on the side of caution, with the first crude price cap review concluding in late March without any tightening measures.  

A key factor behind the crude price cap’s relatively smooth rollout is that it has not yet been activated. Due to the loss of the European export market and generally declining global oil prices since June 2022, the benchmark price for Russian Urals has, between December and early April, remained below the $60 cap, set marginally below pre-embargo price levels. However, the factors that previously suppressed global demand, including recessionary fears, strategic petroleum reserve (SPR) releases, and China’s zero-Covid lockdowns, are now in fluctuation.   

According to the International Energy Agency, Global oil demand is set to rise by 1.9 billion barrels per day in 2023, with China alone contributing half of that growth. China’s factory activity has seen the fastest growth in a decade, and Beijing has resumed imports from Russia after a temporary hiatus. India also reports strong demand growth for the year ahead, recently rebuffing rumours of price cap compliance. With “supercharged” global demand, U.S. SPR drawdowns ending (and reversing), and the OPEC+ cartel again significantly cutting oil production, global prices, and, by extension, prices for discounted Russian oil, will also increase. The Urals benchmark already broke through the $60 barrier on April 5, although, since cargoes are priced over a set period of time, the deals still could fall below the cap by their closing. Barring a sudden banking crisis and recession, rising prices alone could thus trigger the price cap and simultaneously activate Russian countermeasures. 

The Kremlin’s overuse of bellicose rhetoric has unsurprisingly led to diminishing market impacts. Still, the recurring threats to completely cut off price-cap-adhering buyers have been signed into law. Under President Vladimir Putin’s decree, any trader whose contracts “directly or indirectly allow for the use of the price cap mechanism” would be banned from purchasing Russian oil for five months. Moreover, as indicated by Russia’s continued reliance on Western insurance and tankers, there appears to be no ready alternative to continue bringing all Russian oil shipments to the markets. Though certainly damaging to Moscow, such a scenario could again actualise past warnings of global shortages, with still low levels of global spare crude capacity.  

Nevertheless, if rising oil prices or a lowered price cap do not trigger a standoff first, Moscow probably will. The Kremlin ordered a study in January to adjust its energy pricing and taxation schemes. President Putin has since signed into law regulations that, beginning in April, fix the maximum discount on Ural crude compared to Brent crude. Starting at a maximum of $34 per barrel, the price differential will be forced to fall on a monthly basis to $31 in May, $28 in June, and $25 in July, having averaged around $30 since early December. Whether organically rising prices or Russia’s price-fixing regulations triggers the price cap first, EU populations – and developing countries less so – can ill afford another price and supply shock, with yet difficult-to-predict impacts on the global cost-of-living crisis. 

With much of its assets already frozen by Western financial sanctions, Russia’s National Wealth Fund has dwindled rapidly since December. The G7 and EU would do well to continue proceeding cautiously and not risk being seen as the escalating party when sanctions are already biting. Failing to do so could further widen already diverging global perceptions of the war amid mounting cries of double standards from developing countries – out-priced by energy-subsidising European governments.