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Big Questions Linger as Price Cap Nears

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The biggest direct action against Russian oil supplies ever taken by the West is just days away. The EU embargo on Russian crude imports, alongside sanctions on Russian oil shipments and the planned G7 price cap — allowing firms to provide maritime services for Russian oil bought by non-Western buyers at or below the cap — are all due to kick in on Dec. 5. But EU countries have for weeks been wrangling over the level at which to set the price cap on Russian crude cargoes. As PIW went to press, EU member states appeared close to agreeing on a cap of $60 per barrel, which they and the G7 must still sign off on. But hawkish Poland remained hesitant, arguing for a cap of around $30/bbl that would seek to hit Russian oil revenues harder. Like the bloc's difficulty in agreeing to a gas price cap, it has been a vexatious debate. A low oil price cap risks roiling the markets, provoking Russian retaliation and driving up prices and freight rates, while a high cap risks achieving little. G7 leaders are mindful that their efforts to squeeze Russia’s revenues have so far proved relatively ineffective. But the US — which is worried about an oil price spike from Russian supply disruptions — and some Mediterranean countries like Greece with large shipping industries have pushed for a higher cap price in the $60s. The proposed $60/bbl price would be near the top end of a previously discussed range and slightly below the current estimated price of Urals, which has been trading at discounts to benchmark Brent of around $22-$23/bbl, according to Russian data. It also would be above Russia’s cost of production, which energy ministry officials say ranges from $15-$40/bbl.

But the plan is beset with challenges. Moscow continues to insist that it won't comply and has threatened to shut in production if the cap is enforced, although officials have hinted at some flexibility. Meanwhile, just when the world could need more oil to offset any disruptions to Russian supply, other major producers within Opec-plus are also mistrustful of the cap, which may set a concerning precedent for them. Moreover, many traders continue to dismiss the initiative as impractical, which is hardly surprising. The mechanics of the cap, notably that it is a fixed price that must be known at the time of an oil transaction, are different to how Urals crude trades — and how physical crude markets generally tend to work. The fluctuating benchmark oil price could cause problems, with rising prices increasing the risk of Russia retaliating and buyers cheating the price cap system. G7 officials say the price will be frequently reviewed, and the Wall Street Journal reported that the proposed EU text says, at every review, the level should be “at least 5% below the average market price” for Russian crude and products, with the International Energy Agency advising on the price. Still, there are serious questions around timing and compliance. For a Western insurer to cover a Urals shipment, for example, the buyer would first need to attest that the price agreed complied with the cap. But Urals cargoes are normally priced over 10 days after the bill of lading and hedged on that basis. Again, if a Urals cargo is bought from a Russian seller on a delivered basis, how will the buyer attest that the transaction complies with the cap? “I think it’s going to be very hard to police,” says a London-based shipping source. Goldman Sachs said in a recent report it did not think the price cap was enforceable, given the scope for "Tier 2 and 3 players" — insurers, vessel owners, charterers, shippers — to evade liability if supplied with falsified documents.

Russian officials are eyeing workarounds to the price cap and say Russian companies can offer insurance that meets international standards. But they admit that Russian insurance is not fully recognized by China and India, now the two biggest buyers of Russian crude. And it remains unclear whether enough non-Western vessels, including ice-class tankers, exist to fully maintain Russia’s seaborne oil flows, especially with more vessels having to make the longer voyage to Asia, despite China expanding its fleet this year. What is certain is that the number of tankers “going dark” — there are already at least 110, according to the shipping source — and the occurrence of ship-to-ship transfers, where Russian crude is transferred from smaller vessels to very large crude carriers, blended with similar quality crude to disguise its origin and sent to Asia, will increase. India will be a crucial test case. Russia has gone from supplying minimal volumes to being its largest source of crude. India's oil minister has said he country will be happy to take more if the price is right. The US is hoping Indian refiners will use the price cap to negotiate deeper discounts, but that assumes the initiative will at least partially succeed.

Topics:
Oil Supply, Oil Prices, Oil Demand, Opec-Plus Supply , Sanctions, Trade
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