Photo: ANGELOS TZORTZINIS/AFP/Getty Images
Few observers predicted that oil prices would be this low in early 2023 following last month’s EU embargo on seaborne Russian crude and the new EU and G7 price cap on Russian oil. Brent crude was below $80 per barrel as of January 9 and Russian crude is still trading at deep discounts. The EU embargo and price cap are institutionalizing these discounts and forcing Russia to ship its oil over longer distances to a dwindling number of buyers. But while Russia’s seaborne oil exports dropped in December, they could bounce back as risk aversion fades, and it remains unclear how widely the price cap is being adopted.
Q1: What was agreed in December?
A1: As of December 5, the European Union embargoed seaborne crude oil imports from Russia. The G7, the European Union, and Australia also imposed a long-anticipated price cap on Russian crude oil at $60 per barrel. These countries barred support services for Russian crude oil shipments above the price cap—including trading and commodities brokering, financing, shipping, insurance as well as protection and indemnity, flagging, and customs brokering. The U.S. Treasury’s Office of Foreign Assets Control (OFAC) and its counterparts in Europe created an attestation process for market players to verify they are only supporting transactions at or below the price cap. At the urging of EU states, including Poland and Estonia, the European Union also agreed to review the price cap every two months. Policymakers will aim to set the cap at least 5 percent below “the average market price for Russian oil and petroleum products,” calculated on data provided by the International Energy Agency. Each subsequent change to the price cap will introduce an adjustment period of 90 days.
Russian pipeline exports are not subject to the EU embargo, but Poland and Germany have vowed to phase out imports from the Druzhba pipeline’s northern arm. That would leave Hungary, Slovakia, and the Czech Republic as the remaining customers, implying a potential drop in Druzhba pipeline flows from about 750,000 barrels per day (b/d) in 2021 to below 300,000 b/d in the first quarter of this year. The EU embargo also exempts Russian maritime crude oil and product exports to Bulgaria until the end of 2024, as well as exports of vacuum gasoil to Croatia until the end of 2023.
The “price cap coalition” is now preparing to impose caps on Russian refined product exports by February 5. Details are still limited, but it appears there will be multiple price caps for different products: high value light products like diesel, and lower value products like fuel oil. Those price caps will be harder to design and implement, given the lack of global benchmarks for refined products, the smaller refined product tanker fleet, and the complexity of determining the country of origin of various products.
Q2: What was the market impact?
A2: The immediate price impact has been quite limited. Bullish analysts argued last year that the EU embargo and the price cap, combined with tapering U.S. Strategic Petroleum Reserve (SPR) releases, would create a much tighter oil market. So far, this has not happened.
Brent prices fell below $80 per barrel in early December and remained just below that level on January 9, mainly due to concerns about economic weakness. The negative economic outlook in Europe, high interest rates, and skepticism about a Chinese economic rebound in 2023 are dominating market sentiment. Algorithm-driven trading also seems to be increasing volatility and exacerbating market swings, magnifying the impact of negative economic news. But the $60 per barrel price cap—higher than many anticipated earlier last year when the concept was first mooted—also alleviated concerns about a supply shock from Russia. A lower price cap could have been more disruptive, increasing the risk of sanctions evasion and cheating, and creating enforcement challenges.
So far, the embargo and the price cap have succeeded in one key goal: institutionalizing the deep discounts for Russian oil. As of January 9, Urals—traditionally Russia’s key crude blend exported to Europe—was trading below $40 per barrel at the Baltic port of Primorsk, according to Argus price assessments. Russia’s ESPO blend, traditionally exported to Asia, was trading above the $60 per barrel price cap. The discount for Urals is likely to continue, because Russia will now be forced to ship volumes from Baltic or Black Sea ports over much longer distances, mainly to Asian customers.
Q3: What is happening with Russian exports?
A3: Russian seaborne oil exports fell in December by 10 percent to 14 percent over the previous month, according to various estimates, but this may be a temporary phenomenon rather than a steeper decline. Poor weather in December reduced loadings at Russia’s Kozmino port in the far east, and maintenance at Primorsk hampered exports. But risk aversion in the market surely contributed to the drop in exports. It will take some time for traders, insurers, and shippers to develop a comfort level with the price cap attestation requirements. An uptick in Russian exports is quite possible in the next few months.
Russian crude flows are fundamentally changing. Its seaborne crude exports to Europe all but disappeared last month, except for about 160,000 barrels per day in exports to Bulgaria that are allowed under the embargo. Turkey is the only Mediterranean country taking significant volumes. This leaves Russia ever more dependent on buyers in Asia, mainly China and India. Export volumes to India topped 1.1 million b/d in December, extending a large increase in volumes this fall. December also brought a notable increase in oil in transit to unknown customers. Bloomberg reported that tankers holding some 19 million barrels of crude left ports in the four weeks to December 30 showing no clear final destination. These barrels will presumably end up in India, China, Turkey, or other markets in Asia and the Middle East. There has also been an increase in ship-to-ship transfers of Russian crude in Europe and Asia that could be used to disguise cargo origin. Smaller Aframax vessels are loading in the Baltic or the Black Sea and transferring their cargoes to very large crude carriers (VLCCs) offshore Greece and Ceuta.
Q4: Is the price cap being implemented?
A4: At this stage, it is hard to tell how widely the attestation process has been adopted. There is no public disclosure system, so assessments depend on detective work using insurance and shipping databases. The first price cap-compliant cargoes of Russian oil loaded in December, suggesting that some market participants, including Indian refiners, were abiding by the price cap requirements. Tankers transporting this crude appeared to have Western insurance, and at least one ship operator suggested the necessary attestation documents had been prepared. But subsequent reporting suggests that some of these cargoes may have included Russian fuel oil or Kazakh origin crude, which would not be subject to the price cap.
A key question is how successfully Russia can work outside the reach of the G7 through its existing tanker fleet and a growing “shadow fleet” of tankers. Shipping brokers suggest that Russia bought more than 100 tankers in 2022, including perhaps 50 Aframaxes (with capacity of 80,000 to 120,000 deadweight tons, or around 750,000 barrels) and 30 Suezmaxes (capacity of 1 million barrels). But hundreds of tankers have changed hands last year, with many unknown companies buying vessels. Presumably some of these buyers are Russian-owned shell companies. Many of these tankers are nearing their end of life, suggesting a greater risk of accidents for older ships that may have substandard insurance. New traders and middlemen are also cropping up to facilitate the trade of Russian oil, in some cases via vessels insured by Russian state companies.
It will be critical to monitor the growth of Russia’s dark fleet, but for now it cannot decouple from G7 support services for its oil exports. The G7 countries provide about 90 percent of the relevant services for maritime oil trade, including insurance and reinsurance. Instead of evading all G7 services, Russia will probably ship its oil independently and avoid G7 services as much as possible, while acceding to the demands of risk-averse buyers. U.S. Treasury officials have argued for months that this would constitute a win for the price cap coalition. Russia’s key buyers in India and China will have more leverage. Presumably they will either comply with all price cap attestation requirements, or at least demand lower prices that will limit Russia’s oil revenue.
Q5: What happens next?
A5: Russia’s response to the EU embargo and the price cap has been muted. On December 27, President Vladimir Putin threatened to cut off supplies to countries where supply contracts directly or indirectly use the price cap mechanism. However, his terse statement offered few details and there is less to this decree than meets the eye. EU and U.S. guidance only requires an attestation from various entities involved in transactions that buyers did not pay above the price cap, as opposed to an explicit requirement that all contracts note exact transaction prices. Russia’s decree is also set to take effect only on February 1 and will be in force only through July 1. This suggests that the Putin’s decree is not the final word, and that Russia will seek a stronger response over time—but also that it has limited recourse.
The market seems unsure about Russia’s production outlook as well as the ultimate impact of the EU embargo and the price cap. The December drop in exports has led to some speculation that Russia will be unable to find sufficient buyers for its crude—especially Urals—and that it will have to shut in substantial volumes. The International Energy Agency suggested in December that by late March, Russia may have to shut in some 1.8 million b/d in crude oil, condensate, and natural gas liquids (over prewar volumes). A large disruption is certainly possible. It will be challenging for Russia to find alternative buyers for all of the 3.1 million barrels per day of crude oil and feedstocks it exported to Europe before the war. But it is more likely that Russian exports will bounce back from a temporary decline in December, as weather-related challenges subside and as buyers increase their comfort level with new shipping routes and terms.
Exporting oil over long distances to a dwindling number of buyers will drive down Russia’s revenue per barrel, although some countries will push for an even lower price cap to increase the pressure. Over time, Russia, its buyers, and various middlemen will probably find ways to subvert the price cap, especially if oil prices rise. But for now, sanctions architects seem to have the upper hand.
Ben Cahill is a senior fellow for the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C.
Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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