Oil market unconvinced by Russian oil price cap proposal

Analysts and traders have raised serious doubts over the effectiveness of a potential price cap on Russian seaborne crude purchases in an attempt to disrupt oil revenue from one of the world's biggest producers.

Details on the proposed price cap following the 26-28 June G7 meeting in Bavaria remain sparse but the essential outline is for a coalition of global buyers to agree a maximum price to purchase Russian seaborne crude. If transactions are conducted below the "price cap" buyers will be able to access US, EU and UK shipping, insurance and financing markets.

Russia's key medium sour export grade, Urals, is already trading at a significant discount to Brent for European buyers but that still puts the selling price still well above $80/b and in Asia demand has been so resolute that prices have started to recover for Russian crude.

"Our main concern is the price cap and the potential complexity of its implementation might distract from the task of getting existing sanctions to work as effectively as possible," said Standard Chartered in its latest research. "We see the price cap as a complicated add-on policy that might have unintended side-effects, rather than a viable substitute for the development of existing sanctions," it added.

At present, the UK and US have agreed to ban Russian oil with the EU banning Russian seaborne crude purchases by the end of the year as well as prohibiting insurance on vessels carrying Russian crude to third countries.

"I'm not sure how it's going to work, crude oil is a free market and how this works is going to be very interesting," said one Mediterranean trader.

Traders voiced similar concerns over the implementation of the price cap expressing uncertainty over the lack of clarity. Furthermore, European traders said that the new plan "undermined" the EU's latest sixth sanctions package embargoing Russian crude purchases by Dec. 5.

The consensus amongst Urals traders appears that a so called "buyers' cartel", which would set the maximum price for Russian crude purchases, would be too difficult to implement and be inefficient in practice.

"It relies on everyone agreeing to it, the other issue then becomes if its capped and very cheap, everyone will want it so how much volume gets allocated to whom," said a second trader adding that it would also create the incentive for a buyer to "pay just above".

Workable?

Platts Analytics said one option could be altering Europe's current plan for a complete ban on insuring Russian oil cargoes by the end of 2022 by allowing coverage under a price ceiling. Shipping services and US finance could also be included.

"This would require all 27 EU members and international partners to agree, which would be challenging, but likely lower our reference case for shut-ins to grow from 640,000 b/d in June to 2 million b/d by December," Platts Analytics said in its research.

"While this would work toward US goals of reducing Russian oil revenues but limiting global disruptions and price spikes, there are concerns that Russia could refuse to sell price-capped cargoes and cut supplies ... In any case, the US' push to support volumes highlights hesitancy to utilize secondary sanctions on Russian oil exports at current prices, at least for now," it added.

Analysts predict that the price cap would also have to be set above the $40/b breakeven price to incentivize Russian producers to maintain current exports. However, traders suggest that setting the price too low would see a counter intuitive rise in global oil prices due to a loss of Russian production. Conversely, setting the price too high would fail to have the desired effect on Russian oil revenue.

A third trader explained that government intervention in the oil market would be "detrimental to the end user in the long run".

According to the latest Platts assessments from S&P Global, June 30, Urals cargoes delivered to Rotterdam were trading at a $35.20/b discount to Dated Brent, while delivered Mediterranean cargoes have a 30 cents/b premium.

However, an Asian source said that recent demand spikes in China have seen independent Chinese refineries bidding up distressed Urals cargoes with levels heard to have risen from ICE Brent minus $7/b to ICE Brent minus $4/b.

With a suggested price cap of around $40-$50/b, this would equate to a discount of $65/b to Dated Brent, double the current discount in Europe and several times greater than the current discount for Asian buyers.

However, at such a steep discount Russian producers may prefer to shut-in barrels or send more cargoes to storage. Olivier Blanchard from the Peterson Institute for International Economics said in a note that a 20% fall in Russian production would amount to a $10/b rise in global oil prices. Traders concur that the proposed price cap could instead increase global oil prices if there is sufficient leakage in the policy.

At present, exports of Russian crude reached a three year high in May, according to shipping data from Kpler. Data also revealed seaborne exports of Urals to Europe increased in June for the first time since the invasion of Ukraine.

Analysts at PVM Oil note that there could be merits to the new sanctions policy in hurting Russian revenue more than the current buyer's embargo. "Whilst it is a complex issue, which requires comprehensive participation, possibly including China and India, it is the most efficient way, together with the ban on Russian imports, to inflict considerable economic and therefore political pain."