By Alex Budris
The price of Russian Urals oil in July rose above the cap set by the G7 countries and their allies at $60 per barrel. Thus, the plan to prevent a shortage of oil on the market and at the same time punish Russia partly failed. How this happened, what it can lead to and whether the United States has leverage to influence the situation, Forbes figured out.
The G7 (USA, Germany, Japan, UK, France, Italy and Canada), the European Union and Australia, which formed the so-called price cap coalition, announced a maximum price of $60 per barrel of Russian oil transported by sea. The price ceiling came into force on December 5, 2022, along with an embargo on Russian oil imports to coalition countries. The goal was to reduce dependence on Russian oil, reduce Russia's revenues, but at the same time prevent a shortage in the market.
After that, Russia managed to redirect supplies to the East, mainly to India and China, where oil was delivered at a significant discount. The country has closed data on oil production and exports, so the only way to get an idea of this is from statements by officials and data from foreign agencies. The Russian Finance Ministry, meanwhile, regularly publishes data on average prices for Urals, Russia's export blend of heavy sour oil from the Urals and the Volga region and light West Siberian oil. It was traditionally supplied to Europe and sold at a discount to the Brent reference blend.
On August 1, the Ministry of Finance admitted that in July the average price for Urals was $64.37 per barrel, up from $55.28 in June . Energy Minister Nikolai Shulginov said in an interview with TASS on July 27 that the Urals discount had fallen below $15 per barrel. With Brent on that date at $84.24/bbl, the price of Urals would therefore have to exceed $69/bbl. Prices rising above the ceiling in July were reported by Reuters and Bloomberg .
How Urals overcame the ceiling
Stanislav Mitrakhovich, an expert at the Financial University and the National Energy Security Fund, recalls that due to the expected increase in demand for oil caused by China, its largest importer, gradually overcoming the consequences of the pandemic, as well as the production cuts announced by Saudi Arabia and Russia, the price of Brent rose . On Thursday morning, August 3, October Brent futures traded at just over $83 a barrel.
According to Mitrahovich, the price of Urals is growing because the Russian oil industry and related industries - transportation and insurance - are gradually adapting to new realities: “Since companies have adapted to how to draw up all papers in the new conditions, they have learned to avoid risks, then the discount [ Urals to Brent] slightly decreased”.
“In our opinion, the big discounts on Urals compared to Brent over the past year and a half are changing the global market, creating a huge incentive to redirect sales of Russian oil from Europe to more interested buyers in Asia,” says Ronald Smith, senior analyst at BCS Mir Investments. “As this process gains momentum and new trade routes are established that become the new normal, natural market forces lead to a reduction in the discount. We expected this and think that this process will continue until the discount is reduced, perhaps to $5 per barrel or close to 2025.”
The reduction of the discount for Urals oil relative to Brent became possible due to the fact that about 90% of all Russian oil is exported to India and China, Alexander Potavin, an analyst at FG Finam, agrees: “It is beneficial for these countries to buy Russian raw materials, since it is not only for domestic consumption , but also for replenishment of stocks, as well as for processing and subsequent deliveries to the EU countries. That is, a significant part of the profits from the sale of energy carriers now remains with key buyers, and not with Russian companies, as it was before.”
Who made money on the discount
There is a lot of intrigue around the discount on Russian oil, says Mitrahovich of the Financial University. “Indian traders complained about the $4 discount,” he notes. “But this, apparently, is a discount for the [end] Indian buyer, and it is not clear by whom and what was eaten along the way - by some intermediaries, traders, insurers, carriers. The Indian newspaper hinted that they were Russian players, but in fact there may be Western players who are happy to earn money on discounts. There may be Asian ones, but there may also be Russian ones registered in the countries of the global South.”
The Times of India recently published an article, which said that "the romance with Russian oil seems to be losing its charm for Indian refiners, for whom discounts have been reduced to $4 per barrel from peaks of $25-30." Indian oil refiners, the article says, in order to avoid sanctions, buy Russian oil on terms under which the seller provides delivery and insurance. The newspaper claims that sellers of Russian oil charge $11–19 per barrel for freight to deliver oil from the ports of the Baltic or Black Seas, while buying oil themselves below the marginal price by $1–2 per barrel. This is confirmed by Mitrahovich. “Indeed,” he says, “in Russian ports, oil can conditionally cost $59.99 per barrel, so that the participants in the transaction do not formally violate the ceiling, and upon arrival at the Indian port, the price can rise by $10 or more.”
Why Brent Grows
The fundamental factor in reducing the supply of oil from the alliance of OPEC + countries while maintaining the strength of the global economy is pushing up energy prices, says Potavin from Finam. “In July, the cost of Brent oil rose by almost 15%,” the expert says. - The next rate hikes by the European Central Bank and the Fed last week did not spoil the mood of investors either on stock or commodity exchanges. Investors are confident that the US and EU economies will get through this year without falling into recession, which means that demand for oil will not fall.”
“Brent contracts ended July on a positive note, providing a record monthly increase since January 2022,” BCS World Investment analysts noted in a review. — Market participants are monitoring the reduction in supply from OPEC+ and are revising demand forecasts upwards. There is still potential for continued growth; on the horizon of the next weeks, Brent may reach $87–90 per barrel.”
Steps to cut production by Saudi Arabia will definitely exacerbate the existing oil shortage on the market, Potavin said. This month, oil production from OPEC+ countries may show a drop to the lowest level since the fall of 2021, the analyst believes. “Interestingly, we are seeing prices for Brent oil in the region of $83 per barrel, and not around $100,” says Potavin. - The reason for this is the growing production volumes from countries outside the oil cartel, such as the United States, Canada, Brazil, Mexico, Guyana. They partly replace the falling volumes of oil from the OPEC+ countries.”
Brent is already approaching $90 per barrel, having reached its highest level in the last three months, says Deputy Head of the Economic Department of the Institute of Economics and Finance Sergey Kondratiev: “I think that both fundamental and market factors have developed here: the persistence of high oil consumption in developed countries (despite the expectation of a recession), a recovery in demand in China and India, a reduction in supply due to a voluntary reduction in exports by Russia and oil production by Saudi Arabia, a change in the flow of trade in oil and petroleum products due to restrictions imposed by Western countries against Russia and, as a result, high freight rates and complication of logistics”.
The West is unlikely to severely punish violators
Sources and experts told Reuters that the US administration will not crack down on violators of G7 guidelines, instead using soft tactics to persuade the ceiling to be respected. Analysts polled by Forbes agreed that the G7, led by the United States, is unlikely to take the risk of using tough measures.
It is possible that the G7 countries will use soft measures to put pressure on carriers and buyers, says Finam's Potavin. “It is difficult to deal with gray oil supplies for export by sea, since both ships and transport companies change owners many times, and raw materials are often simply issued according to false documents,” the expert explains. - Perhaps there will be no new sanctions, since over the past month Russia has significantly reduced its production, and since August 1, it has also begun to reduce exports. The Russian budget suffers from this, and the upward trend in oil prices no longer affects the ruble exchange rate.”
The US administration is not going to take tough measures because, in the face of rising Brent prices, this could provoke a decrease in Russian oil supplies and create the effect of an even greater shortage, which is risky, says Mitrahovich of the Financial University. “You can imagine how the prices for oil products in Europe will rise and what political consequences this may cause,” the expert notes. - The Americans, although they consider themselves very serious players, are not omnipotent in reality: they are forced to realize the limits of their capabilities and put up with the fact that someone buys Russian oil at a price above the ceiling. And just destroy some companies, conditionally Greek or Middle Eastern, that are involved in the delivery of Russian oil, even if it costs more at the port of departure than the price cap allows,
In addition, Mitrahovich recalls, the United States is in a difficult situation with its strategic oil reserves, which have been seriously reduced due to intervention in the last year. “There is not much oil left to continue interventions,” the expert says. - If shipowners are forced to abandon contracts with Russia in the event of a panic in Europe, the United States may not have enough oil. We must also take into account public opinion, which may not be super stable in terms of approving support for someone to the detriment of itself. At the same time, strategic reserves have been used up.”
“I think that in the current conditions, the US and the EU are unlikely to be ready to follow the path of tougher sanctions - this will lead to higher oil prices and a new round of inflation, the situation of the summer of 2022 will repeat itself, while the US has the opportunity to intervene due to strategic reserves and the EU are now limited,” agrees Kondratiev of the Institute of Economics and Finance. “But even without tough measures from the US, continued price growth is the most likely scenario in the coming months.”
This article originally apeared in Russian at forbes.ru