At first glance, it seems as though the price cap on Russian oil at $60 per barrel is working like a charm. The market is well-supplied, and there does not seem to be a market deficit that many were fearful of. Russia has not curtailed its production in an attempt to force an increase in prices, it has indeed increased supplies. According to media reports and official Russian statistics, published by the Central Bank and the Ministry of Finance, Russia is forced to sell its oil at $47 per barrel, which is way below global $80/barrel prices.
At the very least, these numbers are a sign of trouble ahead for the Russian state budget, as they form the basis for the customs duties and oil extraction taxes levied on oil companies, and, in the first half of 2022, these two taxes comprised more than 45% of the Russian state income.
However, this picture may be misleading as it suggests that Russia as a whole has lost a substantial portion of its revenues. In reality, the situation is much more nuanced.
The Urals price, according to official Russian statistics, and reiterated in the press, is a notional value. Extremely little oil, if any, is sold at this price. This figure is an average of FOB Primorsk and FOB Novorossiysk price assessments, calculated according to methodology, which is irrelevant to the current market environment
The actual sales price of Urals crude in its main market is approximately $70-75/bbl
The non-transparent shipping market creates a mechanism for evading the price cap and channelling a large portion of Russian oil revenues to shadow accounts.
A large quantity of seaborne Russian crude (up to 800,000 bbl/day, 20% of the total seaborne volumes) is sold at $70/bbl or more on FOB basis, thus openly defying the cap.
Let’s delve into the details of each of these points.
Commodity markets operate with a plethora of prices for seemingly the same commodities. There are various grades of the same product, (Brent, Urals, WTI, Dubai, Oman, etc.), spot and futures prices, and different points and terms of delivery (CIF Rotterdam and FOB Primorsk for example). Let us dissect the difference between these last two variations. Rotterdam is where many buyers actually needed Russian crude before the war. At times they might have been willing to pay more for it than for Brent, at times less, depending on the market conditions and variations between diesel fuel and gasoline (in a refinery, Urals yields more diesel than Brent). To transport it there from Primorsk, a Russian port in the Gulf of Finland, one would have to pay for shipping and associated expenses. A buyer may pick up cargo in Primorsk (this would be FOB basis) and take care of the shipping costs, or in Rotterdam (on CIF basis) with shipping costs paid by the seller.
Until 2022 this was a transparent and vibrant trade. Baltic Exchange, a London shipping industry clearinghouse, was quoting two standardised indicators, TD6 and TD17, serving as benchmarks for shipping costs between Novorossiysk and Augusta, an oil trading hub in Sicily, and Primorsk and Rotterdam. These indicators were calculated based on information provided by the Baltic Exchange members – shipping brokers, handling most of the vessel chartering trade.
The Urals-Brent differential was influenced by market conditions, and not political considerations, boycotts, or embargoes.
It is important to remember that Urals FOB Primorsk or Novorossiysk, quoted by Argus and Platts, have never been the proper market prices, derived from the actual deals. They were always assessments, estimates made by the agencies, calculated from the three elements – Brent Dated price, Brent-Urals spread estimate and shipping costs estimates. The agencies used to run the numbers by the market participants to check if they made sense and might get access to price information from some actual FOB sales, but the sense check stopped at that. It is also important to keep in mind that Brent was a reasonable benchmark for Urals, as these two crudes were sold in the same market to the same refiners.
In late 2022 everything changed. Russian crude is no longer sold in Rotterdam and Augusta. London-based shipping brokers handle a much lower share of activities in Russian ports. Baltic Exchange has stopped listing TD17 and has modified the TD6 indicator, so it is not necessarily applicable to Russian cargoes.
However, the Argus methodology, last updated in January 2023, does not seem to take into account all these changes. Argus analysts are both experienced and professional, and although they most likely see the deficiencies of the old approach and are making every effort to provide a reasonable estimate, this may be difficult with the toolbox they have at their disposal.
Since the European embargo, most Russian crude, loaded in the Baltics and the Black Sea, goes to India, predominantly to west coast refineries in the states of Gujarat and Kerala (the number of tankers with non-declared final destinations surged as well, but many of these also ended up in India). Coincidentally, one of the largest refineries there, Nayara Energy with 400 kbd capacity, is controlled by Rosneft. Anecdotal evidence from traders suggests that Urals sells to other Indian refineries at a 6-10 USD discount to Brent, dependent largely on the prices of Dubai and Oman crudes, which are the benchmark types in that part of the world.
European refineries and their parent companies’ trading desks often exchange data with price agencies on a daily basis, so the price information in Rotterdam is based on comprehensive data and is thus able to be very accurate. But this is most likely not the case for Indian refineries, where agencies are only able to produce very rough approximations regarding the price of sales in that market. We can, however, use Indian customs data for our purposes. Unfortunately, official data on December’s deliveries is not yet available, and even so, December arrival volumes would have left Russia a month earlier, that is before the embargo and price cap were introduced. Official data for March 2022 – November 2022 shows relatively small Urals — Brent discounts, decreasing to zero in November. This data supports anecdotal evidence from the traders and suggests that the actual discounts might be even lower. Moreover, these statistics contradict the widely held view that the growth of Russian oil sales in India in the summer and autumn of 2022 was achieved by allowing large discounts on prices.
Hellenic Shipping News has quoted $11-$19/bbl shipping costs from the Russian ports to India, and these rates are higher than rates for comparable distances, such as a voyage from the Persian Gulf to Rotterdam. However, these are open-market quotes. If the rumours of the 100+ tankers recently acquired by Russian actors for the shadow fleet are true, then the majority of Russian trade would be carried by these tankers, and shipping rates and costs would be almost irrelevant, except for the bunkering fuel and insurance elements. It is also likely that additional tankers are booked on a time-charter basis, which also makes the cost of a single voyage non-transparent. Needless to say, these tankers would not be booked through Baltic Exchange shipping brokers, so there is a dearth of information on the actual conditions.
The two elements, Urals-Brent price differential for Gujarat deliveries and shipping quotation give us a range of 17 to 29 USD/bbl discount. The upper range of this brings us close to the widely publicised figure for Russian crude of circa $50/bbl (although it bears reiterating that this is netback to Russian ports, not the actual sale price), but I believe the actual discounts are lower.
This situation also creates a neat way to circumvent the price cap. As long as the oil companies directly or indirectly control the shipping element of the value chain and are able to refer to some high benchmark number for the cost of shipping, they are able to pretend they are selling the crude below the price cap, gain access to insurance services from the Western markets, and collect additional revenues on the shipping leg, thus compensating them for the shortfall created by the formally low oil sale price.
And, it also bears remembering that up to 1.6 – 1.8 million barrels per day leave Russia via the Far Eastern route, partially via pipeline to China, and partially via the port of Kozmino. This has had its capacity expanded from 600 to 800 thousand barrels per day, and the price there is going steadily above the $60/bbl price cap on the FOB basis. Russia is apparently able to ensure sales of at least these volumes without a need to resort to window-dressing so as to be able to employ Western market infrastructure, unavailable for sales over the price cap.
As noted at the beginning of this article, the Russian state budget is the obvious loser in this situation. However, the Russian Ministry of Finance has taken notice of this and there are now discussions on the subject of switching to Dubai crude price as the base for the Russian oil industry’s tax calculations.
There are several categories of Russian player who would be interested in seeing low oil prices. First and foremost there are the Russian oil companies. In the past they may have wanted to boast that they were successful in selling their crude at the top of the market in order to impress their international shareholders and keep their debt holders happy and content. Now they have nobody to impress. It is far more profitable to maintain the illusion that they are selling their oil cheaply, which greatly reduces their tax burden.
Moreover, the sudden murkiness and non-transparency within the industry provide a lot of space for the managers and middlemen involved in the oil trade to be creative with the figures and creates fertile grounds for side deals and kickbacks not seen since the 1990s when billion-size fortunes were made by the people in charge of the commodities trade in the former USSR.
Shipping and trading companies providing this trade also serve as a convenient conduit to syphon some funds away from the watchful eye of the US and EU economic warfare bodies in charge of embargoes and sanctions. Part of the crude value may end up in the accounts of these companies and used for purchases of controlled goods, from oilfield equipment, if used by the oil companies themselves, to electronic chips and other parts and materials for the arms manufacturing, if the government is aware of the actual goings-on and has some say over the use of proceeds, which seems quite likely. This is not unprecedented – back in 2016 Putin admitted that a 50% share of the dividends, paid on the state stakes in Gazprom and Rosneft, is spent by Rosneftegaz on ‘special projects that require close attention’. Going one step further, some of the funds may be used to support and finance pro-Kremlin or extremist groups in the West, in the same vein as the support provided by Moscow to similar groups in the 1970s.
Finally, (and my apologies for indulging in a bit of conspiracy theories), these circumstances create an ideal mechanism for the creation of an emergency fund for Mr. Putin and his coterie if he falls from power and has to leave Russia and hide somewhere. After all, Gaddafi, Mobutu, Abacha, and other dictators of resource-rich countries employed very similar mechanisms.
In any case, it is important to keep the following in mind: first, the conditions and institutional environment of the Russian oil trade have changed dramatically as a result of sanctions, and it thus makes little sense to focus on the tools and benchmarks used to assess the market in the past. They do not provide transparency so much as imitate it. And lastly, if there is opacity, there will always be someone ready and willing to take advantage of it.