30.10.23 Sanctions Review

A Hollow Ceiling and a Rusty Fleet: Russian oil sales and the price cap problems

Conventional wisdom suggests that European Union and G7 sanctions targeting Russian oil have proven ineffective, with India and China purchasing it at a minimal discount to Brent crude prices. However, Benjamin Hilgenstock, an economist at the Kyiv School of Economics and a member of the Yermak-McFaul sanctions expert group, has gained access to classified Russian customs data that tells a different story: roughly half of the shipments may comply with the price cap. The average price of Russian oil falls short of the $70 per barrel mark, while the 2024 budget, with its substantial military expenditures, hinges on a $71 per barrel price point. To meet its revenue targets from oil exports, Russia must attempt to expand its shadow tanker fleet, which can currently carry no more than half of the required volume. The main focus of tightening sanctions is likely to be on combating these discrepancies.

The actual prices at which Russian oil is sold may be lower than those reported by Russian officials and most independent experts, according to Benjamin Hilgenstock, an economist at the Kyiv School of Economics and a member of the Yermak-McFaul sanctions expert group. According to the classified Russian customs data he has been able to consult (which is confidential in Russia), a barrel of Urals crude was selling for an average of just $61.50 in September and $59.10 in August. A barrel of ESPO crude, on the other hand, went for $71.50 and $68.40 in those respective months. Thus, on average, Russian oil cost $67.50 per barrel in September and $63.70 in August. The Russian Ministry of Finance, however, claimed that the average price of a barrel of Urals crude in September was $83.08 and $74 in August. Estimates from the International Energy Agency (IEA) came closer to those of the Ministry of Finance. In August, Urals crude averaged around $71 per barrel. Given that oil was generally cheaper in August than in September (at $86 compared to nearly $94 per barrel of Brent), Hilgenstock and the IEA's assessments diverge significantly.

Hilgenstock's figures closely align with the price caps established by the European Union and G7, which stand at $60 for oil and $45 for petroleum products. In August, the price structure of Russian exports started to diverge, with 48% of shipments adhering to the price cap and 52% selling at higher prices. Before that, the price cap was being observed. The discrepancy in Hilgenstock and the IEA’s estimates could be attributed to the fact that the agency does not receive data on transactions that factor in the price cap. In turn, the Ministry of Finance may not account for such transactions because Vladimir Putin has prohibited Russian exporters from complying with sanctions.

Hilgenstock's findings run counter to the common belief that the price cap has effectively ceased to function, and the discount on Russian oil has diminished to a minimum. It is assumed that the sanctions against Russian oil likely worked up until July, discounting Russian oil to the Brent price, but then as prices moved upwards, the discount shrank sharply and Russian oil began to be sold at prices well above the price cap. It follows that the effect of the sanctions on Russian exports is limited only by higher transport costs (it is more expensive to ship oil to India and China than to Europe) and likely discounts for Indian and Chinese resellers, as well as the costs of the shadow fleet (Re: Russia has detailed how this was created and how it is organised). Hilgenstock himself had previously shared this perspective.

The Russian Ministry of Finance anticipates that the average price of a barrel of Russian oil will exceed $71 in the coming year. The Central Bank, in its 'Basic Monetary Policy Guidelines for 2024–2026,' has provided a more conservative estimate of $60 per barrel of Urals on average for the year. Nonetheless, the regulator has pledged to present a new version of the forecast following the release of the 2024–2026 budget, which envisages a significant increase in both expenditures and revenues. The government believes that oil and gas revenues should increase by 30%, and non-oil and gas revenues by 19%. However, if Hilgenstock is correct, these plans begin to look overly optimistic.

In any case, Russia's revenues from oil and gas exports are increasing (although, this is according to data from the Ministry of Finance, which has diverged from customs data), and the prices at which a significant portion of Russian oil is sold remain unknown. Recently, there have even been proposals to abolish the price cap altogether. For example, the Bloomberg analyst Julian Lee has argued that the use of a shadow fleet has created an environmental disaster risk, as the transport of Russian oil relies on old, rusty tankers that are likely not adequately insured. However, former US Treasury official Ben Harris, who is considered one of the architects of the idea of the price cap, has proposed tightening control over the shipping market, particularly by regulating insurance for vessels carrying oil through controlled Danish, Turkish, and Egyptian waters. At the same time, he suggests raising the price cap for the time being and adjusting it more frequently by monitoring the market situation.

In October, the United States imposed restrictions against violators of the price cap for the first time, targeting two shipowners from Turkey and the UAE. The Price Cap Coalition, which unites the architects of the cap, has called on maritime market participants to monitor compliance with the restrictions more closely. According to expert estimates, the existing number of tankers is sufficient to transport slightly less than half of Russia's required volume. This may explain the discrepancies in the data regarding the price of deliveries. If the price cap is indeed effective, Russian companies will have to expand their fleet. However, they have thus far been buying tankers from European shipowners, which the sanctions coalition is able to influence. It appears that the primary focus of tougher sanctions will be on combating the Russian shadow fleet and efforts to expand it.