08.12.23 Sanctions Review

Prices below the cap: The year that the mechanism to limit Russian oil prices has been in operation has shown its ineffectiveness in its current form

The price cap on oil and the European embargo have deprived Russia of a portion of its export revenues. Experts have estimated that the size of the lost profit exceeded $30bn. In general, the revenues this year will be lower than in 2022. But the backlog created last year is gradually shrinking. By imposing sanctions, the West assumed that the level of globalisation in the world oil trade was so high that even a very large player would not be able to function in isolation from the complex service infrastructure in which US and European companies have historically played a key role. However, it is evident that the West has overestimated its strength. First, exceptions were made to the sanctions, which allowed a number of countries to refine cheap Russian oil and export the resulting oil products to Europe. Second, Russia has been able to build a separate infrastructure for its shadow fleet of shell companies, through which it supplies oil to India and China, which have not joined the sanctions, at prices above the cap. As a result, Russian oil exports have suffered, but not as much as the architects of the sanctions had hoped. By reducing production, Russia and Saudi Arabia are able to keep prices at a comfortable level for themselves. In order to radically reduce these, it is necessary to lower the price cap and at the same time strengthen control over its implementation. However, the experience of this year demonstrates that doing so will be very difficult, if possible at all.

A year ago, Western countries imposed sanctions against Russian oil, relying on a revolutionary mechanism of a price cap, which prohibits the purchase of Russian oil above a certain price. Back in May 2022, when EU countries first announced the embargo, it was clear that not buying Russian oil would lead to shortages and price increases that would compensate Russia for these losses. The price cap mechanism was supposed to deprive Russia of its excess revenues without triggering a crisis in the energy markets. The cap of $60 per barrel was set at $24 below the average price of a barrel over the previous twelve months. New buyers of Russian oil were expected to honour the cap in order to continue to use the services of the Western service companies (e.g. insurance companies) that dominate the global market.

Eleven months later, this measure has reduced Russia's oil export revenues by 14%, as calculated by CREA (Finnish Centre for Energy and Clean Air Research) based on data from Kpler and Reuters. In the absence of sanctions, Russia could have generated more than €225bn ($240bn) between 5 December 2022 and 4 December 2023, while it generated €190.5bn ($205bn). But according to analysts, most of the lost revenue came in the first half of the year, when Russia was adjusting to sanctions. At the peak, in the first quarter of 2023, Russia's losses from the new measure were about €180 million per day. But in the second and third quarters, after it had managed to adapt, the amount of lost profits decreased significantly, to around €50 million per day. 

As a result, according to data from the Argus agency cited by Bloomberg, since July, a barrel of Urals consistently cost more than $60. When the conflict in the Middle East escalated, the price rose above $85. It only dropped below the ceiling in the last few days due to a decrease in global prices. After the imposition of the embargo and the price cap, China and India became the largest buyers of Russian oil instead of the EU. Russia is also entering markets to which it did not previously supply oil, such as Myanmar. During the logistics restructuring phase, Russia offered substantial discounts, but later their size of these discounts was reduced, according to CREA experts.

Urals and Brent oil prices, 2022-2023, USD per barrel

It has never been possible to implement the price cap effectively. There are several reasons for this. First, the mechanism left loopholes for refining: oil products produced from Russian oil were no longer subject to sanctions. A number of countries took advantage of this by refining cheap Russian oil and exporting it to Europe. The second tool to poke holes in the cap was the so-called shadow fleet, which Russia was able to assemble and which now carries an increasing share of Russian oil. In October, according to CREA, the shadow fleet already accounted for 62% of Russian oil exports. At the same time, the tankers within it operate without European insurance coverage.

According to Bloomberg’s calculations, in general, this year 25% of Russian oil was transported by ships officially owned by Russian companies, while 45% was transported by the shadow fleet. Fighting this has proved difficult. Bloomberg was unable to identify the beneficiaries of the companies to which its ships were registered. Some service firms that, according to documents, service them were found in Europe, including in the United Kingdom and Estonia. However, attempts to contact them were unsuccessful. Indirect indicators suggest that these legal entities may not be engaged in actual operations. The US has imposed targeted sanctions on only eight tankers used to transport Russian oil; six of these belong to the state-owned Sovcomflot.

However, it is not only about the Russian shadow fleet. The gamble that the globalisation of tanker shipping would allow sanctions-supporting Western infrastructure companies to actually control the trade from the price side turned out to be wrong, says independent analyst Sergei Vakulenko. It turned out that other major players in the industry, given political restrictions and commercial interest, are able to quite quickly build parallel systems of work — with certain costs, which, however, are paid off and will be paid off in the future, he writes. It is pretty evident that the West has overestimated its strength. And moreover, this development is likely to squeeze Western infrastructure companies in the market.

In just eleven months of 2023, oil and gas budget revenues totalled 8.2 trillion rubles. This is 23.3% less than the corresponding period of the exceptionally successful 2022. But the backlog from last year is gradually shrinking. At the end of nine months it was 34.5%, at the end of ten months it was just 26%. According to the Russian Ministry of Finance, in October, oil and gas revenues to the budget reached a one-and-a-half-year high, exceeding 1.6 trillion rubles ($17.6 billion). This is 28% more than in October 2022. In November, revenues fell by 41% to 962 billion rubles compared to October, due to the decline in world prices. Towards the end of the year, contrary to recent forecasts, the market became surplus. However, analysts of the Central Bank, in the December issue of their ‘What the Trends Say’ report, note that the surplus is not sustainable, as it is largely due to the off-season reduction in consumption in Asia and the Middle East, rather than an increase in supply.

When planning the budget for 2024, the Russian authorities assumed that a barrel of Brent crude would cost on average about $85, i.e. almost $10 more expensive than it is now. However, the cutoff price according to budget rules is $75. As Re:Russia has previously described, demand forecasts for 2024 vary. While OPEC+ expects growth of 2.25 million barrels per day, the IEA expects only 930,000. Both organisations assume that the market will be in deficit. OPEC+ countries agreed to cut production in the first quarter by 2.2 million bpd, of which 1.3 million represents the extension of restrictions in Saudi Arabia and Russia, and another 0.9 million are additional restrictions. Meanwhile, the growth of production outside OPEC+, which has somewhat mitigated the effects of price manipulation by Saudi Arabia and Russia, is uncertain according to the authors of ‘What the Trends Say’. New fields in the US are performing worse than expected. 

Thus, the current market conditions are somewhat favourable for Russian oil export revenues, although not ideal. To significantly reduce these revenues, experts from CREA suggest tightening sanctions. They propose lowering the price ceiling to $30 and simultaneously strengthening control over its implementation. However, as the experience of this year has shown, it will be very difficult, if not impossible, to do so.