27.11.24 Review

The Spectre of Surplus Looming Over The Shadow Fleet: The Western coalition has an opportunity to sharply increase the sanctions pressure against Russian oil


Shifts in the global oil market are creating conditions to intensify sanctions pressure on Russian oil. The current sanctions mechanism, in the form of an oil price cap, was designed to reduce Russia's revenues without restricting access to Russian oil on the market to avoid triggering a surge in energy prices.

Contrary to common perceptions, this 'cap' has been functioning, albeit not fully effectively. During the war, the price of Russian Urals oil averaged 78% of Brent crude prices, compared to 97% before the war. According to Re: Russia estimates, this discount to market prices has deprived Russia of about 20% of the oil revenue it would have earned without sanctions. If the price cap mechanism had been fully effective, this difference could have reached 30%.

The effectiveness of the sanctions was limited by the fact that OPEC+ actions created a slight deficit during this time, meaning a drop in Russian oil volumes could have increased price pressures. However, forecasts indicate that due to weak demand growth and sustained production increases in non-OPEC+ countries, the market is likely to experience a surplus next year. Under these conditions, a reduction in Russian supply would not trigger a price spike but would balance the market or allow other countries to increase their market share.

To implement this scenario, it is necessary to increase sanctions pressure on Russia's shadow fleet, which has so far faced minimal restrictions due to fears of potential supply cuts. These measures are being considered as part of the 15th package of European sanctions. However, for these measures to be effective, US involvement is crucial. Should President Biden introduce such measures, they are unlikely to be rolled back even after the inauguration of Donald Trump, who currently lacks leverage over Russia to implement his ‘peace plan'.

Why and how ineffective are sanctions against Russian oil

While Donald Trump's plans to sharply lower oil prices are facing scepticism from experts (→ Re:Russia: Talk, Baby, Talk), the changed landscape of the oil market opens new opportunities to strengthen sanctions on Russian oil. Today, during a meeting in Brussels, EU representatives will discuss the 15th package of sanctions against Russia, including the issue of Russia's shadow tanker fleet. For the first time in two years, there are conditions for more effective restrictions on Russia’s oil revenues.

When designing the current sanctions mechanism on Russian oil – which includes a G7 embargo and a $60-per-barrel price cap for other buyers – the allies of Ukraine aimed to limit Russia’s oil trade revenues while avoiding the mistakes of 2022, namely preventing a sharp spike in global energy prices. To achieve this, Russian oil was meant to stay on the market but at discounted prices.

Initially, this mechanism worked as intended, but only during the first few months. From January to March 2023, the price gap between Urals and Brent crude reached $30 per barrel. However, this gap gradually narrowed over time (→ Re:Russia: The Discount has Shifted). By late 2023, it had dropped to $12, briefly rose to $18 in early 2024, and then began declining again. In October 2024, according to the Russian Ministry of Finance, the average price of a barrel of Urals oil was nearly $65, while Brent averaged $75.5 per barrel.

Price dynamics of Urals and Brent crude, 2021-2024, $ per barrel

Before the war, the price gap between Brent and Urals crude averaged $2, with Urals priced at 97% of Brent. By October 2024, the average gap had widened to $19.2, with Urals now priced at 78% of Brent. Based on these price differences, and disregarding minor variations in the pricing of Urals and other grades of Russian oil, the 'price cap' scenario suggests that Russia should have earned only 72% of the revenues it would have generated in a non-sanctioned ('peaceful') trading regime for the same oil volumes. However, in reality, given actual Urals prices, the 'discount' led to Russia receiving about 80% of its potential 'peaceful' revenues. Thus, Russia’s oil revenues have only fallen by only two-thirds of the sanctions optimum assumed by the ‘cap’.

HOW THIS IS CALCULATED

To assess the impact of sanctions on Russian oil revenues, we compared three oil price benchmarks. Firstly, this is the average Urals price between February 2022 and October 2024 assuming the pre-war discount to Brent. This represents a benchmark unaffected by sanctions. The second average price is obtained in the following way: this is the actual Urals price, but capped at $60 per barrel during months when prices exceeded this threshold (January 2023 to October 2024). This simulates the scenario of a fully enforced price cap. Finally, the third price is the actual average Urals price over the entire war period relative to what it would have been compared to the pre-war Brent discount. Thus, the ‘peace’ price reflects potential oil revenue benchmarks, the second price shows the full realisation of the price cap's potential, and the third reflects the real impact of sanctions on Russia's oil earnings.


At the same time, Urals prices exceeded the $60 cap in 16 of the last 22 months. The limited effectiveness of sanctions targeting Russia's shadow tanker fleet likely stemmed from Western reluctance to restrict the volume of Russian oil supplies, which could have raised prices in a moderately deficit market. Following new restrictions, Russia's primary oil buyers, India and China, temporarily reduced imports but soon resumed them after confirming the Western coalition’s willingness to overlook violations.

A notable example occurred in spring 2024, when the US Office of Foreign Assets Control (OFAC) sanctioned Sovcomflot. India temporarily cut its Russian oil imports by nearly a quarter. However, supplies quickly rebounded after Eric Van Nostrand, the US Treasury’s Deputy Assistant Secretary for Economic Policy, stated that ‘the US never expected India to stop importing Russian oil'. As a result, India has become the largest exporter of petroleum products to the EU this year, notes the Centre for Research on Energy and Clean Air (CREA): during the first three quarters of 2024, India’s three largest refineries increased their exports by nearly 60%.

The spectre of surplus and the shadow fleet

The current state of the oil market allows for volume restrictions on Russian oil without the risk of backlash. Starting in 2025, the market is expected to face a surplus. Even if a significant portion of Russian oil – such as 1 million barrels per day – were to be removed from the market, this would merely balance it, according to Bloomberg oil strategist Julian Lee, who advocates this idea. Data from the International Energy Agency (IEA) shows that Russia supplied 9.2 million bpd in October, so this scenario represents a roughly 10% reduction in supply. In a context of negative price dynamics, such a decrease would deal a significant blow to Russia.

The rationale for this perspective is outlined in recent publications by the IEA, OPEC+ and the US Energy Information Administration (EIA). While these organisations differ slightly in their estimates, they agree on one point: oil demand growth in 2025 is expected to be weak due to increased supply driven by production growth in the US and other countries, coupled with sluggish demand growth, particularly from China (→ Re: Russia: The Chinese or The Middle East Factor).

IEA analysts project that global oil demand in 2024 will amount to 102.8 million barrels per day (+0.92 million bpd compared to last year's level)., with supply matching this at 102.8 million bpd (+0.64 million bpd). In 2025, demand is expected to rise by 1 million bpd to 103.8 million bpd, while supply is anticipated to grow by at least 2 million bpd to 105 million bpd. At the same time, OPEC+ is forecast to contribute just +0.56 million bpd, with the remaining +1.5 million bpd coming from other countries. At the same time, OPEC+ is capable of increasing production much further. Moreover, as we have previously written (→ Re:Russia: People Instead of Oil), OPEC+ had planned to lift restrictions and increase output by 0.75 million bpd in 2024 and 1.45 million bpd in 2025, but low prices forced a delay.

EIA forecasts global demand at 103.13 million bpd in 2024 and 104.35 million bpd in 2025. The demand growth for 2024-2025 is significantly below the pre-COVID-19 10-year average of +1.5 million bpd annually. In 2024, EIA anticipates a slight demand surplus (+0.5 million bpd), flipping to a supply surplus (+0.3 million bpd) in 2025.

OPEC+, unlike other forecasters, does not predict a surplus in 2025. In its November report, it reduced its 2024 oil consumption growth forecast by 110,000 bpd to 104 million bpd and revised its 2025 forecast down to 105.57 million bpd. TThe revision stems from weaker-than-expected economic data from China, India, other Asian countries, and Africa. According to OPEC+, supply growth will almost entirely come from non-OPEC nations (+1.2 million bpd in 2024 and +1.1 million bpd in 2025).

The actual supply-demand dynamics in the coming year will depend heavily on several regulatory decisions. The next OPEC+ meeting, scheduled for 1 December, will set the cartel’s course of action. According to Reuters sources, production cuts are likely to be extended. Ahead of the meeting, Iranian representative Afshin Javan has said that lifting production restrictions would almost certainly trigger a price collapse. However, Iran’s oil minister Mohsen Paknejad announced that Iran would oppose any new restrictions if they are proposed. Such confrontational statements are highly unusual, particularly from a representative of a founding OPEC member. This stance likely reflects Iran’s serious concerns about potential new US sanctions, which Donald Trump has hinted at during his presidential campaign. The US could target Iranian exports, potentially reducing them, according to the IEA, by 0.5-1.2 million barrels per day (bpd) from the current 3.4 million bpd, according to Bob McNally, president of Rapidan Energy Group, speaking to Bloomberg.

Slowing demand growth and rising output from non-OPEC+ countries are weakening the cartel’s ability to control the market. Several countries – Angola, Ecuador, Indonesia, and Qatar—have already left OPEC in recent years. Gabon and Congo may follow suit. Bloomberg columnist Javier Blas highlights a further risk: Kazakhstan. Since joining OPEC+ in 2016, Kazakhstan has frequently exceeded its production quota. With the Tengiz oil field expansion, led by Chevron, slated for completion next year, Kazakhstan plans to increase output by 0.26 million bpd. While Angola left OPEC+ after failing to negotiate higher quotas, Kazakhstan could follow either path: exiting the cartel or negotiating increased production allowances.

The prospects for a 2025 oil market surplus are strong, albeit not certain. However, the current market conditions provide an opportunity to intensify sanctions on Russia. Julian Lee of Bloomberg specifically suggests targeting Russia’s shadow fleet, which has so far evaded significant disruption. Over the past year, only about 90 tankers have faced sanctions, while estimates of the shadow fleet range from 600 to over 1000 vessels (→ Re:Russia From Shadow to Light). The problem is that sanctioned tankers often re-enter service after simple measures like renaming and reflagging, with no recurrence of sanctions for these returning vessels.

On 25 November, the UK imposed further sanctions against several dozen Russian tankers. The sanctions also targeted Russian insurance companies AlfaStrakhovanie and VSK, which service the shadow fleet, alongside the previously sanctioned Ingosstrakh. Details of the new measures under discussion as part of the EU’s 15th sanctions package are expected soon. But, in any case, current conditions are favourable for enhancing sanctions on Russian oil, including stricter measures against the shadow fleet. US participation is critical for maximising the impact. Ideally, these measures should be implemented during Joe Biden’s remaining presidential term. If adopted, it would be difficult for Donald Trump to roll them back quickly, as he would need leverage over Vladimir Putin to execute his proposed ‘peace plan’ for Ukraine – leverage he currently lacks.