The discounts Russia is being forced to offer on its oil exports after a comprehensive embargo and oil price cap scheme was imposed on crude on December 5, and oil products on February 5, are deceptively big. Nearly half of Russia’s oil exports used to go to Europe, shipped through the Baltic Sea. That trade has almost stopped now. But Russia is still exporting as much oil as it used to but sending it half way around the planet to new customers in Asia. The problem is the deep headline discounts of up to 50% or more are based on Baltic prices, whereas economists say Asian customers pay much smaller discounts, or none at all.
The EU embargo is enforced by sanctioning EU shipping companies that accept cargoes of oil priced at $60 per barrel or more. As bne IntelliNews reported, there are three markets in Europe: piped deliveries via the Soviet-era Druzhba pipeline where prices are set by long-term contract; Russian oil companies delivering their own oil to their own refineries in Europe; and European customers still willing to buy Russian crude on the open market. It is only the last group that is receiving the deep discounts and the volume of these sales is dwindling fast.
The headline price for Russia’s Urals blend in January was $46 a barrel against the $75 Brent was trading at on February 27, and well below the maximum allowed $60 threshold set by the oil price cap scheme.
Economists have been looking for evidence of these whopping discounts in national accounts, companies’ profit reporting and customs date – but they can’t find them.
“We do not find crude oil discounts as large as those reflected in Urals prices towards the end of 2022. In particular, prices in market segments that are unaffected by lower Europe and demand, e.g., exports from Russia’s Pacific Ocean ports, have not dropped in a meaningful way and shipments do not appear to comply with the price cap. What the EU embargo and G7 price cap have, thus, triggered is a fundamental fragmentation of the market for Russian crude oil,” a paper from a team of top economists from the Social Sciences Research Network (SSRN) – Tania Babina, Benjamin Hilgenstock, Oleg Itskhoki, Maxim Mironov and Elina Ribakova – assessing the impact of the oil sanctions found.
The SSRN paper is based on its calculations using high frequency and customs data, and they discovered there is a gap between the price inferred from customs data and the reported “discounted” price. SSRN the found actual average price of Urals since December oil was not the reported $52 but $74 per barrel. Brent was trading between a high of $81 and a low of $71 in December, suggesting that for most of the month there was no discount on Russian oil exports at all, or at least only a few dollar’s worth.
Discounted embargo dogleg
The price of Russia’s oil depends on where it is sent. China, India and many of the countries of the Global South are not participating in the West’s sanctions regime on Russia. And they are willing to pay market rates for its oil as a result.
Russia has exported 6.1mn barrels per day (bpd) since the embargos were introduced and has obtained an average of $73.3 per barrel taking all markets into account, with the EU piped oil paying the least ($62.98) and China the most ($88.12), according to SSRN survey.
That doesn't mean the missing money is ending up in the Kremlin's coffers. The Russian budget did tumble in January to a RUB1.8 trillion deficit and Ministry of Finance (MinFin) reported that oil and gas revenues were down 46% year on year in January, but what appears to be happening is Russia’s oil companies are reporting lower Urals prices, which reduce their tax burden, but are making back the discount through various scams. Money is being siphoned off into dark company-controlled offshore accounts in, what is in effect, a new transfer pricing scheme. MinFin is well aware of what is happening and is already working to tap into this dark flow of profit.
“In the past [Russian oil companies] 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,” Sergey Vakulenko, an independent energy analyst, consultant to a number of Russian and international global oil and gas companies, said in a separate paper, adding that this money would make an ideal “slush fund” for Putin to use in his war against the West.
Cashing in on a distorted market
A key point to note with the sanctions is they are specifically designed to allow Russia to sell its oil. The Western architects were worried about causing an oil shortage that could spike prices. The goal of the oil price cap was to allow the oil to flow but limit the price Russia could charge. The upshot the scheme has been for Russia to simply switch all its deliveries away from Europe and turn to the Global South, where it continues to receive market rates. Asia has been able to absorb all the crude Russia used to send to Europe. Whether it can absorb all the oil products covered by the February embargo remains an open question.
If the goal of the sanctions was to cut the Kremlin off from its biggest revenue earner, so far they have completely failed. Russia's goods exports reached a record $532bn in 2022, resulting in an all-time high trade surplus of $316bn. The export of oil and gas reached $333bn in 2022, representing 63% of total goods exports, with crude oil accounting for $142bn, oil products for $83bn and natural gas for $108bn.
In 2021, Russia produced 540mn tonnes of crude oil, accounting for 13% of global production. Of this, 260mn tonnes were exported directly as crude oil, comprising 13% of global exports. Domestically, Russia refined the remaining 290mn tonnes, of which 140mn tonnes were exported as refined products (11% of global refined exports) and 150mn tonnes were consumed domestically, according to BP.
The two major routes for exporting crude oil are by pipeline and by oil tanker at sea. The Druzhba pipeline system carries oil to the EU, while the ESPO pipeline carries oil to China. The remaining Russian crude oil has historically been exported by sea to the EU, China and other countries to a lesser extent.
The ESPO oil is not included in the sanctions regime and the SSRN paper found that the average price of oil since December on this route out of Russia is $82 per barrel, with half of it exported via the ESPO pipeline to China and another half of it on ships owned by Russian shipping company Sovcomflot, which also operates outside the sanctions regime.
Historically, seaborne EU crude oil imports from Russia originated from Urals fields and travelled via western ports in the Baltic and Black Sea. This is where the largest impacts of the embargoes and price caps are being felt.
In the fourth quarter of last year, China and India, together with Turkey, accounted for two-thirds of total Russian crude oil exports, being sold at prices over $80, as against roughly 30% of the total volume in the first quarter of last year.
Russia also exports oil via the Druzhba pipeline (chart), which has not been sanctioned at the EU level. The origin of this oil is also from the Urals fields serving western ports. Pipeline oil to Europe consists of 60% flows through Druzhba’s northern branch (to Germany and Poland) and 40% through its southern branch (to the Czech Republic, Hungary and the Slovak Republic). Over the course of 2022 both Germany and Poland cut their imports of oil via Druzhba to zero, but at an average price of $63 per barrel, according to SSRN.
Russian exports of discounted crude and fuel oil to China jumped to record levels in January as the re-opening of the world’s biggest energy importer gathers pace after the dismantling of Covid Zero restrictions. The buying spree was likely underpinned by private refiners, but state-owned processors are now showing more interest in Russian crude after concerns around potential blowback from the US and allies kept them on the sidelines. Russia’s overall crude and fuel oil exports to China reached 1.66mn bpd last month, according to Kpler data as of February 20. That’s more than the previous record set in April 2020, when the Asian nation was emerging from its initial virus restrictions. Deliveries to India are also running at record levels of about 1.5mn bpd.
“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,” said Vakulenko in a note. “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 price of Urals is key, as the twin oil sanctions are key to the FOB (free on board) price of Urals when it is delivered to the tanker that is supposed to deliver it to the customer. However, that gives Russia a lot of leeway to play games with the price of Urals to keep it below the $60 cut-off, after which the oil price cap mechanism kicks in. The reported Urals price is increasingly becoming a guess.
“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,” says Vakulenko.
There are many problems with the FOB price, the price that is quoted when the oil is delivered to the tanker. This is not the price that the customer pays, as they also have to pick up all the services like shipping and insurance when the oil is finally delivered at its destination.
Over the last year Russia has been increasingly setting up these services as a way to bring the price it is paid for providing oil without increasing the cost of Urals. For example, it has been widely reported that Russia is operating a “ghost fleet” of tankers for which it can charge (chart). According to recent reports there could now be more than 600 ships in this fleet – enough to carry all of Russia crude and oil production to non-aligned markets.
In the chart below the number of ships registered to "unknown" has sharply risen since the sanctions came into force. And as bne IntelliNews reported last year, the Central Bank of Russia (CBR) has also recapitalised Russian maritime insurance companies so they can take over the role of providing insurance and adds more fees at the same time.
The Russian state-controlled Russian National Reinsurance Company (RNRC) has become the main reinsurer of Russian ships, including the state-owned national shipping company Sovcomflot's fleet. RNRC is controlled by the CBR, which has recently recapitalised the company to RUB300bn ($6bn) from RUB71bn and hiked its guaranteed capital to RUB750bn so the firm has adequate resources to provide reinsurance under international maritime law.
These various add-on services and charges can amount to as much as an extra $25 per barrel, bringing the “discounted” Urals price per barrel up to close to the cost of a barrel of Brent.
Taking these extras into account Vakulenko estimates that the actual cost of a barrel of Urals is closer to $75 than $50.
At the same time, the combination of selling to “friend countries” such as India or the Kingdom of Saudi Arabia (KSA) that are ignoring the sanctions or schemes like ship-to-ship transfers that create non-sanctioned brands means that 70% of Russia’s seaborne exported oil, some 800,000 bpd is sold at market rates of $70 or more on a FOB basis, openly defying the oil price cap scheme.
Prior to the war Russia could sell Urals at Primorsk, its biggest oil port in the Gulf of Finland, on a FOB basis, or the customer could buy it in Rotterdam in the Netherlands, a major European oil terminus, on a CIF basis.
Cost, insurance and freight (CIF) is an international shipping agreement, which represents the charges paid by a seller to cover the costs, insurance and freight of a buyer's order while the cargo is in transit via a waterway.
Much of this trade was handled by the Baltic Exchange, a London-based commodity exchange, that also collected data from members on deals to form prices.
“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,” says Vakulenko.
At the same time up to 1.6-1.8mn bpd leave Russia via the Far Eastern route, partially via ESOP pipeline to China, and partially via the port of Kozmino – deliveries that also operate outside the sanctions regime. The price of the ESOP blend is steadily above the $60 threshold on a FOB basis.
In late 2022 the Baltic trade between Primorsk and Rotterdam came to stop and the Baltic Exchange no longer has any data to form prices, but despite this the exchange is still quoting prices based on survey of traders and producers.
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, and India doesn’t share its price information with the Baltic Exchange. Moreover, since January the number of tankers travelling to “Other Asia” has soared as the market increasingly goes into dark mode, but many of these have also ended up in India, says Vakulenko.
Coincidentally, one of the largest refineries in India, Nayara Energy with 400,000 bpd capacity, is controlled by Rosneft. As bne IntelliNews reported, the economics of Russian oil producers sending oil to their own foreign refineries is very different to selling oil on the open market, as the FOB price of exported crude is irrelevant. It is the profits earned by the company’s trading arm in the country of the refinery from the sale of refined products that make the profits, not the cost of the company’s own crude shipped there as feedstock.
“Anecdotal evidence from traders suggests that Urals sells to other Indian refineries at a $6-$10 discount to Brent, dependent largely on the prices of Dubai and Oman crudes, which are the benchmark types in that part of the world,” says Vakulenko. Indeed, Russia’s Ministry of Finance (MinFin) is talking about abandoning the Urals price completely when calculating taxes and using the Dubai prices instead to improve its revenue collection.
More recently, reports show that the discount India was enjoying had fallen to zero in November, according to Indian customs data. Russian Deputy Foreign Minister Andrei Rudenko said on February 16 that India is still paying the full market price for oil. Rudenko said that Russian energy companies are working to fulfil orders as fast as possible and that India has not joined the price ceiling scheme. Deputy Prime Minister Alexander Novak said in February that India is still not getting a discount to Brent prices. (chart)
0223 Russia India OOTT discount for Urals vs Brent prices
0223 Russia India OOTT volumes of oil delivered March to November 2022
“Despite popular belief that China is getting large discounts on its purchases of Russian crude oil, this appears to be incorrect. In fact, we calculate an average price of $84 per barrel based on transactions reported to Russia’s customs service – with pipeline oil slightly cheaper at $81/barrel vs. seaborne crude from Kozmino at $84/barrel. While India receives a discount for Pacific Ocean shipments – as Russia is trying to gain alternative customers through all available export channels – it is significantly smaller (by $10-11/barrel),” SSRN reports.
The picture will not be clear until the January-to-March new customs data is released; as it takes a month for a tanker to steam from Russia those will be the first months that are affected by the EU embargos in December and February.
Abandoning the Baltic means to abandon a well establish market that used to provide a lot of information on prices and volumes.
“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,” Vakulenko says.