The EU’s oil embargo on importing Russian oil comes into effect today. The blanket ban on seaborne oil deliveries is softened by the oil price cap scheme, so that the EU can import oil from Russia provided it costs less than $60. The ban is enforced by threatening shippers with secondary sanctions if they carry Russian oil that costs more than this.
The goal of these sanctions is to cut Russia off from the money it makes from exporting oil.
This much is well known, but I have been digging into the details and it is all actually much more confusing than first appears.
The first thing to say is the goal of cutting Russia off from its oil revenue has completely failed. At $60, the cap makes no difference at all. The price of oil today is $86 per barrel, but if you take into account the $25-35 discount on the Urals blend then that is less than $60, so the price cap mechanism is not triggered. Russian oil shipped out of Primorsk is currently selling at $45 per barrel. That means the EU can import as much oil as before if it wants.
Secondly, instead of reducing the amount of money Russia earns from oil exports, the exact opposite has happened this year. Russia is on course to have a $250bn current account surplus. That is an insane amount of money: it is more than twice the $120bn surplus it had last year and that was already an all-time high. Rather than Russia being on its back foot because of sanctions, the Kremlin is currently earning more money than it has ever done.
However, the sanctions have made a difference, as Russia has been forced to totally reorganise its export business, and even before these sanctions came into effect exports to the EU had already tumbled.
Some facts: at its peak pre-war Russia was producing 11mn barrels per day of oil. In 2021 it exported a total of 7.8mn bpd, of which 5.3mn bpd went to Europe: 1.9mn bpd by ship and 3.4mn bpd by pipe.
In words: Russia exported about two thirds of its oil, of which two thirds went to Europe, out of which two thirds went by pipe and one third went by ship. So cutting off the EU market is very painful, but not that devastating.
Since the war started things have changed. This year Russia will export about 2.5mn bpd to Europe – exports to Europe have already been halved, mostly due to self-sanctioning. Moreover, most of this reduction has been in the piped part of that oil, as Germany and Poland receive most of the piped oil and have already reduced that to about zero. That leaves the 1.9mn bpd of shipped oil, and if that is cut off then only 0.6mn bpd of oil exported to Europe remains (to Hungary and Turkey).
That is a very different result, as Russia will in this case lose almost all its oil exports to Europe. And finding a buyer for the roughly 5mn bpd that used to go to Europe is a tall order – it’s not clear the market can absorb that.
I’m sure you are well aware that China and India have taken up most of the slack. Actually, this shift to send oil to Asia has been underway since 2014, when China imported no Russian oil at all. Today there is an oil pipeline to China carrying over 1mn bpd and China has become Russia's biggest single customer for shipped oil, along with India, where imports of Russian oil have exploded this year. Asia has taken up almost all the slack created by Europe’s reduction, or around 3mn bpd.
The problem the Kremlin now faces is that it might have to find buyers for around another 2mn bpd if the EU embargo works – or Russia just cuts Europe off if it tries to use the oil price mechanism, which is what the Kremlin says it will do.
Russia has been building up its tanker fleet to avoid the sanctions and has added about 100 new (actually they are all old) tankers to its fleet of around 85 vessels, totalling about 2% of the total global fleet of around 11,000 tankers. On top of that I have seen reports that lots of dodgy shell companies have been booking space for some 400 more tankers. No one really knows what is going on here. If Russia relied on just its own fleet it would be about 60 tankers short of being able to carry all of the 2mn bpd, but if there are a lot of scabs then it could maybe move all of it.
It also turns out that the tanker operators are a pretty unsavoury bunch. I read that the tanker transport costs for Russia have increased to $200,000 per day above the average of $60,000 per day, and they happily do ship-to-ship transfers mid-ocean to hide the origin of the oil and any number of other scams. So, enforcing the oil price cap is going to have a lot of leakage.
The other issue is: who will buy it? Sales to China and India are pretty maxed out but I presume that more buyers can be found. The Kingdom of Saudi Arabia (KSA), for example, has been buying Russian crude to refine for its domestic needs, which just frees up more of its own crude it can sell… to Europe, which needs to replace the missing Russian crude. More leakage.
But the fact that the market will struggle to absorb all this Russian oil does mean that production will almost certainly fall. The Yale report said that Russia’s production will have dropped to 6mn bpd by the end of the decade, but that is a wild exaggeration. The Kremlin was estimating a 15% reduction in production at the start of the war, but Russia produced 10.7mn bpd in October and is actually on course to end this year up on last year. But here too there is a lot of uncertainty and the consensus is that production will fall somewhat next year. I’ve seen estimates that Russia will have to decrease its output by anything from 0.5mn bpd to 1.5mn bpd.
The final issue is that if you remove say 1mn bpd of oil from the market then the prices will go up. CEO of Marco Advisors Chris Weafer says that we could be looking at $100 oil again this winter: even if Russia is producing 1mn bpd less oil, if it can sell that oil at $75 then what is lost in production is more than compensated for by the increase in price.
The bottom line is, this will hurt Russia, but the scheme is not going to work very well and it is going to come nowhere close to cutting Russia off from its petrodollars. The oil embargo is likely to turn into a global game of whack-a-mole, and the West simply doesn’t have the reach to enforce its rules around the whole planet.
The crux of the problem is that if there are profits to be made – and the sanctions are going to introduce massive distortions into the most sophisticated commodity market on earth, so there is a massive amount of money to be made – the market will do its thing. It has already done its thing by sending all that European oil to Asia and there is no reason to think it won’t do its thing again. As I have argued elsewhere, increasingly sanctions on Russia are boomeranging back to hurt the West (in this case read Europe) as much or more than Russia.
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