The EU and the G7 are preparing to impose price caps on Russian petroleum products early next month, in order to ratchet up pressure on Moscow’s revenue stream, three months after introducing a similar cap on Russian crude oil. Details are yet to be agreed, but time is running out before a February 5 deadline. It is also worth examining how effective the caps could prove.
What we know
The European Commission has proposed that the EU set a $100 per barrel price cap on premium Russian oil products such as diesel and a $45 per barrel cap on discounted products like fuel oil, Reuters, Bloomberg and others reported last week.
The caps would work by barring Western insurance and shipping companies from insuring or carrying cargoes of Russian oil products unless they were bought at or below the caps.
Western officials including US Treasury Secretary Janet Yallen have expressed confidence that a final deal will be reached by February 5, when the price caps are due to come into force. The EU will also introduce a ban on most Russian petroleum product imports on the same day, just as it imposed an embargo on the majority of crude oil supplies in December.
The caps will need to be approved unanimously by all EU member states before the approval of other G7 nations is sought. The bloc’s ambassadors had sought to reach a consensus at a meeting on January 27, but no agreement was reached. But there is still time, and the agreement on a Russian oil price cap was notably made at the eleventh hour.
Meanwhile, Western governments are also set to review whether the $60 per barrel cap on Russian crude oil should be adjusted. The market price for Russian oil has remained significantly below this cap, and so it has so far done little to dampen Russian revenues from oil exports.
On January 26, Russia’s flagship Urals oil blend was trading at only $47 per barrel, representing a significant discount to Brent, which was selling for $84 per barrel. The discount has widened since Moscow launched its invasion of Ukraine, because of some buyers shunning volumes and as a result of complications that sanctions have caused to completing transactions.
Urals could well rise above the cap along with other benchmarks in the future if the market were to tighten. But the original EU plan was to have a cap that was at least 5% below average market rates, and this has not proved the case.
The caps and ban on Russian petroleum products are likely to have a more profound impact than the similar measures that targeted crude oil in December. Russian producers, struggling to find customers for their crude oil, have tried to offset the impact by processing more oil at their refineries in Russia and then exporting for resulting fuel. This will no longer serve as an mitigating option once the new measures come into force.
For most of the last year Russia has enjoyed windfall profits as a result of soaring oil and gas prices. But with global oil benchmarks now trading at below multi-year averages, Russian crude trading at a sizable discount, and given the recent drop in European gas prices to pre-war levels, there are signs that this honeymoon period is now over, especially as the full force of the price caps and embargoes begins to be felt.
In a government budget announced in December, the Kremlin forecast that its oil and gas revenues would slump by 23% in 2023. At the same time, Moscow has also had to ramp up defence spending significantly to fund its war in Ukraine.
Russian President Vladimir Putin signed a decree on December 27 that banned oil and oil product exports to any country abiding by the oil price caps.
The ban on crude exports is due to come into effect on February 1, applying to supplies delivered under contracts that “directly or indirectly” stipulate the $60 price cap. The ban applies to all stages of supply up to the end-buyer, the Kremlin said.
It is unclear how far the ban will extend in practice, though, as the decree includes a clause that allows Putin to overrule the restriction in special cases. The ban extends only until July 1, and it is also clear when it will also apply to Russian petroleum product supply.
By curtailing its supply, Russia could cause a spike in global oil prices, although the impact will depend on how global demand fares in the coming months.