A new cap on Russian oil leaves world relying on the Gulf

Reuters/Christopher Pike

On December 5 two profound sanctions against Russian oil came into effect. So far, they have passed off smoothly, with minimal disruption, and oil prices remain around their lowest levels of the year.

But restrictions on one of the world’s top three oil producers and exporters, and a key member of the OPEC+ alliance, present Middle East countries with both challenge and opportunity.

The EU and G7 measures, imposed as part of the response to Russia’s war in Ukraine, actually have three components.

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The first is an outright ban on nearly all seaborne imports of Russian crude into the European bloc, combined with a voluntary decision by Germany and Poland to halt purchases of oil by pipeline.

That leaves just a group of central European countries – the Czech Republic, Slovakia and Hungary – receiving pipeline oil, and Bulgaria still taking some maritime shipments. The US, UK, Canada and Australia had already banned Russian oil imports outright.

The second is a G7 initiative to cap the price of Russian oil sales, and to deny shipping and insurance services to any cargo sold above the cap. As they control some 90 percent of maritime insurance, this is a meaningful measure.

The capped price chosen was $60 per barrel, rather lower than had been expected. But, given the slump in world oil prices since early November, and the widening discount for Russian exports, its main export grade, Urals, was already trading below $60.

The third measure comes into force on February 5 – a ban on Russian refined product exports to Europe. Given the continent’s reliance on Russian diesel, that could be the hardest to replace.

Timing is everything. Fears of recession and China’s Covid struggles have led prices to fall anyway, easing inflationary pressures. Had the cap and ban come into effect in the summer, they would have cut Russian revenue more – but been politically hard to sustain.

Russia has, predictably, said it would not comply. But it may have little choice. At the very least, the G7’s hope is that it would give Moscow’s remaining customers negotiating leverage, even if they do not formally observe the price ceiling.

Russia has been hastily assembling a “dark fleet” of old tankers, at considerable expense. These have to make considerably longer voyages to its remaining Asian customers than the previous short journeys between Black Sea or Baltic ports and Europe.

Europe’s purchases of Russian crude had already dropped significantly since the war began, due to “self-sanctioning”, from about 2.5 million barrels per day (bpd) in January to 1.45 million bpd in October. The difference was picked up by Iraq, Saudi Arabia and a number of other countries. In turn, Russia diverted its exports to India, mostly, Turkey and China. 

Overall Russian oil exports have not dropped much. The intent of the cap is to cut revenues going to the Russian government, not to reduce the volume of sales – although the Kremlin might decide to cut output in retaliation.

But if the G7 sees that the mechanism is working, compliance is high, and world oil prices moderate, it could lower the ceiling, say to $50 per barrel.

So the leading Middle East oil producers have benefited from picking up market share in Europe, which has for some time not been a very important target area for them. However, even pre-war, Saudi Arabia had already struck deals to increase shipments to Poland, which was seeking to diversify its crude sources.

Conversely, they face more competition in India, which had previously taken minimal volumes of Russian oil.

One Middle Eastern country has been particularly hard-hit: Iran, which was only able to sell to China, and that under heavy disguise. Chinese independent refiners have picked up Russian purchases, cutting the amount Tehran can sell, and creating more competition for use of the “dark fleet”.

These shifts run counter to the overall thrust of the Middle East oil exporters’ strategy, which had been to target the fast-growing large Asian markets in China, India and also Indonesia, Vietnam, South Korea and Malaysia.

But Russia’s eventual penetration into these countries will be limited: by their reluctance to depend too much on an unreliable and distant supplier, in preference to their longstanding and trusted partners in the Middle East.

There are opportunities for the Gulf too. For instance, Abu Dhabi’s Ruwais refinery recently took a cargo of, presumably discounted, Russian crude, while it can export its own unsanctioned oil.

A number of traders of oil from Russia have set up business in the UAE, while the port of Fujairah has become an important centre for storing and blending Russian oil.

When the ban on Russian oil products comes into effect in February, a number of large, modern new refineries in the Middle East, designed to produce European-specification output, can be expected to benefit. These include Jazan in Saudi Arabia, Duqm in Oman, Ras Al Zour in Kuwait, and an expansion of Ruwais.

In the longer term, Russian oil production is likely to drop. It will find difficulty in accessing capital and technology for the large new projects in East Siberia and in the offshore Arctic to replace its mature fields in West Siberia.

If the cap becomes a permanent feature of the market, that will exacerbate such problems.

US production growth has also been running out of steam as oil companies prioritise returning cash to shareholders. So the world will rely on the Gulf to meet the next few years of demand growth.

Abu Dhabi National Oil Company has aggressive plans to boost production capacity to 5 million bpd by 2025, from over 4 million bpd today, and possibly to 6 million bpd by 2030. Saudi Aramco has a more cautious aim to add 1 million bpd by 2027.

Iraq has set ambitious goals, and though it will fall well short because of bureaucratic wrangles and insufficient infrastructure, it should also see some gains in output by 2027.

The measures against Russia create some disquiet within OPEC, that price caps could eventually be turned on them. The European ban causes marketing and logistical contortions. But overall, the Gulf is set to benefit from the self-induced crippling of a major competitor.

Robin Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis