Uncertainty over Russian price cap clouds recovery of crude

Wana via Reuters

The oil market is looking perkier than it has for a while, but it is too soon to be rolling out the barrel.

Brent crude is about 8 percent up in the past month and consistently nudging the $80 per barrel level, which many producers in the region regard as a “sweet spot” – high enough to satisfy national exchequers while not too pricey to cause “demand destruction”.

The expectation is that demand will continue to recover for the rest of the year and many experts think the steady upward tick in prices will continue. Goldman Sachs sees $86 per barrel by the end of the year.

However, there is one complicating factor in this generally benign outlook: as the price of Brent rises, so does the price of Russia’s flagship Urals crude oil. And that presents a big problem.

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After the invasion of Ukraine and the introduction of Western sanctions, Urals crude traded at a sizeable discount to Brent – as much as 30 percent for a while – as global traders and consumers worried about incurring sanctions against Russian oil or, in a few cases, taking a moral view about trading it.

The real downer for Urals was the introduction of a price cap on Russian crude exports in December last year. As long as the price of Urals was below $60, it could be bought, shipped and insured by Western traders.

The aim was to reduce Russian revenue to fuel the war, while ensuring a sufficient flow onto global markets to keep down crude and gasoline prices.

For a long while, that policy seemed largely successful. Last month Moscow received just half of what it had in oil revenues a year earlier, according to official figures, while there was little sign of any big reduction in Russian exports –  although that may change if and when Moscow abides by agreed Opec+ cuts.

But that is not the whole picture.

Some commentators have talked about the “smoke and mirrors” nature of the global crude trade, in which adherence to sanctions terms and conditions is largely a matter of self-verification with no independent supervision.

A trading industry has sprung up as Russia has adjusted to the newly hostile environment, for example, by deploying old and uninsured tankers to ply their trade between Russian western ports and markets in Asia that were keen to snap up an energy bargain with few questions asked.

In addition, legitimate traders saw an opportunity to make big profits on arbitraging crude prices – making money out of price differences for the same product.

The top four traders – Vitol, Cargill, Glencore and Trafigura – made a combined $50 billion in profits last year, five times the previous decade’s average.

There is no suggestion that any of these companies have been involved in sanctions busting, but the crude-trading business is a lucrative one in troubled times – as Dubai has found to its great benefit.

The Financial Times last week called the emirate the “new Geneva” of the oil industry, as Russian traders moved to the UAE to conduct their business.

Given all this, it is difficult to get a full picture of the effect of sanctions on Russia and the global oil business from official figures alone. Now a further complication will be added as Urals crude creeps above the $60 level.

How will Western sanctions enthusiasts react? Will they lower the cap to inflict more damage on the Russian economy, or increase it to ensure continuing supply to global markets? Either move has serious implications for prices.

The issue is further confused by the fact that the biggest beneficiary of the sanctions system so far has not been the West or the fighters in Ukraine, but Iran which is itself under Western sanctions.

Iran has found willing buyers in Asia and is now shipping more oil than at any time since 2018. This big addition to world oil supply has also helped keep the gasoline price down, but it is hard to imagine this was the intended aim of Western energy policymakers who seem to have turned a blind eye to Iranian exports.

Opec heavily criticised the price cap on Russian oil when it was introduced, fearing “distortions” in markets and prices.

We will know in the next few months whether the distortions caused by price caps will be temporary, or more permanently damaging.