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Russian sanctions have rejuvenated the world’s ‘ghost’ oil market

Moscow says it will not comply with an oil price cap, but may have little choice if it wants to continue selling

Unsplash/Zbynek Burival
Delivered prices for Urals crude sit around $18 below Brent

In the 1980s, when oil prices averaged less than $26 per barrel, famed trader Marc Rich could earn up to $14 per barrel in margins by selling sanctioned Iranian oil to boycotted Apartheid-era South Africa.

Today, intermediaries make money on Russian oil – but how, and how much?

The workings of this grey market are essential for Russia’s financial health, and the effectiveness of Western sanctions.

Following Russia’s invasion of Ukraine on 24 February 2022, many European and American companies ‘self-sanctioned’, freezing or divesting their activities there.

Mr Rich’s company became Glencore in 1994, one of the commodity world’s giants along with Vitol, Gunvor, Trafigura and Mercuria, and the trading arms of the big oil-producing companies.

With a few exceptions, these firms – even Gunvor, once majority-owned by Putin confidant Gennady Timchenko – now say they don’t handle Russian oil. 

On December 5 last year, the EU followed the UK, US, Canada and Australia to ban the import of Russian crude oil with a few small exemptions ( had already done so). From February 5, the import of refined oil products such as diesel and petrol (gasoline) was also prohibited.

Exports to non-European countries continue to be allowed, but to use European or other G7 insurance and shipping services – which, pre-war, carried nearly half Russia’s western exports – they must comply with a price cap.

Crude oil must be sold at less than $60 per barrel, high-value products such as diesel under $100 per barrel and low-value products such as residual fuel oil at below $45 per barrel.

This is intended to reduce the revenues going to Moscow’s war machine, while still allowing Russian oil to flow to prevent an economically damaging price spike.

In practice, the ‘free-on-board’ prices where the oil leaves Russia are less than these levels.

Moscow has said it will not comply with the price cap, but may have little choice if it wants to continue selling. It has already had to divert most of its exports to a few continuing customers – Turkey, China and especially India. They are able to extract hefty discounts.

The missing barrels in Europe are supplied now by Saudi Arabia, Iraq and other Middle East producers along with the US and West Africa.

Price differential

Before the war with Ukraine, Russia’s main export crude grade, Urals, traded at about a $3 per barrel discount to Brent, the international benchmark, reflecting its slightly lower quality. It was exported from Russia’s western ports and pipelines mostly to Europe.

Immediately following the invasion, the price differential quickly widened to as much as $40 per barrel, narrowed as Russian exporters adjusted, then expanded again as the new EU bans came into effect, standing at about $38 per barrel.

But delivered prices of Urals to the west coast of India are about $16-18 per barrel below Brent.

This tells us that about $20 per barrel is disappearing in the supply chain.

Some of this accounts for legitimately higher costs for shipping and insurance, given the much longer transport distances, and the withdrawal of many players from handling Russian business.

Some of the gap reflects value capture by savvy traders and insurers, and perhaps directed back to Russian interests to avoid both the price cap and Russian taxation.

The discount on delivered barrels should be captured by India-based refiners – including Nayara, which runs India’s second-largest refinery in Gujarat, and is owned by Russian state oil giant Rosneft with some other Russian partners.

Nayara and other refiners including the large Reliance and BPCL are reported to use the UAE dirham for Russian oil trade due to its convenient peg to the US dollar.

To avoid the ceiling on sales prices, the Russian authorities and companies have employed various measures.

The government has set a fixed discount for tax purposes, trying to prevent evasion and keep fiscal revenues at home. More significantly, it has used Russian tankers and amassed a ‘shadow fleet’, mostly older vessels ready to be scrapped.

Some of these have previously engaged in carrying Iranian oil, to circumvent American sanctions. Russian charterers may be paying 50-100 percent above normal rates.

These ships have to make much longer voyages, though, and during the winter Russia was short of ice-class tankers able to navigate the Baltic. They use Russian insurance, which is of doubtful validity and capacity in case of a major accident. 

New dealers

In place of the well-known international traders, a crop of other dealers has sprung up – some relabelling of well-known Russian companies, some existing smaller players who have seized an opportunity, some start-ups or fronts.

Major state Chinese companies have just resumed buying Urals crude, but they do so through traders to avoid using Western shipping or insurance.

The beginning of the oil products ban has introduced further complications. Trading refined products inconspicuously is in a way easier, since they can go to end-users rather than to a few large and well-monitored refineries. They can be blended to conceal their origin.

But the logistics of moving multiple different fuels, which are usually transported only over moderate distances, are more complex than for crude oil.

Deputy prime minister and former energy minister Alexander Novak said last week that Russian oil output would be reduced by 500,000 barrels per day in March – likely a reflection of difficulties in obtaining enough shipping or finding customers, rather than an inability to produce.

The oil market has now been bifurcated. Relatively small amounts of sanctioned Iranian or Venezuelan oil, at about 1 percent of global production, were one thing. Finding non-European ships and homes for more than 8 million barrels per day of Russian crude and products, or about 8 percent of world production, is another problem entirely.

The EU and G7 will tighten sanctions, while ingenious traders and shippers will attempt to stay one step ahead, through legitimate or murkier means.

It is a situation Mr Rich would have delighted in – and he has plenty of modern-day emulators.

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