OPINION: A new dawn - the geopolitics of the oil market after the G7 price cap
Quantum Commodity Intelligence - The introduction of the price cap mechanism on Russian seaborne oil exports by the Group of 7 (G7) and Australia alongside the EU sanctions banning the import of seaborne Russia crude is a turning point for the global oil market.
Tobias Wellner, a senior analyst at global risk consultancy Control Risks, looks at the short-, medium- and long-term ramification of these two developments including whether and how any EU sanctions might be enforced and the likelihood of the emergence of a non-western oil market.
Seeking to punish Russia for the conflict in Ukraine and reduce its revenue from oil exports, the EU has now banned the import of seaborne Russian crude oil.
From 5 February 2023 the EU will prohibit all imports of Russian petroleum products.
The G7 price cap is a mechanism intended to prevent the new EU sanctions from causing a global oil price shock while reducing Russia's oil revenues.
It allows countries that are not G7 or EU members to continue using shipping, insurance and ancillary services from companies based in the G7 to import Russian seaborne oil, provided it is sold at or below a cap price of $60/b.
So far, the mechanism has proven to be successful in the sense that there has not been an oil price chaos on the markets.
Oil prices have remained stable since the EU embargo and the cap mechanism came into force on 5 December.
However, there has been temporary disruption as shipping companies and authorities in different destinations and transit points started to implement new reporting requirements.
Mind the cap
In the short term, the global oil market is likely to remain volatile in the coming weeks as a result of teething issues from the price cap enforcement.
G7-based companies in the trading, brokering, financing, shipping and insurance industries (with a 90% market share) will have to implement new certification, record-keeping and reporting mechanisms to enforce the price cap.
Under a three-tier attestation system G7 businesses now have to prove that the Russian oil they are servicing was purchased at or below the determined price.
US and the UK authorities as well as those in the EU also suggest that companies update their terms and conditions, train staff and adopt policies.
These are all processes for which many businesses will need additional time and money.
Teething problems as a result of the unprecedented oil market intervention are likely to lead to disruption (at least temporarily) in the oil export servicing industry, and possibly also to operational disruption to Russian oil exports to third countries in the coming months.
Turkey's maritime authorities stopping several oil tankers shipping Russian but also Kazakh oil, this week was a first sign of the kind of teething problems that lie ahead.
Enforcement inequalities
The responsibilities for the enforcement of the EU sanctions as well as the price cap lie with each EU member state.
However, there are not yet shared legal definitions of what constitutes a sanction breach or how penalties should be enforced across the EU.
EU governments with big shipping industries, such as Greece, Malta and Cyprus might not be interested in strict sanction enforcement for political reasons.
This leaves a lot of regulatory uncertainties for the market in the coming months.
While some businesses might opt not to service Russian oil at all anymore, others will seek business opportunities in the grey market within the jungle of different national legislations.
Disagreement ahead
The announcement of the $60/b price cap level followed weeks of negotiation within the EU and there remains ample room for further disagreements within the price cap coalition.
Poland and the Baltic states had argued in favour of a lower price cap of around $20-40/b. To appease intra-bloc opposition, the EU has agreed to review the price every two months "to respond to developments in the market".
It remains unclear how the G7 and the EU will be able to find renewed consent if adjusting the price cap becomes necessary, for example should global market prices for oil change drastically or in the scenario that Russia escalates the conflict over Ukraine.
Little impact
At the current level, the price cap mechanism is unlikely to materially reduce Russia's oil export revenues.
The $60/b cap price is well above Russia's oil production costs, reckoned by specialist analysts to be between $25 and $50/b.
It is also above the price Russia is selling its Urals-branded oil at discount to India and China, which was approximately USD 55 per barrel in early December.
Until the new sanctions came into effect, the EU was the biggest importer of Russian crude and oil products.
It has spent $68 billion on Russian oil and petroleum product imports since the conflict in Ukraine escalated on 24 February, according to the Centre for Research on Energy and Clean Air.
In comparison, China has spent $42 billion and India $13 billion since 24 February. India and China have both not formally accepted the cap mechanism, with India arguing that as a developing country it is most concerned about securing cheap oil for its citizens.
Russia has had plenty of time to contingency plan against a number of oil price scenarios and is intent to expand its exports to China and India in the coming months.
India's share of Russian oil imports has increased significantly over the last two months.
About 1/5 of all of India's oil imports come from Russia already.
Notably, these imports are not affected by the G7 oil price cap, because Russia uses its own tankers and insurances for these exports, as Indian media reported.
China's imports of Russia oil are also not impacted by the G7 cap mechanism.
Most of the Russian oil to China flows through pipelines and those refineries that import seaborn oil have long done so independently of G7 businesses via Russia's far east port of Kozmino.
A new market?
In the longer-term, the establishment of a non-western oil market has become more likely.
For those not supporting the price cap mechanism it offers an opportunity to become less reliant on the European shipping and insurance industry. The geopolitical blow-back of such a development remains low for now.
The US has ruled out secondary sanctions against companies undermining the price cap.
There have already been reports about Russia's 'shadow tanker fleet' that can still transport oil undermining the cap mechanism.
However, it remains unclear how reliable these ships are and if they can fill the void created by the absence of European tankers. But in restructuring lies opportunity.
The importance of non-G7 shipping and insurance companies will increase in the coming years.
Tanker market profit margins have been incredibly high in recent months providing plenty of investment incentives.
Russia has already offered help to India with building or leasing tankers.
Its insurance companies, such as Ingosstrakh, have previously underwritten shipments to India and will become more important alongside other newly set up insurance companies in non-G7 jurisdictions.
Increasing geopolitical competition between Russia, China and the West are set to continue, and will increasingly play out in the energy markets.
The introduction of the oil price cap might well signal the dawn of a more decentralized, less western-led oil market.