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Friday, January 27, 2023

Explained | What does a price cap for Russian oil mean? 

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Shun Tai crude oil tanker is seen anchored at the terminal Kozmino in Nakhodka Bay near the port city of Nakhodka, Russia on December 4.
| Photo Credit: REUTERS

The story so far: After months of negotiation, western countries comprising the Group of Seven nations, the European Union and Australia, agreed to a price ceiling of $60 per barrel of seaborne Russian Urals crude oil that came into force just as sanctions against freighters carrying Russian crude oil took effect earlier this week.

Why did the West want a price cap?

Western nations, led by the G-7, want to punish Russia for having invaded Ukraine and rein in the profits accruing to Russia from oil exports. But they also want to keep some oil from Russia flowing globally so that supply is not significantly affected, which could push up energy prices. With a recession in parts of the western world already a possibility, oil price spikes would only hasten the spiral into economic contraction. So western nations came up with the concept of a price cap, above which accessorial services such as ship insurance, vessel clearances and the like would not be available to freighters carrying Russian oil. About 95% of global insurance for freighters by tonnage comes from European countries, especially the United Kingdom. Without such services, Russia would find it difficult to sell its crude above the price cap.

How has Russia responded?

Russia had first said the price cap might only impact its output minimally. Later, it also spoke about considering a ban on export to countries that insisted on the price cap. Deputy Prime Minister Alexander Novak has been quoted by the Russian media as saying that a mechanism was being worked out and that the ban on oil export to such countries would take effect before the year closed.

Russian news agency Interfax quoted Mr. Novak as saying, “Global consumption, economic growth in the world must be provided with energy resources. There is not much oil in the world, and Russian oil has always been and will be in demand. Yes, supply chains will change. Nevertheless, we do not see any tragedy in this.”

Russia is also said to be considering a floor price in retaliation to the price cap, as another option. A floor price would aim to ensure that it did not sell below that level. This tug of war would theoretically put Russian oil buyers, who want European insurance and other services to continue, in a bind.

How has Russia’s oil output been this year?

Between January and November, Russia’s production rose 2% to about 488 million tonnes, as per global media reports. China and India are popular examples of countries that bought discounted oil. But the likes of France and major oil producer Saudi Arabia too purchased oil from Russia. Saudi used the discounted price to buy oil to run its power plants, while selling its own costlier variant to the world.

Recently, India’s External Affairs Minister S. Jaishankar cited the European Union’s oil imports from Russia as being six times as much as India’s between February 24 and November 17.

How much oil does India import from Russia?

Interestingly, India — whose imports of Russian oil was only about 0.2% of total oil imports in the year ended March 2022 — has had Russia serve as its top oil supplier in October and November. Reuters reported that in November, India bought 53% — or about 3.7 million tonnes — of all the seaborne Urals crude that Russia exported.

How have global oil prices behaved since the cap was announced?

A Reuters report quotes Yevgeny Suvorov, economist at Centrocredit Bank, as saying that if Russia’s oil price fell to $45 to $50 a barrel, that would hit the country’s budget; it also cited analysts at Raymond James as putting “the economic loss for Russia at about $37 billion over a 12-month period”.

As per oilprice.com, Urals crude had touched about $53, compared with about $73 to a barrel on November 8. Brent crude, the global benchmark, had also declined to sub-$80 per barrel, which is below the price it commanded before the war started.

Oil prices are also reacting to different global pulls. Earlier in the week, they settled after dipping below their lows since January as there was hope that China would go easy on restrictions in response to protests and hence help spur demand as its economy opens up.

On the other hand, ships carrying Kazakh oil have been piling up for passage through Turkish ports. Turkey has been insisting on proof of insurance from the freighters, which was taking time to verify, leading to the long queues. Delays in transit typically places upward pressure on prices. The U.S. has intervened to convey that no such proof is needed, hoping that the assurance would allow the bottlenecks to resolve.

How much does ship insurance typically cost?

The cost of insuring a tanker of oil can range widely depending on routes the ships take and the political atmosphere surrounding those routes at a given time. When oil tankers were attacked in West Asia in 2019, the cost of insurance rose from a few thousand dollars to several hundreds of thousands of dollars. Media reports pegged the increased rates at the time between $1,85,000 and $5,00,000.



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