Pressure Cap: The effectiveness of secondary sanctions and the growth of oil supply create favourable conditions for a possible lowering of the price cap on Russian oil

Two factors — the increased effectiveness of sanctions control over Russian oil and an increased supply on the global oil market — create favourable conditions for a possible reduction of the price cap on Russian oil. A decision on this could be made at the G7 summit in June. The fact that such a scenario is being discussed was first confirmed by the State Department. The fight against Russia's shadow fleet and sanctions against Sovcomflot, whose ships have been shipping significant volumes of oil to China and India, led to an increase in the discount on Russian oil to $20 at the beginning of the year. Last week, the Russian government acknowledged this by raising the discount rate it had set for oil producers to this value. The move will result in a loss of 850 billion rubles worth of budget revenues. In 2023, Russian oil producers coped with the conditions created by the first phase of the price cap strategy. However, in the longer term, this strategy assumes that the parallel growth of pressure on buyers of Russian oil in Asian countries and the growth of oil supply at the expense of non-OPEC+ countries will create conditions for increasing the discount. Moreover, Indian buyers of Russian oil are more vulnerable to sanctions, which means that the dependence of the Russian oil industry on Chinese buyers will increase, which they will not hesitate to exploit. In the long term, Russia may face a de facto monopsony of the oil and gas trade by China.

Sanctions pressure on Russian commodity exports continues to intensify. According to Bloomberg and Reuters, India has stopped accepting oil transported by Sovcomflot tankers, which fell under US sanctions at the end of February. Even the Rosneft-controlled Nayara Energy refinery has halted purchases. This is a serious problem. Sovcomflot, as estimated by Bloomberg, recently accounted for about 15% of shipments to India, and last year it was about 20%. Furthermore, India does not allow tankers from the sanctioned Russian shadow fleet to enter its ports. These ships — already 41 of them in total — are immobilised, according to experts from the Kyiv School of Economics in a report published in March. Following India, China is also ceasing operations with Sovcomflot to avoid secondary sanctions. According to Reuters, the last tanker of the company has entered the Chinese port of Tianjin (the US allowed completion of operations already underway by announcing sanctions).

Moreover, Russia is facing difficulties in receiving payments for its deliveries. The largest banks in China (ICBC and Bank of China), the UAE (First Abu Dhabi Bank, Dubai Islamic Bank, and Mashreq), and Turkey (Ziraat and Vakifbank) have started blocking transactions that lack written guarantees that individuals or entities under US sanctions are not involved in the deal, as reported by Reuters. Even if payments go through, processing them takes weeks and months due to the complications of compliance, say agency sources. And this applies not only to dollar payments, but even ruble and yuan payments, which account for more than 90% of Russian-Chinese trade. The sanctions coalition’s strategy is working: in an effort to minimise their costs and risks, the counterparties of Russian companies are becoming instruments of the coalition.

These problems have not yet affected physical volumes of supplies. In the week ending 24 March, Russia, according to Bloomberg estimates, supplied 3.3 million barrels per day, up from 3 million the previous week. Some of the supplies that were not accepted by India were redirected to China, while some still reached India: oil from Sovcomflot tankers was transshipped to shadow fleet tankers off the coast of Oman, according to the agency. According to the Kyiv School of Economics, in February, the share of the shadow fleet in Russian oil deliveries increased from 65% to 75%. In general, counterparties of Russian oil producers in India are more vulnerable to sanctions and therefore more disciplined. This means that China's share of Russian oil exports will increase, as will the dependence of Russian oil producers on Chinese buyers.

The intensification of sanctions pressure within the 'second phase' of the price cap policy has led to an increase in the discount on Russian oil. According to calculations by the Kyiv School of Economics, by March it reached $18 per barrel. The US Treasury Department's report on the effectiveness of the price cap estimates the discount at $20. This is almost half as much as in the first half of 2023, but noticeably more than in the last few months of last year, when a barrel of Urals was only $12-13 cheaper than a barrel of Brent. Meanwhile, the Russian government had intended to use a $15 discount of Urals to Brent to calculate oil taxes in 2024. Last week the estimated figure was increased to $20. Thus, the government has recognised that external conditions for Russian oil will at the very best not see an improvement. The $20 discount for tax calculation was in effect in 2023. At the same time, the reduction to $15 was supposed to allow the budget to collect more than 860 billion rubles from oil producers. However, these plans will not materialise and the money will have to be found elsewhere.

Further, the main challenge for Russia's oil exports is that increasing the effectiveness of sanctions and control over their enforcement against the backdrop of growing oil supply brings the issue of lowering the price cap back into focus. Initially, the G7 countries set it at a fairly high level ($60 per barrel), fearing destabilisation of the oil market and a new price hike in the event of drastic retaliatory actions by Russia. However, the growth of oil production in non-OPEC+ countries, primarily in the US, has made the negotiating position of Russian suppliers weaker — its oil could potentially be substituted. Russia's main oil ally, Saudi Arabia, is also interested in regaining the market share it has lost as a result of voluntary supply cuts (→ Re:Russia: OPEC Minus).

According to calculations by the Centre for Research in Energy and Clean Air (CREA), if the price cap were set at $30 per barrel in December 2022, by February 2024 Russia would be short of €46 billion, i.e. a quarter of its revenues. The blockade of shadow fleet tankers also incurs losses, but not as significant: CREA experts estimate these at €500 million per month. Experts from the Kyiv School of Economics suggest that the sanctions coalition should lower the price cap by at least $10 and more actively combat the shadow fleet (→ Re:Russia: Minus $50 Billion).

The next meeting of G7 leaders will take place in June. In its February report, the US Treasury Department acknowledged the success of cracking down on the shadow fleet and the growing discount on Russian oil, but did not mention the possibility of changing the cap. When asked directly by a TASS correspondent about the possibility of lowering the price cap, US Assistant Secretary of State for Energy, Jeffrey Pyatt, answered affirmatively ('The short answer is yes'), but avoided discussing any details. It is obvious that G7 leaders will be guided by market conditions; however, in general it can be said that more favourable conditions are emerging for lowering the cap at the moment. As Re:Russia has repeatedly written, the widespread belief in Russia that its economy has coped with sanctions is a misconception. Pressure on buyers of Russian oil is increasing as its supplies are gradually replaced on the global market. The weak initial effect of the sanctions is becoming a more severe effect in the long term, which for Russia means a gradual but almost irreversible loss of market niches. The likely prospect for the Russian oil sector in such a scenario is not a 'turn to the east', but a de facto monopsony of Russian oil and gas exports by China.