After months of discussions, the EU has unveiled its plans for enforcing a price cap on Russian oil exports in response to Moscow’s invasion of Ukraine. U.S. Treasury Secretary Janet Yellen subsequently set the potential price cap at $60 per barrel.
Having already closed its ports to Russian ships, the EU outlined in detail how it plans to enforce the price cap in its eighth sanctions package, published on October 6. Any vessel transporting Russian crude oil—and, in three months’ time, Russian oil products—being sold above the price cap would be prohibited from obtaining any shipping industry services from European providers, such as insurance, financing, servicing, and bunkering.
The design was likely influenced by the “180 days rule” introduced by the United States in 1992, which prohibited ships that transported oil to Cuba from entering U.S. ports for the next six months. That approach led to the creation of a separate fleet of oil tankers serving Cuba.
The EU’s approach goes even further. There would be no time limit on the vessel’s period of excommunication, and neither a change of flag nor a change of ownership would end its pariah status. In the long run, this could create a major headache for service providers, who would be obliged to check a ship’s history since the introduction of sanctions. And as the story of Cuban sanctions—first introduced in the early 1960s— shows, that period may last decades.
The authors of the EU sanctions are hoping that ship owners presented with a tempting offer to deliver a sanctions-defying Russian cargo to Asia will consider the risks too great, and simply stay away from Russian crude altogether. Then Russia, faced with a shortage of transportation and therefore a need to curtail production and lose revenue, will succumb to the inevitable and start selling oil at the capped price.
The price cited by the U.S. Treasury of $60 per barrel is 20 percent lower than what Russian crude has been fetching recently, but closer to the upper limit of the price range in recent years. Inflation adjustment brings the value lower in real terms, but it is still a relatively generous offer: at least for now. Ironically, if the global economy goes into recession, which is highly likely, market prices might come close to this benchmark, or even fall below it. For Russia, however, the stakes are higher than simply preserving its cashflow at current levels: it’s more important to retain full control over its own oil exports.
Russia is far from the only country alarmed at the prospect of a price cap, even if it would only apply to Russian oil for now. At a summit in Vienna on October 5, the OPEC+ countries agreed to cut their production quotas by 2 million barrels per day: a significant departure from previous changes, which have usually been limited to 500,000 barrels.
In fact, only Saudi Arabia, UAE, and Kuwait will need to make modest reductions, since most OPEC+ countries are already producing substantially less than their quotas, and even below the newly established targets, despite operating at full capacity. It seems likely, therefore, that OPEC+ only announced the step in order to signal that after December 5, when the first wave of Russian oil sanctions enters into force, the other OPEC+ members will not step in and fill the void, but will allow prices to increase and the world to feel the consequences.
This is an unusual move for OPEC+, which positions itself as a stabilizing force on the global oil market. Oil-exporting countries loathe price hikes almost as much as price troughs, since hikes lead to economic slowdown and a fall in demand, followed by overinvestment and a price slump further down the line.
There are two reasons why OPEC+ would not try to stabilize the market on this occasion. First, its ability to do so is quite limited, due to global underinvestment in the oil industry since the price slump of 2014, especially during the pandemic, when fewer new wells were drilled. As global demand returned to pre-COVID levels, therefore, OPEC+ countries met it with an aged and less productive well stock.
Second, there is a fear within OPEC+ that if successful, the sanctions mechanism could subsequently be applied to other causes, both political and cartel-busting, and that OPEC countries could become the next target. They would therefore prefer to see the mechanism fail.
Russia itself has made it clear it has no intention of submitting to the price cap. At the annual Russian Energy Week on October 12-13, Russian President Vladimir Putin, Deputy Prime Minister (and former energy minister) Alexander Novak, Energy Minister Nikolai Shulginov, and the captains of the Russian energy industry all insisted Russia would not sell its oil at below-market prices as a matter of principle. If necessary, the companies are prepared to reduce production by up to 70 percent of current levels, and are actively developing alternative supply chains that would bypass the EU.
In the global oil industry, shipping and loading schedules are generally compiled two months before the month of the loading. December cargoes are sold in October, and their schedules drafted at the same time. The price cap battle will therefore start to unfold in the coming weeks, and it’s extremely unlikely that Putin will yield to pressure without putting up a fight.
As a result, the oil and shipping market will almost certainly end up in turmoil. Russia will need its own dedicated fleet: most likely consisting of end-of-life tankers, since that would carry far less risk for the shipowner. About fifty tankers are forecast to be scrapped in 2023-2025, which could form a pariah fleet of Russian oil strikebreakers.
Russia will need about 200 tankers to keep going at the previous rate, since its ports of Primorsk and Novorossiisk currently send out one tanker each per day, and if the destination is Asia, the round-trip time is one hundred days. At the end of 2021, Russia’s biggest shipping company, state-controlled Sovcomflot, had fifty-one tankers flagged in various jurisdictions. New Suezmax tankers cost $80 million, while their scrap value is $10–$15 million, so 150 tankers will cost at least $1.5–$2.5 billion: a hefty price, but one that Russia can probably afford.
Russia might also count on at least some support from Indian, Chinese, and Persian Gulf shipping companies to alleviate the deficit of ships while it tries to accumulate a larger fleet for its oil exports: those countries are used to working with Iranian oil, which is also subject to sanctions.
At the same time, however, Russian oil companies and their clients will attempt to charter tankers from the market. That would be a one-way ticket, since from then onwards the vessel would have to get any auxiliary services from a limited pool of non-European suppliers, most likely at a higher price.
For a time, such a vessel would probably be able to command a premium for its services to Russian cargo shippers, due to the scarcity factor. But if at some point Russia concedes defeat and starts to comply with the price cap, that ship would be a stranded asset and would have to be scrapped.
Whatever tactics are used, the accumulation of a fleet will take some time. In the meantime, Russian production may be reduced and limited by the available shipping capacity, which will likely lead to a period of volatility on the oil market.
