OILY PRICE CAP

December saw two significant events on the global oil market, which can have a major impact on the price and supply of oil.

After lengthy discussions, the European Union agreed to introduce a price cap of $60 per barrel on Russian oil because of the ongoing war between Russia and Ukraine. On the other hand, OPEC+ ministers took the last decision of the year to maintain the current quotas. In other words, OPEC+ will maintain the oil production at 2 million barrels per day (mbpd) pursuant to the decision approved at the 33rd ministerial meeting on October 5, 2022.

We can see the outcome of both decisions as early as next year. Meanwhile, the Russian authorities promise a serious response to the European price cap soon. They claim that it adds uncertainty to the existing difficult situation on the global oil market. Moreover, the Kremlin stated that they were considering various response options.

Unprecedented decision

Last summer the US proposed the introduction of a price ceiling on Russian oil exports but not banning it from the market. Hence the EU accelerated discussions on this plan in September, with the decision to be announced by the end of November. However, discussions have taken a while. Poland and the Baltic states insisted on lowering the ceiling to $30 per barrel—an idea supported by Ukraine—while Greece and Malta wanted to raise it above $70, for a lower threshold would reduce the profitability of shipping, i.e. their core business.

On December 2, the EU member states finally agreed a ceiling of $60 per barrel. The document was published in the EU official journal two days later. It is expected that the price ceiling mechanism will be reviewed every two months starting from mid-January 2023 and will take into account the market changes. The cap will be set at least 5% below the average market price of Russian crude oil and oil products calculated on the basis of data provided by the IEA. The restriction came into force on December 5 in parallel with a ban on Russian maritime deliveries of oil to the EU agreed last summer as part of the 6th sanctions package (with some exclusions).

It is difficult to forecast price fluctuations under such twin measures as there are fears of supply losses due to the boycott as well as reduced demand due to the global economic slowdown.

The G7 countries (Britain, Germany, Italy, Canada, France, Japan and the US) and Australia have formed the Price Cap Coalition. Thus, starting from December 5, companies from these countries will be banned transportation, insurance, provision of financial, brokerage and technical services related to maritime deliveries of Russian oil if its selling price exceeds a certain ceiling. A similar measure will be in place for petroleum products from February 5, 2023.

So, if an EU or G7 company decides to transport, provide brokerage, financial or technical services for Russian oil, it can do so only if the selling price of the oil is no higher than $60 per barrel.

Later, on December 8, Norway joined the $60 per barrel price ceiling on crude oil supplies from Russia.

"This would significantly reduce Russia's revenues and help us stabilise world energy prices. This will benefit countries with emerging markets. The ceiling will be adjusted over time," EC President Ursula von der Leyen stated.

Washington considers the price cap to be fair. The US Treasury believes that this cost should be sufficient to give Russia an economic incentive to continue selling raw materials to other countries. US Secretary of the Treasury Janet Yellen believes that the price cap on Russian oil supplies will ensure the flow of cheaper oil from Russia and prevent disruption of supplies to the global market.

Washington also highlights the benefits this measure will bring to developing countries. The US Treasury believes that limiting the price of Russian oil would allow the 50 largest of them to save $160bn annually. The US names China and India as the main beneficiaries. It also explained that the price ceiling is high enough for Moscow to have an economic incentive to continue supplying fuel to global markets.

China reacted to the idea back in the summer through Chinese Foreign Ministry spokesperson Mao Ning, who said that China and Russia have always developed energy cooperation in a spirit of mutual respect, benefit and gain.

Indian Oil and Gas Minister Hardeep Singh Puri said that the Indian authorities were not at all concerned about the price ceiling on Russian oil set by the Western countries, as its impact on India would be zero. Besides, India intends to continue buying oil from Russia. "We will continue buying oil from who we need to," Puri said in his interview with the Indian news portal BQ Prime.

India currently buys oil from 39 countries. Despite a relatively small share of the Russian supplies in the total volume of the Indian oil imports, it has risen sharply since the war in Ukraine.

Impact assessment

There are different opinions on the impact of the price ceiling on the Russian economy. Some believe that the effect will be minimal, as Russian oil has been trading at a significant discount below $60 per barrel for several months anyway. Others are confident that the measure will have an impact, especially when combined with a ban on the purchase of offshore supplies.

JPMorgan Chase expects only a slight reduction in Russian oil production after the introduction of the price cap mechanism—by 500,000 bpd in 1Q2023 and stabilise at 10mbpd in the following quarter. Consequently, they have lowered the 2023 average Brent oil price forecast to $90 from the previously expected $98 per barrel.

"We believe that as long as the price cap mechanism is adjusted to reflect market oil prices, Russia will continue to negotiate directly with buyers and make deliveries," JPMorgan said in a review.

The availability of tankers ready to carry Russian crude will largely influence the price, the bank's analysts said in a survey.

The world's largest independent oil trader Vitol believes the Russian exports can fall by 1mbpd. However, this number may increase, as the Kremlin announced that it would not supply oil to countries supporting the price ceiling.

Analysts at Bernstein estimate that Russia may need as many as 100 tankers ready to operate without Western insurance. This is a level Russia will struggle to secure, even if it uses the so-called shadow tanker fleet successfully employed by other sanctioned countries such as Iran and Venezuela.

Michael Wirth, president of Chevron, is one of those who doubts the effectiveness of restrictive measures. He believes that in the global oil market sanctions only create opportunities for those who circumvent the system for profit.

"It is extremely difficult to curb a complex global market with an administrative mechanism introduced and supported by a few countries," Wirth said. He added that it was not clear how the rules will be enforced.

No change on the oil market

As we can see from the outcome of the December 4 OPEC+ ministerial meeting, which took place after the EU announced a price cap for Russia, the alliance of 23 oil-producing countries has so far decided to remain as an observer to assess the market situation after the launch of the price cap mechanism and wait for Moscow's response.

It is unclear whether Russia notified its OPEC+ partners about the measures it will take and the expected reaction from the buyers. Yet the alliance decided not to change anything.

The final OPEC+ declaration adopted on December 5 consider it necessary to maintain the current oil production plan, which provides for a 2mbpd cut from November 2022 to the end of 2023. The parties also reiterated their willingness to meet at any time and to take the necessary additional measures in response to market conditions in order to maintain a supply and demand balance.

The next Join Ministerial Monitoring Committee (JMMC) will convene on February 1, with a full OPEC+ ministerial meeting slated for June 4, 2023.

Responses

It is not difficult to guess Russia's reaction to the price cap. Meanwhile, the Kremlin promised a proportionate response (a mechanism for banning the application of the price cap currently under review) and to reduce the oil production. It also warned that Russia would not supply oil to countries supporting the Western decision.

"I have already said that we would not sell oil to countries that support this decision. Maybe we even introduce production cuts. We have agreed with OPEC+ on a production quota. We will think about additional cuts, if necessary. We are thinking about it, there are no decisions yet," President Vladimir Putin said.

He also said that the practice of capping prices could be bad for the market as a whole, driving up oil prices so that they "hit those who propose such solutions".

"...If we only listen to the consumer, this will bring investment to naught. All these measures will lead to a catastrophic price spike at some point," the Russian president said.

Meanwhile, after the introduction of the joint EU and G7 price cap on Russian oil prices and the OPEC+ decision, prices went down contrary to most forecasts. Both Brent and WTI have updated their lows since last December in an attempt to counter a possible slowdown in global economic growth and shrinking fuel demand.

However, many analysts believe that in the longer term a ceiling on Russian oil prices can push the price up to $100 a barrel or more.

ING analysts predict that the average price of Brent oil in 2023 will be $104 per barrel. "There is still a lot of uncertainty about Russian oil supplies, given the EU price cap. Nevertheless, we believe that Russian supplies will fall significantly early next year by around 1.8mbpd year-on-year in the first quarter," ING overview said.

The introduction of a price cap on Russian-origin oil is an unprecedented decision, changing all the existing foundations and rules of global trade. It is a challenge to the entire market, where the prices have been determined exclusively by producers. This is a powerful signal to all major oil suppliers that it is the consumers that actually try to set a price level acceptable to them. Similar restrictions may well be applied to any other producer in the future, if this mechanism proves effective. However, whether this will cause a conflict of interest with OPEC+ is a big question. Since the cartel led by Russia and Saudi Arabia has a privilege of regulating supply levels and maintaining market stability and, consequently, oil prices. It is unlikely that OPEC+ will succumb to consumer whims; rather, we will likely see more cooperation between oil producers, in particular within OPEC+ to prevent any changes to the existing rules of the game.