August 15, 2022 [S&P Global] – China and India hold the key to the success, or failure, of a price cap on Russian oil proposed by the G7. Asia’s largest oil consumers are expected to buy even more cheap Russian crude if the US-led coalition’s attempt to starve President Vladimir Putin of oil earnings to fund its war in Ukraine plays out.
But the market remains divided over whether the latest efforts to hurt Russia financially will fall flat or even backfire, accelerating a potential global recession.
Far from expecting China and India to join the G7 price cap alliance, the US hopes the price cap will expand the discount for Russian crudes on the global market giving Asian refiners additional leverage to negotiate down prices in supply talks with Russia.
Cheapening the value of Russia’s oil exports rather than stemming their flow to world markets has become the West’s key priority.
Russian crude exports remain close to pre-war levels and the value of its oil has been recovering in recent weeks due to tight markets for physical barrels. At the start of the summer, Europe’s remaining buyers of Urals crude enjoyed discounts of up to $40/b vs Dated Brent. Although still well below the pre-war discount for Russia’s key export grade to Brent of $2.5/b in January, they have halved to a $20/b discount since early August, data from S&P Global Commodity Insights shows.
Supported by strong Chinese and Indian demand, Eastern Russia’s ESPO crude blend has seen its discount to Dubai crude shrink from $25/b in July to around $5/b in early September, according to the IEA.
“Regardless of which options the countries take, the price cap helps us achieve our objectives by putting downward pressure on the cost of Russian oil exports,” the US Treasury Department’s Assistant Secretary for Economic Policy Ben Harris said Sept. 9. “Ultimately, we believe the price cap would be successful in our goal of substantially hurting Russia’s main source of revenue.”
Balancing act
As it stands, the cap mechanism requires two key elements to get it off the ground — coordinating a ban on providing insurance services needed to ship Russian oil above a certain price and setting that price ceiling below current market values but above the cost of production.
Too low and the price cap could trigger Russian retaliation by shutting in swathes of oil production that will boost global crude prices, further fuel inflation and deepen the world’s energy crisis. Too high and Russia will continue to benefit from redirecting its oil away from Europe at current prices.
“The most critical issue is the level of the price cap,” said Ehsan Khoman, MUFG’s EMEA head of emerging markets research, “Set it at zero and it’s akin to an embargo as Russia will not sell its oil for free but set it at market prices then its novelty is quite trivial.”
Putin has already said he would halt all oil exports to countries imposing a price cap. That would mean Russia attempting to redirect even more oil exports to its key trading allies China, India and Turkey.
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