The European Union’s ban on seaborne imports of Russian crude went into effect on Dec. 5. The G-7 and EU price cap meant to complement that ban has been set at $60 per barrel.
Western sanctions are designed to curb Russian profits while simultaneously keeping global markets supplied with petroleum.
On paper, what has transpired to date looks like a convoluted, naively designed and messy fiasco. In practice, the plan might work, at least partially — though not the way you’d think if you took it literally.
EU sanctions and G-7 ‘relief valve’
In June, the EU agreed to ban seaborne imports of Russian crude beginning Dec. 5 and imports of Russian refined products beginning Feb. 5. It also banned EU shipping services — including shipping reinsurance — for all Russian exports to non-EU countries as of those dates.
U.K. protection and indemnity (P&I) clubs insure over 90% of the world’s tankers. U.K. P&I clubs heavily rely on EU reinsurance. Thus, the EU sanctions would effectively bar most tankers from Russian export trades.
This alarmed U.S. officials, who feared EU sanctions went too far. By cutting off too much Russian volume, they feared oil prices would spike, prices for U.S. consumers would rise and per-barrel returns to Russia would increase.
To rectify this, the U.S., through the G-7, came up with the price-cap plan to act as a “relief valve” for EU sanctions. Any Russian crude exported under a price cap set by the G-7 could continue to use G-7 countries’ insurance and finance. Theoretically, Russia would receive less money for its crude, tankers could continue to carry Russian exports and oil markets would not be disrupted.
The complication
But U.S. government officials have acknowledged that the G-7 price cap requires the EU to follow suit with its own price cap. Even if U.K. P&I insurers get the green light under the G-7 price cap, their reinsurers would be unable to participate due to the EU sanctions, unless the EU had its own price cap that put its reinsurers in the clear.
After lengthy and contentious negotiations, the EU countries finally agreed to a $60-per-barrel cap just days before the import ban went into effect. The G-7 countries followed suit at the same price.
But the plan still looks unlikely to work as stated on paper. Western insurance and finance providers may opt not to participate and instead “self-sanction,” as they reportedly already are. Russia may refuse to sell any crude or products under a cap. Russian officials have insisted they will not.
How price curbs could work in practice
This all sounds like a recipe for policy failure. However, even if no cargoes move under a price cap, Russia may still earn less from oil exports and a good portion of its exports may still continue to flow.
On the pricing side, uncertainty over EU sanctions, the price cap, and how they will be enforced has affected sentiment among Russian oil buyers. The fewer buyers interested in taking the risk of importing Russian oil, the higher the discount Russia will have to accept from the remaining buyers.
This is already happening. On Nov. 28, Argus Media reported the price of Russia’s Urals crude had fallen to a 22-month low, partially due to “anxiety around sanctions risk.” Citing data from Platts, it said Urals was assessed at $54.94 per barrel, a $29.50 per barrel discount to Brent, the highest spread since Aug. 11.
In a separate report, Argus said that reduced buying from Europe in recent months has “increased availability,” leading to “deep discounts for Russian crude” relative to Brent. “With the EU embargo on seaborne Russian crude from Dec. 5 expected to free up even more supply, Urals values are under pressure.”
If Russia must give a higher discount to buyers due to unease over sanctions combined with the effect of the EU import ban, it’s the same outcome price-wise — less cash to Russia — as if the oil was delivered under a cap.
How Russia could maintain volumes
The second part of the Western plan is to keep enough Russian crude flowing to avert a global price spike. The stated policy is for Russian oil to continue moving aboard mainstream tankers using Western insurance under a cap protocol.
“There could be a scenario where oil will actually be sold according to the cap and sanctions wouldn’t apply, so the Western insurance market would actually be able to service it,” Lars Barstad, CEO of tanker owner Frontline (NYSE: FRO), said on a quarterly call on Dec. 1.
Alternatively, the desired outcome — continued flows — could occur if Russian oil was instead carried by a fleet of tankers that didn’t use U.K. P&I insurance and Western finance.
U.S. Treasury Secretary Janet Yellen openly acknowledged this option. Asked about India’s potential to continue buying Russian exports, she told Reuters: “India can purchase oil at any price they want as long as they don’t use these Western services and they find other services. Either way is fine.”
‘Shadow fleet’ expands
This scenario is already playing out. The EU sanctions deadline and talk of price caps led to a flurry of buying activity in recent months as private shipowners acquired tankers to assumedly operate without Western shipping services. Market forces — i.e., the potential to earn huge spot-rate upside by moving Russian oil — incentivized shipowners to act.
“We have seen high activity in the S&P [sale and purchase] market for more vintage tonnage that we expect to enter this [Russian] market,” said Barstad. These vessels would “be potentially insured in other markets.”
According to brokerage BRS, there are now 1,027 tankers in the so-called “shadow fleet,” which it defines as those involved in oil transport for Venezuela, Iran or Russia, or linked to those countries’ governments. Of those, 503 are over 34,000 deadweight tons (DWT) in size.
BRS reported that 111 tankers of 34,000 DWT or larger have been sold since Russia’s invasion of Ukraine. “These tankers have generally been elderly with an average age of 18 years,” BRS said. “The majority of these tankers have been sold to ‘niche’ private shipping companies, which we believe have viewed the ongoing situation with Russia as an opportunity.
“In our view, there is now enough dirty [crude and fuel oil] shadow tonnage to permit Russia to support its exports at close to today’s levels. We believe that if anything will hinder Russia’s crude exports post-Dec. 5, it will be [Russia’s inability to find] sufficient non-OECD buyers to replace the 1.4 million barrels per day currently purchased by European refiners.”
The counterargument is that there will not be enough shadow tankers, particularly given winter weather restrictions in northern Russian ports requiring the use of ice-class vessels, meaning that Russian crude exports will be reduced.
Longer lifespans for tankers
The EU ban on Russian imports is expected to be highly positive for crude-tanker demand due to the longer voyage distances required for the EU’s replacement imports. But the expansion of the shadow fleet is a negative for tanker supply, as well as for shipping safety.
Vintage tankers that would ordinarily be scrapped will now remain in service. Data provider VesselsValue reported Tuesday that the value of 20-year-old very large crude carriers (VLCCs; tankers that carry 2 million barrels of crude) has increased 51% since January. The value of 20-year old Aframaxes (750,000-barrel capacity) has surged by 86% since the beginning of this year.
One of the top talking points of tanker executives is that the number of new tankers on order is much lower than tankers 20 years or older. Employment of vessels of this age “is not only limited but almost impossible in the compliant tanker market,” said Barstad. Frontline estimated that there are around twice as many 20-year-old tankers in the segments it operates in as there are tankers on order.
However, this calculation is much less bullish for future rates than it was in previous cycles because of the enhanced ability of older ships to extend their lifespans in the shadow fleet.
Safety, environmental risks of divided fleet
The side effect of Russian sanctions is the further bifurcation of the tanker business. On one side, there is the mainstream tanker fleet. On the other, tankers carrying Russian crude after Dec. 5, along with those in sanctioned Iranian and Venezuelan trades.
This increased bifurcation runs counter to the industry’s goal of a global regime with all vessels under the same safety and environmental regulatory framework.
Shadow tankers frequently turn off Automatic Identification System vessel-position equipment. Questions have also been raised about shadow-tanker insurance in the event of a spill, as well shadow-tanker classification societies (the organizations that maintain technical standards).
“We consider that the increased use of vintage tonnage poses a risk in itself,” said BRS. “There is uncertainty surrounding the upkeep of vintage shadow tonnage, with many of these vessels having moved to niche classification societies.”
All tankers loading at Black Sea ports will have their insurance vetted by Turkish authorities prior to transiting the Bosporus Strait (a new requirement that is already creating a traffic backup).
The Russian trade will also increase ship-to-ship transfer (STS) operations on the high seas, as smaller tankers capable of entering the country’s ports must transfer cargoes to larger vessels for long-haul runs. “The increased use of ship-to ship transfers has highlighted the risk posed by undertaking such complex maneuvers on the high seas, rather than more sheltered locations,” said BRS.
According to Barstad, “We are already seeing these STS operations happening, not inside EU territory, but in other areas. The very, very concerning part of that is that not all of these areas are suited to do STS operations, so the safety and pollution risk increases.”
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