Price cap on Russian crude could soon face its biggest test

G-7 and EU shipping service providers — including the all-important U.K. ship insurers — can participate in a voyage if they have written attestations that the cargo is priced below the cap.

Around a quarter of Russian seaborne exports are in the Pacific via the Eastern Siberia Pacific Ocean (ESPO) pipeline, loading in the port of Kozmino. The remaining export volume is primarily Urals grade crude loading in the Black Sea port of Novorossiysk and the Baltic Sea port of Primorsk.

According to price assessments by Argus, ESPO crude out of Kozmino is well above the cap and has been so since the beginning of sanctions. ESPO closed Thursday at $71.56 per barrel (based on the “free on board” or FOB price, which excludes shipping costs).

Now, the price of Urals is getting uncomfortably close to the cap. It is trading at a 35% discount to Brent, but as Brent rises in the wake of OPEC cuts and rebounding demand, Urals is now within a few dollars of the cap. Urals hit a recent high of $57 per barrel on Tuesday, according to Argus data.

OFAC warns on ESPO trade

According to Vortexa, the Russian trade out of the Black Sea and Baltic Sea is dominated by Greek tankers, whereas ESPO loadings are dominated by Russian and Chinese tankers.

However, there are shipping service providers bound by G-7 and EU price-cap rules involved in the ESPO crude trade out Kozmino, not just in Europe. 

This is raising red flags, given that ESPO crude is clearly well over the cap, spurring a special alert from the U.S. Office of Foreign Assets Control (OFAC) on Tuesday.

“OFAC is aware of reports that ESPO and other crudes exported via Pacific ports in the Russian Federation, such as Kozmino, may be trading above the cap and may be using covered services provided by U.S. persons,” said the sanctions enforcement agency.

“We issued this alert to provide an additional warning to U.S. industry to be careful if you’re dealing with ESPO or other Pacific Russian crudes,” said Claire O’Neill McCleskey, assistant director in OFAC’s compliance office, during a Capital Link webinar on Thursday.

She said U.S. entities may have been provided false documentation and may have been unaware of a ship’s location due to manipulation of Automatic Identification System (AIS) ship-position data, a common practice known as “spoofing.”

“Specifically, what we’re seeing, which led to us to issue this alert, is that sometimes there will be a discrepancy between what a very basic vessel-tracking service shows and what a more sophisticated tracking service shows,” McCleskey said. The basic tracking system will not show a call at Kozmino; the more sophisticated service will.

Asked by FreightWaves whether OFAC had contacted any of the U.S. entities that might be involved in the ESPO trade above the cap and whether any actions were being considered, she replied, “Unfortunately, I can’t answer that one directly. But I will just say that information reported to us by U.S. persons is a very important source of information and we’re obviously conducting quite a lot of industry engagement.”

More Western tankers in Urals trade

The complications for tanker shipping would be much more extreme if Urals pricing breached the cap for an extended period, as ESPO already has. 

Oil prices in general are predicted to increase in the second half of this year, implying future upward pressure on Urals.

The Baltic and Black Sea trades were largely handled by the so-called “shadow fleet” immediately following the Dec. 5 price cap and EU import ban. Shadow tankers are generally defined as those with opaque ownership that operate outside G-7 and EU financial, shipping and insurance regimes.

Brokerage BRS estimated that nine out of 10 Russian crude export cargoes were carried by shadow tankers immediately following Dec. 5, but it’s now down to only three of 10, with only one in five Russian petroleum product cargoes loaded on shadow tankers. 

Mainstream tankers using Western shipping services have become heavily involved in the Russian trade out of the Baltic and Black seas.

Alex Younevitch, head of freight for Argus, told FreightWaves: “The proportion that the shadow fleet takes [of] Russian barrels has been decreasing gradually. Shipowners in the general market are now more used to the procedures of getting P&I [insurance] coverage of Russian business. 

“The shadow fleet is still active, though, as it can be perceived as convenient by some players,” Younevitch said.

Argus shines light on sanctions premiums

Mainstream tanker players are entering the trade not just because they’re more comfortable with the cap system, but because it’s financially lucrative.

The extent of the “sanctions premium” is the focus of a new freight pricing product introduced by Argus on Wednesday. It assesses average weekly Russian crude freight costs (including both the mainstream and shadow fleets) to China and India versus a non-Russian-cargo benchmark.

To take one example, Argus’ data shows that the freight cost to move Urals from Novorossiysk to the west coast of India aboard an Aframax tanker (with a cargo of 80,000 tons) earned an average of 42% more than a baseline Aframax over the six weeks ending last Friday. 

The Russian cargoes earned as much as 57% more in freight in the week ending March 31 in this particular trade. The premium had fallen to 33% in the week ending Friday. The spread, while still high, has narrowed.

Younevitch explained, “With the general fleet now heavily involved, Russian-origin freight is directly influenced by supply and demand fundamentals in the open market. 

“So, if there is oversupply and a weak market for Aframaxes and Suezmaxes in the Atlantic [Suezmaxes carry around 140,000 tons of crude], this is mirrored in the Russian-origin freight, and the sanction premium gets narrower.”

Pendulum could swing back to shadow fleet

The looming question: If Urals goes over the cap for an extended period, what happens to all the mainstream players that recently entered the trade? Will they have to pull out if their U.K. insurers balk? 

“If the price of Russian crude remains demonstrably over the $60 per barrel price cap, the situation can become more complicated,” warned Erik Broekhuizen, manager of marine research and consulting at Poten & Partners, in a recent research note.

“Will charterers be able to continue to provide their attestations?” he said, referring to the written confirmation of sanctions compliance required by insurers and regulators.

If not, the pendulum would shift back to the shadow fleet. 

Younevitch explained: “The sanctions premium is likely to increase if the Urals price goes above the cap and shipowners in the general market struggle to get insurance coverage. That would mean demand would have to be served by the limited shadow fleet tonnage, naturally increasing the cost of freight.”

Looming test for cap system

If the shadow fleet is big enough to handle the load after mainstream tankers are forced to pull out, Russia could reap higher income via the rising price of Urals and make an end run around Western sanctions.

If the shadow tanker fleet isn’t big enough — or if concerns over sanctions curb buying interest in India — the price cap could theoretically sway Russian strategy.

“Would Russian producers provide even steeper discounts to international benchmarks to keep their price under the cap?” asked Broekhuizen. “This would preserve the employment of some of the mainstream owners that are currently active in the fleet.

“In India, some of the banks that are facilitating oil transactions have informed their clients that they will not handle payments for oil that is bought above the $60 price cap. The attitude of the Indian banks is very important because India has become a key customer of Russian crude.”

Yet another possibility if the crude cap is breached: The West could blink first and raise the cap over $60. “The G-7 now faces a dilemma. Raising the price cap would keep the oil flowing, but that would also increase Russia’s revenues,” said Broekhuizen.

Good news on diesel front

The key concern for Western economies is how all this plays out for the price consumers and businesses pay for fuel. The goal of the G-7 and EU price-cap regime is to reduce revenues to Russia but not reduce energy supplies to the world.

The price of diesel is key. And the good news is that there’s no imminent problem with the $100-per-barrel price cap for diesel.

Russian diesel was selling for an average of just $70 per barrel last month, according to the International Energy Agency, citing Argus.

“Nobody anywhere in the world is paying anything close to the cap,” said Benedict George, associate editor for European products at Argus, during a presentation on Russian diesel exports this month.

The Department of Energy issues a weekly average for retail diesel, a benchmark used in most trucking surcharges. The latest average, issued Monday, came in at $4.12 a gallon. That’s almost identical to the average in the week immediately prior to Russia’s invasion of Ukraine.

Over the 10 weeks since the EU banned Russian products imports and the G-7 and EU implemented the diesel price cap, the DOE diesel benchmark has dropped 11%. There’s no fallout yet from Western sanctions when you look at the prices at the pump.

Click for more articles by Greg Miller 

Related articles:

• European tanker owners make a fortune off Russian oil trade
• OPEC+ throws tanker shipping a curveball, shaking confidence
• China-Russia vs. US-EU: How global shipping is slowly splitting in two
• One year later: How Ukraine-Russia war reshaped ocean shipping
• Welcome to the dark side: The rise of tanker shipping’s ‘shadow fleet’
• Could Russia sanctions work in practice even if they fail on paper?
• In search of shipping’s next supercycle: Are tankers next?