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Fuel for Thought: Russian crudes come under renewed pressure as G7 price cap nears

  • Featuring
  • Eklavya Gupte    Robert Perkins    Sam Angell
  • Commodity
  • Oil
  • Topic
  • War in Ukraine

The value of Russia's key crude exports has come under renewed pressure as EU sanctions and the G7's price cap edge closer amid growing signs that the curbs pose little threat to Moscow's resilient output and oil revenues.

The outright price for Russia's flagship crude Urals slumped to 22-month lows in the run-up to the Dec. 5 start for the mechanism as weak physical market fundamentals and anxiety around sanctions risk have spurred even steeper discounts.

The discounts for Urals and ESPO—Russia's eastern-bound export crude—against regional benchmarks have also widened again in recent weeks although they remain well below record levels seen in the aftermath of Russia's Feb. 24 invasion of Ukraine.

Platts, part of S&P Global Commodity Insights, assessed medium sour Urals at $54.935/b Nov. 21, the lowest since Jan. 29, 2021. Compared with Dated Brent, the Urals discount widened to $29.50/b Nov. 24, its highest since Aug. 11. Russia's eastbound ESPO crude is valued higher and Platts assessed it at $74.32/b Nov 25. But the grade has also lost ground against regional benchmark Dubai over the last week, Platts data shows.

The weakening values for Russian crudes come as G7 moves closer to setting the level of its price cap on Russian oil, designed to stymie the Kremlin's oil revenues by controlling access to shipping services.

But following a week of crunch talks between diplomats in Europe to hammer out the mechanism's closely watched price cap, reports that the price ceiling considered could be a higher-than-expected $65-$70/b has surprised the oil markets.

Although consensus on the cap level has yet to be reached, many oil traders have rightly questioned the utility of the cap if it is set above the level at which Moscow's main export grade is currently trading.

"To me, this price cap means they want [Urals] to flow at current levels," a trader said, noting that the impact of the cap as an outright price will also be dependent on movements in international benchmarks to which Urals trades at a differential.

Russian Urals crude oil discount to Dated Brent Widens in late 2022

Softer fundamentals

Russian crude has been trading at record discounts of up to $40/b in wake of Russia's invasion of Ukraine as key buyers in Europe shunned Moscow's oil. The bulk of Russia's crude exports is now flowing to refiners in Asia, with China and India being its key customers.

With the oil market turning bearish as a growing list of poor economic data has undermined confidence in demand, Brent crude prices and Urals crude differentials have taken a hit in the past few weeks.

Such concerns are exacerbated by weakness across physical crude markets, particularly in Asia, where rising coronavirus cases have dampened demand from China, the world's largest crude importer, and weighed heavily on the Middle Eastern sour complex.

That looks set to drive the Urals to even steeper discounts to Dated Brent just as the price cap comes into force, before even considering the logistical effects of the looming sanctions.

Demand for Russian ESPO from Chinese and Indian refineries has also slowed in recent cycles with traders citing a hefty overhang in December-loading cargoes.

"Oman [crude values] have come off, a lot of [Upper Zakum] has come off a lot … why would you take Russian barrels?" said a second trader.

Platts assessed ESPO at a discount of $6.74/b to Platts Dubai Nov. 25, a six-week high after discounts for the grade had almost shrunk back to pre-war levels earlier in the month.

"It's hard to find much bidding interest in the eastern market at all, no matter what grade," the second crude trader said. "Everything is dropping like a stone, including Russian crudes."

Delivered values for the Russian Urals to India have also shrunk through November, even as freight rates have soared, an Indian refining source said. With the Middle Eastern sour complex continuing to soften, some traders suggested major buyers are likely to look more favorably on conventional sour flows compared with riskier Urals over the coming weeks.

Russia's Urals is classified as a medium sour grade, with a specific gravity of about 31.7 API and sulfur content of 1.7%, while ESPO is lighter and sweeter, with 34.7 API and sulfur content of 0.55%, according to the Platts periodic Table of Oil.

Discounts for Russian crude in Asia shrinking in late 2022

Supply outlook

S&P Global forecasts Russian crude and condensate output to fall by 1 million b/d between November and March, that is 1.5 million b/d below pre-conflict levels, due to the looming EU bans and G7 restrictions on maritime services and financing. The EU crude import ban and G7 price cap will both be in place from Dec. 5 onward.

But paul Sheldon, chief geopolitical advisor at S&P Global, said odds are rising that supply could exceed expectations.

"Russia has already had significant time to prepare, increasing its ability to secure a sufficient fleet of ships and non-Western maritime services," Sheldon said. "A softening of the EU ban on ships not complying with the price cap (if finalized) could increase tanker availability, more sanctions exemptions could arise, and/or a price cap as high as reported levels could cause Russia to hold its nose and maintain supplies, especially if the alternative is damaging shut-ins."

Almost five months in the making, G7 nations have yet to set the maximum price at which shippers from G7 and EU countries may legally transport Russian crude and products.

Russia has so far insisted it will not sell its oil under the price caps, which forces it to develop alternative supply chains to bypass the measures or shut-in its displaced oil.

Many expect refiners in China, India, and Turkey—the top current destinations for Russian crude— to absorb more of the affected oil. Combined, the three buyers have seen their seaborne imports of Russian crude almost treble from prewar levels to over 2 million b/d, accounting for nearly 70% of Russia's seaborne flows.

But the logistical risks brought by the new sanctions regime present an additional hurdle. The so-called shadow tanker fleet carrying Russian crude is expanding, with the G7 oil price cap regime expected to banish Russian barrels into non-mainstream trades. This is likely to exacerbate maritime trade risks for the shipping industry.

"The general consensus is that ... the majority of mainstream tanker owners will be prevented from lifting Russian barrels," said shipbroker BRS in a recent note.

Uncertainties over implementation and likely Russian workarounds mean, even when the G7 does set the price cap, the impact of Russian export flows will be hard to call.