The imposition of a price cap on oil from Russia – being finalised last week by senior officials from the G7 governments in Washington – is an even trickier matter in current oil market and geopolitical circumstances than it usually is. The unofficial oil price range of US$40-75 per barrel of Brent (pb) in place for the vast majority of former U.S. President Donald Trump’s tenure in office was managed through a combination of threats (of the withdrawal of the U.S. military from Saudi Arabia, and the passing of ‘NOPEC’ legislation, principally) and rewards (the ongoing guarantee of security for Saudi Arabia and investment by U.S. companies into the country), as analysed in full in my latest book on the oil market. However, Saudi Arabia was not at the time a leading nuclear power in the midst of an invasion of a major European country initiated by a president who had staked everything personally on its success. Economically as well, the stakes relating to the previous de facto oil price range were not as complicated as they are now, with a seismic transition being engineered to wean Europe and other powers off cheap Russian energy, but time still needed to do so. The major global economies are already having to deal with the inflationary effects of high energy prices catalysed by Russia’s invasion of Ukraine in February, with economy-crimping hikes in interest rates now adding to the negative economic pressure seen from the end of various quantitative easing measures in place since the Great Financial Crisis. Therefore, on the one hand, the last thing that the major economies of the G7 want now is for this to be compounded by a huge drop in Russian oil and gas supplies during this transition process but, on the other, they are keenly aware that every incremental dollar added to the price at which Russia can sell its oil and gas means that it can stay longer in Ukraine and kill more Ukrainians. It also means that the personal stakes for Russian President, Vladimir Putin, continue to rise, which, in turn, increases the chances of a broader escalation into nuclear warfare as and when he realises that he faces guaranteed failure in his war.
This delicate balancing act was recognised by U.S. Treasury Secretary Janet Yellen that a price cap in the US$60 pb of WTI range would give Russia an incentive to keep producing oil, and would equate to around US$68 pb of Brent, given the recent historical US$8 pb premium of Brent over WTI. The final price cap on oil from Russia will be decided upon in the run up to 5 December, which is when a European embargo on Russian oil and associated restrictions on transportation and insurance of seaborne oil is set to come into effect.
Given the apparent ideological duality at play in the conception of this oil price cap, it is by no means certain that it will be rigorously enforced. That is, given that the G7 does not want to stop all oil exports from Russia but rather only to limit how much revenue it can make from each barrel, the question for global oil markets remains how much oil can Russia manage to export even with the price cap in play? In broad oil market terms, this is the key figure, as Russian oil exports leaking into the global market at prices above the oil price cap will feed through into the global oil supply and demand mix, which in turn will feed through into prices. The answer to this question in large part depends on shipping, and on the Russia-Iran-Iraq-China corridor.
First, there is the question about how many ships Russia can secure to move its oil. Several senior sources in the oil industry in the U.S. and European Union energy security spheres, spoken to exclusively by OilPrice.com last week, believe that Russia could secure in very quick time at least three quarters of the shipping needed to move its oil as usual to established buyers, and up to 90 percent within a few weeks after that. Before the invasion of Ukraine, according to IEA figures, Russia was exporting around 2.7 million barrels per day (bpd) of crude oil to Europe, and another 1.5 million bpd of oil products, mostly diesel. More broadly, as at the end of January this year, also according to the IEA, Russia’s total global oil exports were 7.8 million bpd, two-thirds of which were crude and condensate. Therefore, using the likely scenario range above, the global oil markets would only lose between 0.78 million bpd and 1.95 million bpd of pre-Ukraine invasion levels of Russian oil, even with the cap in place, regardless of all other factors. Given the huge oil tanker fleets operated by Russia itself, China, India, and Iran, there would be no shortage of vessels available to it, and the commonly cited ‘problem’ of shipping and cargo protection and indemnity insurance would be easily enough covered from all the countries mentioned, as it was when such shipping insurance-related sanctions were placed on Iranian oil tanker fleets by the U.S.
Second, the Russia-Iran-Iraq-China corridor also offers several other mechanisms for moving oil under a sanctions environment. Iran, in collusion with Russia and China, and using Iraq as a conduit, when necessary, had no choice but develop its own methods of circumventing sanctions since 1979, at which it has become so adept that it is a matter of national pride at the highest levels. In December 2018 at the Doha Forum, Iran’s then-Foreign Minister, Mohammad Zarif, stated that: “If there is an art that we have perfected in Iran, [that] we can teach to others for a price, it is the art of evading sanctions.” Towards the end of 2020, Iran’s then-Petroleum Minister himself, Bijan Zangeneh, added a little detail to one such tried-and-trusted method: “What we export is not under Iran’s name. The documents are changed over and over, as well as [the] specifications.”
As also analysed in full in my latest book on the oil market, shipping-related methods to circumvent sanctions are simple enough, involving the disabling – literally just flicking a switch – on the ‘automatic identification system’ on ships that carry Russian oil, as is just lying about destinations in shipping documentation, as mentioned by Zanganeh. In Europe, Iran used this method to get oil into some of the less rigorously policed ports of southern Europe that need oil and/or oil trading commissions, including those of Albania, Montenegro, Bosnia and Herzegovina, Serbia, Macedonia and Croatia. From there, the oil was easily moved into Europe’s bigger oil consumers, including through Turkey. For Asian-bound shipments, the reliable methodology for Iranian sanctioned oil, also available to Russian oil, has allegedly involved Malaysia (and to a lesser degree Indonesia) in forwarding oil exports to China, with tankers bound ultimately for China engaging in at-sea or just-outside-port transfers of Iranian oil onto tankers flying other flags.
It is apposite to note at this point that there several Russian crude oil grades that are also extremely close in specifications to the comparable grades in Iran, and therefore Iraq, with which Iran shares many major oil reservoirs and fields. If the G7 decided to toughen up its sanctions against Russian oil exports, then Moscow and Tehran could agree to a swap deal of one sort or another that would see Russian oil go to anywhere that Iran needed it, with a compensatory amount of ‘Iraqi’ (read ‘Iranian’) oil going to wherever Russia wanted, as Iraq oil is not under any sanctions. This core strategy of ‘rebranding’ Iranian oil as Iraqi oil has seen huge volumes of Iranian oil moved through Iraq’s existing crude oil export infrastructure, including very large crude carriers loaded in and around the southern export hub of Basra. It has also been done directly into southern Europe via the Turkish port of Ceyhan through the crude oil pipelines running through the semi-autonomous Iraq region of Kurdistan, although these have been subject to ongoing disruptions for years, and there are also plans for further pipelines from Iraq to Jordan and Syria.
OilPrice.com understands from sources close to Iran’s Petroleum Ministry spoken to exclusively last week that there was “significant change” to this previous longstanding agreement on the demarcation of crude oil flows coming from Russia, Iran, and Iraq – that is, that Russian oil exports had precedence over Iranian/Iraqi ones into Europe – during the very recent trip of Russian Deputy Prime Minister, Alexander Novak. “The basis for a new arrangement regarding crude oil flows coming from ‘Russia/Iran/Iraq had been laid out at the January [2022] meetings [in Moscow, when Iranian President, Ebrahim Raisi – the first visit of an Iranian president to Russia in almost five years at that point], and these were discussed further in the last couple of weeks,” the source told OilPrice.com.
