Russian crude prices have breached the G-7 price cap. Now what?

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The price of Russian Urals crude, exported from ports in the Black Sea and Baltic Sea, is now at or above the $60-per-barrel price cap set by the Group of Seven nations and the European Union. If it stays there or rises further, European tanker owners and their U.K. insurers will not be able to legally participate in this lucrative shipping trade.

“The breach [of the] price cap could have significant ramifications for Russia-origin oil continuing to be carried on international tonnage,” said ship brokerage Braemar on Friday.

The price cap was put in place on Dec. 5. Urals flirted with $60 in April but global prices fell in the following months, pulling Urals back from the brink. This month, oil prices have risen at the same time the discount of Urals to the global benchmark, Brent, has shrunk.

Urals has topped $60 by a few cents since Wednesday, the first time it has done so since the cap plan was implemented, according to data from price-reporting agency Argus. (Russian ESPO crude loaded in the Pacific has always been over the cap.)

The question for Western governments is: Will there be sufficient non-Western tanker tonnage available to maintain Russian export flows, preventing a further rise in global oil prices that negatively impacts consumers?

The questions for tanker markets: Will an exodus of European tankers from Russian trades weigh freight rates in non-Russian trades by injecting more tonnage? And will new restrictions on Russian trades mean that non-Western tankers — the so-called “shadow tankers” — earn an even higher premium?

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Shock could be ‘less dramatic’ than expected

“If the price persists above $60 per barrel, the players moving Russian crude may have to increasingly rely on the ‘shadow fleet,’” Sheel Bhattacharjee, head of European freight at Argus, told FreightWaves.

“This is likely to widen the freight spread between Russian cargoes and the general market. However, the shadow fleet can expand if the incentives are there. So, there may be enough vessels to carry Russian volumes, especially following the recently announced cuts to Russian oil production.”

As a result, said Bhattacharjee, “the initial shock could turn out to be less dramatic than some may expect, and the market is likely to rebalance itself again even if the Urals price remains above the cap long-term.”

According to data from Kpler, Russian seaborne crude exports averaged 3.4 million barrels per day (b/d) in June, down 12% from May to the lowest monthly volume since December. Seaborne exports in the first half of July have averaged 3.2 million b/d, down 7% from June.

Even so, Russian crude export flows are still above pre-invasion levels. Average seaborne exports this June and July are up 4% from those in June-July 2021.

“Moscow has promised a further 500,000 b/d cut to exports in August,” said the International Energy Agency (IEA) on Thursday. IEA data shows that virtually all Russian crude exports continue to move to just two countries: China and India.

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Crude tanker owners earning huge premiums in Russia

Russian crude is loaded aboard Aframaxes (tankers that carry 750,000 barrels) or Suezmaxes (1 million-barrel capacity). They sail either directly to India or China, or they do ship-to-ship transfers to very large crude carriers (2 million-barrel capacity) that handle the long-haul leg.

If the price of Urals exceeds the cap for an extended period, forcing Western tankers out of the trade, the non-Western tankers that remain could reap higher premiums. Russian freight premiums are already very high. Average freight rates for Aframaxes and Suezmaxes have been declining globally since April. Rates for Aframaxes and Suezmaxes carrying Russian oil have fallen less, increasing the freight spread.

Argus launched a new product this year that compares weekly Russian crude export freight rates to a non-Russian baseline. It shows that in the first week of July, an Aframax loading 80,000 tons of Russian Urals in the Black Sea port of Novorossiysk for delivery to western India earned $3.68 per barrel more in freight than a baseline tanker. That’s a premium of 90% — meaning an Aframax is earning almost twice as much in this Russian trade as it could elsewhere.

The cost of transporting 140,000 tons of crude aboard a Suezmax from Novorossiysk to northern China was $3.17 per barrel higher than the baseline, a premium of 76%, according to Argus data.

In the Baltic Sea, the freight cost for a 100,000-ton cargo of Russian Urals loaded on an Aframax in the first week of July at the port of Primorsk for delivery to western India exceeded the non-Russian baseline by $3.89 per barrel or 87%.

Urals-Brent spread cut in half since January

The breaching of the price cap occurred as global oil prices were rising. Brent just topped $80 per barrel for the first time since late April. Cuts by the OPEC+ producers could put further upward pressure on crude prices. “So far, [OPEC+ cuts] have not led to a steep decline in global supply. That may be about to change,” said the IEA. “Supply should shift toward a lower trajectory in the coming months as Riyadh [Saudi Arabia] implements steeper cuts.”

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As the price of Brent has risen, the discount of Russian Urals compared to Brent has declined. That is not a positive trend for Western policy: The whole point of Western sanctions is to force Russian exports to sell at a steep discount, reducing revenues to the Kremlin.

The narrowing of the Urals-Brent spread is an example of the broader market trend toward a lower discount of medium-sour crudes to light-sweet crudes. (“Medium” and “light” refer to crude gravity; “sweet” and “sour” refer to sulfur content.) Medium-sour crude pricing is rising more than light-sweet pricing. Russian Urals is medium-sour. Brent is light-sweet.

David Fyfe, chief economist at Argus, told FreightWaves: “We have real physical tightness in medium-sour crude, in part because of the diversion of Russian crude long-haul into Asia. More crude on the water equates to tighter prompt supply.

“And in addition to Saudi and Russian supply curbs in July and August, we’ve had disrupted Canadian crude production and several months of shuttered Iraqi Kirkuk exports. So, prices of medium-to-heavy-sour crude have appreciated versus light-sweet benchmarks.”

According to Argus data, the discount of Russian Urals compared to Brent skyrocketed from almost nothing to around $40 per barrel in the days following the invasion of Ukraine. After falling in mid-2022, the discount again hit $40 per barrel in January following the EU ban on Russian crude imports and the G-7 price cap. Since then, the discount has been cut in half, to $20 per barrel.

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