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Analysis | Russian oil price cap may not be the hoped-for fail-safe

Expect the oil market to become much more volatile in the coming weeks.

As of December 5, it will be illegal to import Russian crude oil into the European Union by sea (with minor exceptions) and for EU companies to provide services such as insurance and financing for ships carrying the oil around the world. If the latest round of sanctions is ratified, it will also be illegal for European ships to be used in that trade.

The nuisance can be enormous. Moscow has already lost much of its European market, with buyers shunning its wares before the ban goes into effect. But the country still ships some 630,000 barrels a day to EU countries. The volume transported worldwide on ships owned by European companies is significantly greater.

Russia doesn’t have many obvious options for turning that capacity around, and almost none of them are close. Sales to India, and to a lesser extent to China and Turkey, surged in the weeks after President Vladimir Putin ordered his troops to invade Ukraine. But that flow peaked in June and has declined slightly in recent months.

New Delhi, Beijing and Ankara may not be willing to increase volumes without sharper price discounts. They will certainly see the prospect of Russian crude stranded by European sanctions as an opportunity for tough negotiations about what they are willing to pay.

Outside of those three countries, Russia has not had huge success in finding other customers. It continues to occasionally send cargo across the Atlantic to its friends in Cuba. One or two have ended up in Egypt or Fujairah in the United Arab Emirates.

About 3 million barrels have been sent to Sri Lanka, but the tankers sailing that route have been forced to anchor off the port of Colombo for weeks until the government can find the money to pay.

If the size of the fleet available to carry Russian oil shrinks with the loss of European ships, long periods of shutdown of the remaining ships will give Moscow even more of a headache.

Shipping crude oil from the Baltic to India moors ships at least four times as long as delivering cargo to Rotterdam, so the same volume requires four times as many ships. Prolonged delays will further increase that requirement.

The US Treasury Department has attempted to solve this problem with its proposed price cap for Russian crude oil — an idea that has gained popularity among politicians in allied countries, even if it has been rejected elsewhere.

The concept is simple: if a buyer pays less than a price to be agreed, he can use European ships and secure financing and insurance. The goal is to keep Russia’s crude oil flowing while simultaneously depressing the Kremlin’s revenues.

The view in Washington seems to be that if the capped price is set above the cost of production, Russia will have an incentive to continue exporting. What they don’t seem to understand is that the decision for Russia is a political one, not a commercial one.

Putin has said more than once that his country will not sell crude oil to buyers who want to impose a cap, while Deputy Prime Minister Alexander Novak said after the recent OPEC+ meeting in Vienna the “mechanism is unacceptable”. Novak also warned it could force Russia to temporarily halt some production.

US Treasury Secretary Janet Yellen is wrong when she says that “this limit will help us properly supply global energy markets.” It will not. I do not believe that a single barrel of Russian crude will be sold at a capped price.

But that is Putin’s choice. The alternative to the price cap is not the free flow of its oil; it is the full force of EU sanctions. The US proposal aims to provide a way to circumvent those sanctions, even if the Russian leader refuses to take advantage of them. The Kremlin will bet that stopping Siberian oil pumps will hurt buyers more than Russia, a calculation it has already made for natural gas.

Can oil markets weather this loss on top of a 2 million barrels per day cut in OPEC+ targets that comes into effect in November?

The first thing to keep in mind is that OPEC+ action is largely an illusion. The actual drop in production from September production levels could be just a tenth of the headline figure – barely enough to make you break a sweat. At the same time, demand forecasts are being lowered – the result of high prices and an impending recession. Those two factors could mean the world will need less Russian crude in the coming months.

But with so many moving parts and Russia doing everything it can to keep markets sharp as the sanctions deadline approaches, don’t expect markets to quietly enter winter.

This column does not necessarily reflect the views of the editors or Bloomberg LP and its owners.

Julian Lee is an oil strategist for Bloomberg First Word. He was previously a senior analyst at the Center for Global Energy Studies.

More stories like this are available at bloomberg.com/opinion

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