The long-awaited oil sanctions and price cap on Russian oil are slated to go into effect in just a few weeks, on Dec. 5. The sanctions apply to G7 countries (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States) and companies, and they will prohibit (with some exceptions) the importation of Russian crude oil and petroleum products. The sanctions also ban the maritime transportation of Russian crude oil starting Dec. 5 and Russian petroleum products starting Feb. 5, 2023, as well as the use of associated services that facilitate the maritime transportation of Russian petroleum.
An exception to the sanctions is the price cap policy. If a third party transporting Russian crude oil or petroleum products pays at or below the price cap amount, they can access G7 maritime transportation services. However, policymakers have not yet announced what the price cap will be or whether the price cap will be fixed or fluctuate with the market price of oil.
This leaves buyers and shippers in a difficult situation as most oil shipments are contracted for a month in advance. Many are concerned that the sanctions will come into effect while they have ships carrying oil or products at sea. Indian and Chinese refiners, which aren’t subject to the G7 policy but use maritime transportation services located in these countries, are starting to shy away from ordering Russian crude oil for loading after Dec. 5 because the price cap policy has not yet been clarified.
Traders need to prepare, as best they can, for how the market will react to the sanctions and oil price cap policy. Here are two possible ways the price cap policy could play out—if it does come into effect on Dec.5.
Scenario 1: Russia Gives In
The first scenario explains how policymakers envision the price cap policy working and is based on the premise that Russian President Vladimir Putin is desperate for revenue and needs to sell Russian oil. He will be motivated to do so even at deeply discounted prices because Russian producers can’t cut production (due to difficulty turning off production in Siberia and a lack of storage). This scenario relies on China not increasing its imports of Russian oil because it already imports a significant amount of Russian oil and will be hesitant to increase Russian imports because it might make China too dependent on Russian oil.
India, Turkey, and Indonesia would all increase their purchases of Russian oil at cheap prices that are at or below the price cap and refine it into products that they then sell worldwide—essentially “washing” Russian oil to make it acceptable for G7 nations to buy, in product form. This will keep Russian oil on the market while severely reducing Russia’s oil revenue. Some Saudi and Iraqi crude oil that has been going to India and China will be redirected to markets in Europe, but not as much as the 1 million bpd that Russia was supplying. There could be a temporary price spike while this all gets evened out, but in the end, prices will be lower and Putin won’t have the revenue he needs to wage war in Ukraine (ideally).
Scenario 2: Russia Holds Out
The second scenario is how the price cap policy could play out if Putin doesn’t react as the G7 expect. It is based on the premise that Putin, even if he is desperate to sell oil, won’t act out of desperation. He will refuse to sell Russian oil at or below the price cap and will hold out on maritime supplies to India, China, Turkey, and others until they agree to pay his price (which is already discounted from the market price). He will do this even at the risk of damage to Russian oil fields or storing oil in less-than-ideal conditions.
A Russian holdout would cause the market price of oil to rise—but the increase might not be temporary. Russia’s non-G7 customers would agree to pay Putin’s price because they are priced out of other oil supplies. The longer the impasse continues, the more the price of discounted Russian oil will rise. However, because Russian oil is still cheaper and more available than other supplies, these countries will buy as much Russian crude oil as they can, given that G7 maritime transportation services are unavailable to them. They will “wash” the crude oil into products for G7 consumption. Russian oil will remain on the market, some Saudi and Iraqi oil will get rerouted to customers in Europe, but consumers everywhere will pay higher prices for a longer time because of the “Russian holdout” effect on the market. Because prices are higher, OPEC might be inclined to increase production so more Saudi and Iraqi oil is available for European consumers.
Until the G7 finalize their price cap mechanism, the market will continue to be volatile because customers don’t know what to expect. Once the policies go into effect, traders should be prepared for both of the above scenarios and their impact on the oil market.