December 2022 has been the most happening in terms of news flow for oil market, with the focus now shifting back towards Russia. It was all about China two weeks ago, as the Western media went into overdrive on how China faces a massive slowdown in demand due to mass spread of Covid. The protests in China were made significant events – even from big research houses, terming the protests as critical to oil prices for the next six months.
Sure enough, that was not going to last – as latest from China suggests the restrictions have been considerably eased, and China is now expected to be back on track faster than earlier expected. Opec and the alliance including Russia, stood firm on the 2 million barrels per day production cut deep into 2023 – while not ruling out an interim meeting in the wake of EU’s embargo and price cap on Russian crude.
The price cap was long coming, hence the muted response from the market. There is near consensus that Russia’s response and not the price cap itself would determine the efficacy of the step. The Kremlin’s initial response is very much on the expected line, out rightly rejecting any idea of entertaining the sanctions. A detailed response with action plan is expected in the next few days, and that is what keeping investors on the edge.
Here is what the price cap essentially means. Almost 80 percent of Europe will stop buying any crude from Russia via sea route. Any other country cannot buy at more than $60/bbl. This, of course, is easier said than done, as the premise is that insurance and shipping companies stationed mostly in the West will have to abide by the rules.
There is another side to the story, that tells how a big fleet outside of the West’s purview has grown in the past year or so. The big buyers outside Europe and China and India – both of whom have refrained from openly condemning Russia in the war. It is likely that Russia will not entertain any price caps and will instead respond with a larger production cut on its own – with or without Opec’s approval.
The price cap at $60/bbl itself is not that far off from where Russian Ural crudes were seen trading a month ago. The West cannot afford Russian oil off the market completely, and that is where it would want China, India, and other regional buyers to keep buying. There is an opportunity for bigger buyers to bargain for steeper discounts with Russia. Will the discounts be any better than the ones already in place is anyone’s guess, but Russia would surely not want to lose this much ground.
Russia also has the option of completely shutting the supply to Europe as much of Eastern Europe’s landlocked countries still depend on pipeline crude oil supply from Russia. That is what should keep the premiums high. Mind you, another embargo and price cap are in line in February 2023 – that extends to Russian refined oil products’ export to EU and the rest of the world. That could potentially have a bigger impact as 40 percent of Europe continues to rely on diesel from Russia.
Meanwhile, this may open a small window of opportunity for Pakistan. Government officials have of late been congratulating on a “deal” with Russia. That may not be the case, as the West essentially wants the region to consume Russian oil, albeit, with a cap. Whether or not Islamabad has the means to irk Washington remains to be seen. Finding a vessel that is not answerable to Europe may well be a good start.
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