The Western world has been gradually weaning off Russian petroleum and imposing price caps on Russian oil imports, following the breakout of the Russia-Ukraine War. However, the question remains whether these measures are actually having the desired effect.
This topic of “Russian Petroleum Embargo- Highlights, Reasons & Impacts” is important from the perspective of the UPSC IAS Examination, which falls under General Studies Portion.
What are the recent measures?
- Recently, the EU imposed a ban on Russian petroleum products. This is to be accompanied by a price cap on 2 levels:
- For commodities that sell for more than crude oil, such as diesel, a price cap of $100/ bbl (note: bbl is one oil barrel) is to be applied.
- For commodities that sell for less than crude oil price, like fuel oil and naphtha, a limit of $45/bbl has been agreed upon.
- In December 2022, a price cap of $60/bbl was imposed by the G7 on Russian crude oil. This is to be reviewed in March.
- The USA and the EU announced that any 3rd party that buys Russia crude oil for more than $60/bbl wouldn’t be able to access:
- Western insurance
- Western finance
- Western brokerage services
Why are these price caps being imposed?
- The West has been discussing the price cap idea since the oil prices reached triple digits and Russia was earning more through its petroleum exports than it had before the war.
- The Western governments found that the continued purchase of Russian oil was negating the impact of their other sanctions.
- The price cap has 2 main functions:
- Russian oil accounts for 10% of the global supplies. Completely cutting it off would drastically disrupt oil prices. A price cap, especially one that is above the average production cost ($ 25-40/bbl), could balance the West’s need to punish Russia economically while maintaining Russian oil supply in the international market.
- A price cap would force Russia to cut down supplies and compel international buyers to pay less-than-market prices for Russian oil. This would affect Russia’s export earnings.
What has been their impact?
- It is an established economic concept that administrative price controls aren’t effective and such controls tend to give rise to profitable arbitrage opportunities for traders.
- The price cap has many loopholes. For instance, the seller could state a price, in bill of lading at the loading port, that complies with the price cap but then increase it through freight and other charges. Another way is by deploying a shadow fleet of tankers to bypass the insurers.
- Russia has already reduced its production by 800kbd to 1 mbd, accounting for 25% of its exports. However, several traders are still carrying on business with Russia. For instance, some traders have registered their offices in countries (like UAE) that aren’t subject to the sanctions. They then exploit the opportunity to buy cheap and sell high.
- The drop in production of Russian oil has tightened the market. However, right now, the prices are being held up by several factors- relatively mild winter temperatures, US’ releasing more from its strategic petroleum reserves than expected and a laggard Chinese demand.
- The price cap has had an adverse impact on Europe, given their disproportionately high dependence on Russian petroleum products.
- Europe has turned to alternative suppliers like the US, Middle East and India to address their oil needs. However, many suppliers are now selling at a premium.
- Ironically, India is sourcing crude from Russia, processing it in their refineries (especially the one in Jamnagar) and then selling the finished products, like diesel, to Europe.
- Such round-about ways are extending trading distances which are in turn tightening the shipping markets. The tanker freight rates and the stock price of shipping firms have sky-rocketed.
- Interestingly, the US petroleum industry has benefited the most from Europe’s current energy crisis.
- In November 2022, the US administration allowed Chevron to pump oil in Venezuela on the condition that what crude oil they produce there would be sold only into the USA.
- This decision comes despite the US administration not recognizing Venezuela’s current Maduro-led government’s legitimacy.
- This is allowing the US firms to convert the cheaper crude oil into expensive products like diesel for export, at a premium, to Europe.
- Apart from this, the LNG from USA has significantly replaced its Russian counterpart in Europe.
What is the way ahead?
- Overall, the recent petroleum trade restriction on Russia has had several negative consequences for a large part of the world, while presenting commercial opportunities for opportunists. For instance, Europe is now becoming increasingly dependent on the USA for its energy needs.
- Russia is seeking customers outside its traditional marketplace, Europe. However, this means longer shipping routes, which translates into a significant strain on the global tanker capacity.
- For now, the oil prices have been holding up. However, the trend could easily reverse. These factors could hike the prices and put the oil importers in a precarious position.
- Saudi Arabia and UAE are unlikely to use their surplus producible capacity to address the supply gap in the global market.
- China is working on returning to a high economic growth trajectory.
- Countries like Saudi Arabia are now facing a precarious position with respect to the USA as the latter could be tempted to repeat the price cap tactics against the former in case of political disturbances. This discomfiture could become yet another factor contributing to the emergence of India as an increasingly important strategic market, in these countries’ eyes.
The recent moves to curb Russian petroleum exports is redesigning the contours of global energy geopolitics. It is vital that the stakeholders come to the table for diplomatic resolution, rather than resort to trade sanctions, especially at such a sensitive time when the global economy is recovering from the fallouts of the pandemic.
Practice Question for Mains:
Examine the impact of the price caps imposed by the West on Russian oil. What is the way ahead? (250 words)