Oil prices fall as EU hints at Russian cap of $70/bbl

On Wednesday, 23rd November 2022, the price of Crude fell sharply by nearly 5%. Brent Crude fell sharply from $88/bbl to around $84/bbl. For the last few days, oil has been gradually drifting lower due to concerns over demand. The concern has been that the COVD restrictions on China could sharply crimp oil demand. In addition, the likely recession in the UK, EU and the US were also expected to hit demand. The latest salvo has come in the form of the EU hinting at a price cap of between $65 and $70 per barrel. The cap prices is the price above which Russian oil will not be purchased by the EU.

One of the reasons the 04th of December is a crucial date for oil prices is that; it is the day when the price caps will be applicable for the EU buyers from Russia. Even today, EU remains the largest consumer of Russian oil. For the last few months, Russia and EU have been fighting a battle of attrition over oil price caps with Russia even threatening to cut oil supplies to the EU. Obviously, that is not feasible for either of them. The price cap of $65-70 per barrel may be a level that would suit the EU buyers and would also suit Russia since they would still make a decent margin on the sale of oil.

Read: Why have oil prices fallen so sharply in recent weeks?

For Russia, it would be a solution for now. Anyways, today Russia is selling Russian oil to countries like India, Turkey and China at a discount since Russian oil is under US sanctions. The difference is that from 04-December, even EU will join the sanctions club. The middle path worked out for EU was that they would be able to buy Russian oil based on price caps so that Russia cannot make big profits on its oil sales. For Russia, it would be status quo and would reduce its incentive to sell oil to countries like China and India at steep discounts. It would also please the US since Russia’s oil prices realizations would be constricted.

For Russia, it could eventually end up being a win-win situation. They will be able to supply oil and gas to Europe without any disruptions. Even assuming a price cap of $65-$70, it leaves Russian oil drillers with enough margin over and above the cost of production. This price is much higher than what other countries have been pushing for, but EU cannot afford to antagonize Russia beyond a point. If the price cap is kept too low, Russia may prefer to supply oil to China and India instead of EU. Russia is already selling crude at discount and the current price cap of $65-70/bbl would probably serve all the parties quite well.

The final word on this subject is yet to be said. However, the indications are that the Group of Seven (G7) nations may eventually settle for a figure between $65 and $70 per barrel. Of course, some European nations have complained that this price was too high compared to the pre-war prices, but EU would have to offer at least these levels to keep Russia interested in supply oil to the EU region. For now, we have to await the meeting of the EU ambassadors. The actual price cap is expected to be announced later in the day. However, the cap will require the backing of all member states to be approved.

Russian oil anyways trades at around $65/bbl, so it may not be much of an issue for Russia. If the G-7 price cap for Russian oil is set at the same level, it wouldn’t do much harm to Russia. US knows that the world cannot do without Russian oil and so it wants to keep the oil flowing. However, the US also wants to reduce the profits generated by oil. The American argument is that by reducing revenue for Vladimir Putin’s war machine, they can reduce the risk of the war escalating and may curb war crimes on Ukraine. However, price caps may eventually end up legitimizing Russian sales of oil in the country.

Incidentally, India may have a problem going ahead as the price cap would ban companies from providing shipping and insurance service to Russian oil anywhere in the world unless the oil is sold below the threshold. To sweeten the impact on Russia, the EU has proposed a number of grace periods to its latest version of the cap legislation and has significantly narrowed the penalties on shipping provisions. In the final analysis, EU will still get its oil (perhaps a lot cheaper). In addition, Russia may also not have much to worry about. It could be win-win all the way. For India, they need to just wait and watch. Perhaps, the caps would pull down global prices. That is the hope for now.