EU countries agreed on a cap on the global price of Russian petroleum products, ahead of a full import ban on Russian oil products. Ambassadors agreed to cap the price of oil products that trade above the price of crude oil, including diesel, gasoline, and jet fuel, at $100 per barrel, Politico reported. Products that trade at a discount to crude will be capped at $45 per barrel. With a critical unintended consequence: to make us dependent on China.
A decision on the cap level was delayed after Poland and the Baltic states pushed for a downward review of the crude price cap and for lower price caps on petroleum products. A deal was reached on the proviso that both sets of price caps will now be subject to a review every two months, starting in March 2023.
The new EU ban on Russian diesel and other oil products represents the bloc’s latest economic retaliation against the Kremlin in response to the invasion of Ukraine. Before the war, Russia typically supplied more than half of the EU’s diesel imports and around 10 percent of its total diesel demand. The imminent EU import ban had led to fears of a supply or price shock, but soaring imports in recent weeks have eased worries for now.
The EU ban and the G7 price cap are intended to work in tandem. While the EU sanctions close off one of Russia’s most important markets for its fossil fuels, the price caps are intended to permit Russian exports to continue flowing on the global market, avoiding a major oil supply shortage or price shock.
Diesel is currently trading at around $120 to $130 per barrel, so the cap will likely not directly hit Russia’s income from exports of the fuel immediately. Moreover, the EU ban is expected to lead to a major shift in export flows, with buyers in the Middle East and Asia likely to buy up volumes that previously flowed to Europe. The agreed cap, at $60 a barrel, is higher than the current Urals price, above the five-year average of the quoted price, and higher than Rosneft’s average netback price.
According to Reuters, “the G7 price cap will allow non-EU countries to continue importing seaborne Russian crude oil, but it will prohibit the shipping, insurance, and re-insurance companies from handling cargoes of Russian crude around the globe unless it is sold for less than the price cap”. This means that China will be able to purchase more Russian oil at a large discount while the Russian state-owned oil giant will continue to make a very healthy 16% return on average capital employed (ROACE) and more than 8.8 billion roubles in revenues, which means an EBITDA (earnings before interest, taxes, depreciation, and amortization) that more than doubles its capex requirements.
In this way, the cap looks like a subsidy to China and a price that still makes Rosneft enormously profitable and able to pay billions to the Russian state in taxes. Thus creating an unnecessary and artificial bottom to old prices.
Apparently, G7 didn’t take into consideration one strong reason why oil prices have roundtripped in 2022: competition and demand reaction. By putting a $60-a-barrel cap, which is a bottom price, the G7 has almost made it impossible for prices to reach a true bottom if a demand crisis arrives. On the one hand, the G7 has taken 4.5 million barrels a day, the estimated Russian oil exports for 2023, out of the supply picture with a minimum and maximum price, but additionally has made OPEC keener on cutting supply and raising their exports’ average realized oil price higher.
In this scenario, China will secure a long-term supply at an attractive price from Russia and sell refined products globally at higher margins. Sinopec and Petrochina will find enough opportunities in the global market to secure better margins for their refined products while guaranteeing affordable supply in a challenging economic situation.
What killed the oil crisis of the seventies was the rise of investment in other productive areas. What has allowed oil prices to do an almost 180-degree year-to-date move is higher supply, non-OPEC competition, and demand response.
The energy sector already suffers from concerning levels of underinvestment. With this price cap, the incentive for producers to sell what they can and invest as little as possible is even higher, and this may imply much higher oil prices in the future. China and Russia also know that renewables and other alternatives are nowhere close to being widely available alternative and that, anyhow, this would require trillions of dollars of investment in the mining of copper, cobalt, and rare earth.
By adding a cap on Russian oil prices to the increasing barriers to developing domestic resources the G7 may be planting the seeds of a commodity super-cycle where dependence on OPEC and Russia increases, instead of decreasing. Thus taking developed countries from a modest dependence on Russia to a massive dependence on China and Russia.