Oil market is holding its breath ahead of December

Energodigest | 22 November 2022
The clock is ticking fast towards 5 December, the date when the EU restrictions on seaborne imports of Russian crude will take effect. When these sanctions were first adopted in April this year, it was assumed that Russia’s output of liquid hydrocarbons would take a nosedive, while other exporters would be able to ramp up production to cover for the shortfall. However, this hasn’t happened. Russia has quickly diverted its westbound exports to the East, while its crude production rose 3% YoY in the first nine months of 2022 to 10.7 million b/d (see Fig. 1). Yet the restrictions have not been lifted, but even expanded. The G7 is planning to cap the price of Russian crude oil[1] and block insurance and financing for ships carrying it to third countries at a price above the set threshold.
A barrel of Russia’s flagship Urals oil grade was trading at an unusually high discount to Brent this spring (see Fig. 2), though in the following months the price gap narrowed as the discount decreased from around $30 in April to an average of $20 in October, with Urals trading at $79.6 per barrel. When it comes to capping Russian crude, a historical Urals average of $63-$64 a barrel[2] was mentioned in media reports as a possible upper limit, while it was highlighted that the price cap to be announced shortly would not include shipping and trading costs.[3]
Unlike the discount, which is driven by the market and is offered to compensate buyers for the lack of insurance coverage for tankers carrying Russian crude, the proposed price cap is effectively a measure of state control. Capping prices is akin to creating a buyers’ cartel. But this move doesn’t make much sense as long as there is no vigorous competition between suppliers, while major oil-consuming nations such as China and India tend to support market pricing.[4]

Along with a ‘cut-off price,’ there is no clarity about other details of the new mechanism. Market players are concerned that the longer they are kept in the dark (though the EU is planning to announce the final terms on 23 November), the higher the risk that buyers will turn down shipments that are already out to sea. All of this is complicated by major environmental risks for neighboring countries in case of oil spills.

The prevailing uncertainty is rattling the market even further. But as potential threats become clearer, so will the ways to adapt to new conditions. Yet there is another unknown ahead of the oil market as China imposes new lockdowns, which could affect economic fundamentals and demand, thus dragging down global benchmarks as well.
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