My Asharq: EU & G7 debate Russian oil-products’ caps. Two-caps needed by 5 February. High impact likely later this year.

Video: My answers in English; Host’s questions in Arabic.

Tom O’Donnell, on Asharq, 28 Jan 23. Written explanations of my answers are below.

Note: Questions in Arabic; my responses in English.

I explained how the crude oil cap is thus far successful. This bodes well for the products’ cap effectiveness.

The market situation is relatively favorable for application of EU sanctions on all Russian refined products on 5 February. Demand is still soft as Europe, even if it is not going into recession, and it is coming out of an unusually war winter that also softened demand. Also, China is not yet roaring back from its COVID reopening attempts.

So, there is no anticipation prices will spike when Europe begins fully refusing Russian diesel and other refined products on 5 February.

The price cap proposals being debated intensively since Friday, 27 January, by EU officials are $100/bbl on products that normally gain value on refining, such as diesel, and $45/bbl on products that lose value, such as fuel oil. Both proposals are well above the present market prices.

However, if, later in the year, as perhaps Europe and China’s economic activities rebound, and prices of oil and oil-products increase – say, to $100/bbl for crude as Goldman predicted this past week – then both the crude and the two refined products’ caps will begin to collide with market prices that Russia would otherwise expect to fetch on the market.

The EU and G7 will then have to decide whether to soften the caps to insure the market is sufficiently supplied, or perhaps decide it is possible to squeeze Russian profits significantly more without causing any worrisome shortages. In any case, as I told Asharq, this means it is the Western alliance that is in the driver’s seat, not Mr. Putin. This is a good place for the alliance to be if they wield their price-cap-setting discretion wisely.

I also gave my view that Putin will likely have new problems finding diesel markets.

EU-and-G7-sanctioned Russian crude oil has largely been diverted to Turkey, India and China, and been sold well under the $60/barrel initial price cap. In fact, Bloomberg and others recently reported Russian Urals blend selling for about $47/barrel, well below the $60 cap.

In other words Turkey, India and China are taking full advantage of Russia’s problems in finding alternative markets when they take its sanctioned and capped oil, significantly cutting Russian income. Yet, as especially the Biden administration hoped, enough Russian crude gets sold so that the global market continues to be satisfactorily supplied, and with no price spikes.

However, it may be harder for Russia to sell its refined diesel fuel in especially India and China than its crude oil, even at significant discounts below the cap to be imposed by the EU and G7.

Both these Asian countries have very large domestic refining sectors and their refineries have been making unusually high profits on refining cheap Russian crude. If they agree to take a significant amount of Russian refined diesel, it could mean a need to cut their own production. Their thirst for cheap sanctioned-and-price-capped Russian diesel might not be as great as it has been for cheap sanctioned-and-capped crude oil. Unless, that is, Russia agrees to sell it really cheap – well below the caps being discussed.

These sanctions and price caps on Russian oil and products won’t stop it waging the war in Ukraine; but they are already severely crimping the Russian budget, which was reported to have suffered a deficit in 2022 unlike any seen since the crises of the early 1990’s.

This means great hardships within Russia in the coming year, in parallel to the effects of major new troop mobilization(s). Meanwhile, Russia will be facing a major escalation in capabilities of the Ukrainians on the battlefield, as the USA and NATO are now resolved to supply heavy tanks, fighter aircraft and a spectrum of other heavy and new weapons required for Kyiv to begin waging “combined arms” offensive operations. Such capacity has not been seen in Europe since WW2. (See my previous blog – my opinion article at Kyiv Post on the meaning of the German delay to supply Leopard tanks.

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