Russian oil exports collapsed in the first full week of the Oil Price Cap regime, with Bloomberg reporting a decline in Russian loadings by 1.86 million barrels a day (mbpd), or 54%, to 1.6 mbpd.
This was not supposed to happen. Ursula von der Leyen, President of the European Commission, assured us that the Oil Price Cap would "stabilize global energy markets." Similarly, US Treasury Secretary Janet Yellen, the chief advocate of the price cap, noted that "the objective is to protect the world from the consequences of a global spike in oil prices," and indeed, put "downward pressure on global energy prices" by "maintaining a reliable supply of oil onto global markets", according to the US Treasury's website.
These hopes were built on fragile and arguably improbable assumptions. Maintaining a reliable supply depended upon 1) Russian compliance with the Price Cap and 2) western shipping, brokerage and insurance companies willingness to operate under Cap requirements; or alternatively, 3) Russia's ability to maintain exports levels in full circumvention of the Cap regime.
To the first point, Russia does indeed appear to be complying with the Cap. The Kremlin has announced that Russia will not sell oil to countries in the Cap coalition, that is, countries which have, almost without exception, already barred Russian oil imports. Putin is thus akin to the teenager who cries, "Yeah, I didn't want to go to your stupid party anyway!" It radiates weakness and desperation. Russia remains willing to place cargoes on vessels operating under Cap conditions. The simple read is that Russia has caved.
The second condition is more problematic. Western shipping companies appear to be shunning Russian cargoes. Readers will recall that I warned specifically of this, concluding that "our analysis does not preclude a complete collapse of Russia's western crude exports." One week of data is far from definitive, but still, collapse is exactly what Russian exports have done.
This possibility seems to have eluded both the Treasury and the EU Commission, suggesting a policy process that was both insular and superficial.
Treasury could claim that an oil export collapse could not have been anticipated. This argument would be more compelling had the EIA not been forecasting just such a collapse since July. The EIA, formally known as the Energy Information Administration, is the energy markets analysis and forecasting arm of the US Department of Energy. This is the home of oil markets expertise in the US government and just a 20 minute walk from the US Treasury building. The due diligence process should have started with a call from Treasury to the EIA and its experts. EIA analysts are not only competent, but in my experience, accessible and really nice people. Treasury would quickly have learned that the EIA anticipated the Price Cap would lead to a 2 mbpd drop in Russian production, as compared to the 1.9 mbpd fall booked last week.
The EIA staff would have explained their thinking, which should have prompted Treasury to conduct further due diligence, notably discussions with shippers, insurers, brokers and other stakeholders, including oil companies like Shell. This does not appear to have happened. Oil prices, for example, are not set in dollar terms the way Treasury supposes, leading to confusion about whether brokers were complying with Cap requirements or not. Similarly, chaos broke out at the Bosporus Strait when Turkish officials refused passage to tankers without specific insurance guarantees for that particular crossing, something insurers do not ordinarily provide. (Imagine, for example, GEICO being asked to provide specific insurance proving that you are covered to drive across the George Washington Bridge.) Further, Shell stated that it would not hire tankers previously contracted to carry Russian cargoes for fear Russian crude dregs would remain in the tanks, thereby exposing Shell to the risk of violating Cap terms. This alone has deterred shippers, not to mention other considerations. Had Treasury conducted any of this due diligence -- less than a week's work for an analyst -- it would have known that the risk of western service providers balking at the Russian trade was quite possible and likely probable.
The situation might yet have been saved by Russian craftiness in assembling a 'shadow fleet' of tankers and by Russia providing its own in-house insurance, which would have allowed Moscow to evade the Price Cap. Alas, Russia has developed a reputation for titanic incompetence in recent months, not only in military affairs, but also in oil export management, it seems. Shipping consultancy Braemar has estimated that Russia needed about 240 tankers to conduct its crude export trade and would fall short 100-110 tankers in the event western service providers were unwilling to carry Russian cargoes. The early data looks even grimmer, with trade down more than 50%. Russian incompetence never fails to astonish.
Source: Braemar
Napoleon Bonaparte once famously stated, “I'd rather have lucky generals than good ones." Treasury and the EU Commission have been lucky to date. A loss of 2 mbpd of supply is large by global standards. As a rule of thumb, every reduction of the oil supply by 1 mbpd (1% of global demand) should lead to an increase in the oil price by roughly $10 / barrel. Therefore, the current collapse of Russian oil exports, should it be sustained, might be expected to increase oil prices by $20 / barrel, all other things equal. This would prove a political disaster for the Cap's advocates and the western allies more broadly.
Treasury's good fortune, if we can call it that, is that all other things are not equal. Notably, the world appears to be sliding into recession, with the result that oil prices have been falling on their own. A global downturn may yet save the optics of the Price Cap. True, this is akin to a cardiologist being relieved that his heart patient died of cancer, but still, sometimes one has to take their wins where they can find them.
It is still early days for the Oil Price Cap regime. Perhaps western shippers and insurance companies will become more comfortable with the Russian oil trade under current rules. Perhaps the Russians will collect themselves and quickly assemble an alternative fleet to move their oil. Or possibly a global recession may render the entire issue moot.
Be that as it may, the assumptions underpinning the Oil Price Cap have proven faulty to date. Should the global economy not implode, the political risks for the Cap advocates will rise sharply.