- Thursday’s $4 swing in crude prices may be the new normal in oil
- Worries of Europe in recession, overtightening by central banks add to jitters
- Price cap may be enforceable so long as crude prices don’t shoot way beyond $60
Two dollars either way — that could be the new normal for crude price moves in a day, at least in the short term, as the market tries to figure out the strategy for trading with the price cap imposed on Russian oil.
Thursday’s trading took oil to near one-year lows, forcing it to settle down for a fifth straight day but not before a choppy session where prices swung more than $4 a barrel partly on the notion that the price cap on Russian oil was disrupting the passage of crude through Turkey.
Reports of a tanker pile-up in Turkish waters, with authorities there apparently checking one vessel after another for oil of Russian origin, sent crude prices rallying initially on Thursday.
The U.S. Treasury then issued a statement saying there was no need for Turkish authorities to do checks beyond the declaration made by shippers. “Our understanding is that virtually all of the delayed tankers are not carrying oil from Russia and are not affected by the cap,” the statement said. The Treasury also said the government in Ankara was working quickly to resolve the issue and that Turkey shared U.S. interests in maintaining a well-supplied oil market.
Crude prices fell then as it became clear that there was no supply of snafus due to the price cap.
The market’s swings on the day were also exacerbated by the closure of the gigantic 622,000 barrel-per-day Keystone pipeline after an oil spill. The pipeline carries heavy Canadian crude from Alberta to the U.S. Midwest and Gulf Coast. Its shutdown, in principle, put a hefty amount of crude back into the market at the same time that global economic slowdowns raised fuel demand fears.
Said John Kilduff, a partner at New York energy hedge fund Again Capital:
“Choppy is the word to describe how oil markets are likely to be in the coming days and weeks. There are worries about Europe in recession and of central banks over tightening to get a handle on inflation. Then, you have the occasional headline of a pipeline in trouble, like Keystone. Anything could yank the matter two bucks either way on any day. The market is nervous as a tick.”
That’s the way it’s been since the week started with the $60 price cap imposed by Western governments as the selling price for each barrel of Russian crude.
The move, formalized on Dec. 5, has had traders scratching their heads to figure out a landing price for Urals — the reference for Russian oil, which is one of the world’s more important benchmarks for crude other than the Dubai Light and the ubiquitous U.S. West Texas Intermediate and U.K. Brent.
In theory, the price cap on Russian oil shouldn’t matter much as it does now, as Urals on their own were quoted at around $60 per barrel just before the limit announced by the West.
In practice, though, the cap matters a hell lot — at least to the Russians.
Remarks out of Moscow have shown how pissed Vladimir Putin is at the United States and its pesky European and other allies in the G7 for trying to stop his advance in Ukraine by using Russia’s own oil as a weapon against him.
In Putin’s mind, of course, no one has the right to weaponize energy other than him. But whether the West has a right to reduce what Russia earns from its oil to finance its war against Ukraine is not for debate here.
What really needs to be examined is whether the cap will effectively limit the price of Urals at around $60 and — by extension — set the same ceiling for Brent and WTI. Before we figure that out, let’s make a quick run-through on what’s for and against the cap. In fact, the Atlantic Council did an excellent probe just a week ago on this, and we can use some of that.
In its purest form, the price cap prevents firms in participating countries from providing shipping, insurance, and other services, including trading and brokering to shipments of Russian crude oil that are sold above a certain per-barrel price, in this case, $60. In practice, the onus will be on these providers to ask their clients for proof that they have bought at a cap-compliant price.
Guidance from the U.S. Treasury’s Office of Foreign Assets Control, or OFAC, shows some regard for the fact that shipping and insurance firms may not have complete information about how much their clients pay for each shipment. It calls upon them to request attestations that the cap has been respected via simple and already standard contract provisions. Firms that are requesting these (and have no reason to believe they are false) aren’t likely to face enforcement actions. This approach does give OFAC and its counterparts the authority to pursue whoever may have lied in an attestation, for instance, by making a separate transaction above the cap.
At $60, it is assumed that Russia still makes a profit on its oil. The much-discussed Chinese and Indian buyers that the measure is designed to affect would simply use the cap in their negotiating tactics. When the stakes are low, it isn’t worth circumventing Western (especially European) firms’ hold on the shipping and insurance markets. If it were, Iran and Venezuela would have had an easier time exporting their oil in recent years.
Here’s where the opportunities for cheating arise, especially if the price difference between Russian-made Urals crude and Brent crude increases.
History has shown that it is possible for the shipping industry to misrepresent or obscure the origin of its cargo. There are also opportunities for cheating, especially if the price difference between Urals and Brent increases.
OFAC has threatened cheaters with consequences, but taking action against them may well chill participation by other participants in the scheme and further undermine the dual policy goals of keeping Russian products on the market but cutting revenues for Moscow.
The Biden administration and governments in Washington, Brussels, and other capitals will be judged on whether Russia’s export revenue will decline without pump prices at home increasing too much. As long as these two conditions are fulfilled, it doesn’t matter whether the cap is the decisive factor.
For now, the cap is not significantly below the price of Russian crude, so it’s not clear how Moscow will respond. Putin himself has just approved an increase in production. Assuming most of Russia’s supply remains on the market, the effect on prices will be small.
Should global prices increase and the capping force Russia to accept an even higher discount, Moscow might respond by selling less. The question is whether this is a little less or whether most of Russia’s supply becomes temporarily unavailable. Prices are well down from their March peaks of just over $130 for WTI and just below $140 for Brent. While this is mainly due to the risk of a recession in Europe, it is also true that engagement from the governments behind the price cap has reassured market participants. Initially, it was feared that additional layers of complexity would add tension to the market and result in higher prices.
Whatever the case, the cap might become harder to enforce if crude prices take off dramatically and continue to stay high. Between a $60 cap and $80 Brent, it may not be worth taking the risk of being fined, and Russian revenues will be down compared to 2022 anyway. But temptation will grow as market prices for crude grow.
As the cap nears its first week, the G7 seems to have executed its mission without the spike in crude prices that many had feared.
On the contrary, the market plunge that brought WTI to a near one-year low of under $72 has put the Biden administration within striking range of refilling the U.S. Strategic Petroleum Reserve at $70 a barrel. Yet, there’s also the possibility that the bid to refill some 200 million barrels of that reserve could boost crude prices.
This week’s volatility in oil might be with us for a while.
Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold positions in the commodities and securities he writes about.