Oil Volatile as Traders Await Price Cap Details, Russian Sanctions

The long-awaited oil sanctions and price cap on Russian oil are slated to go into effect in just a few weeks, on Dec. 5. The sanctions apply to G7 countries (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States) and companies, and they will prohibit (with some exceptions) the importation of Russian crude oil and petroleum products. The sanctions also ban the redirected to markets in Europe, but not as much as the 1 million bpd that Russia was supplying. There could be a temporary price spike while this all gets evened out, but in the end, prices will be lower and Putin won’t have the revenue he needs to wage war in Ukraine (ideally).

Scenario 2: Russia Holds Out/h2

The second scenario is how the price cap policy could play out if Putin doesn’t react as the G7 expect. It is based on the premise that Putin, even if he is desperate to sell oil, won’t act out of desperation. He will refuse to sell Russian oil at or below the price cap and will hold out on maritime supplies to India, China, Turkey, and others until they agree to pay his price (which is already discounted from the market price). He will do this even at the risk of damage to Russian oil fields or storing oil in less-than-ideal conditions.

A Russian holdout would cause the market price of oil to rise—but the increase might not be temporary. Russia’s non-G7 customers would agree to pay Putin’s price because they are priced out of other oil supplies. The longer the impasse continues, the more the price of discounted Russian oil will rise. However, because Russian oil is still cheaper and more available than other supplies, these countries will buy as much Russian crude oil as they can, given that G7 maritime transportation services are unavailable to them. They will “wash” the crude oil into products for G7 consumption. Russian oil will remain on the market, some Saudi and Iraqi oil will get rerouted to customers in Europe, but consumers everywhere will pay higher prices for a longer time because of the “Russian holdout” effect on the market. Because prices are higher, OPEC might be inclined to increase production so more Saudi and Iraqi oil is available for European consumers.

Until the G7 finalize their price cap mechanism, the market will continue to be volatile because customers don’t know what to expect. Once the policies go into effect, traders should be prepared for both of the above scenarios and their impact on the oil market.

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Written By: Ellen R. Wald, Ph.D