Russian oil & Opec effect: Outcome of buying Urals oil above

The risks to Indo-Russian oil trade escalate when Urals crude starts trading above the cap imposed by the European Union

Over the past year, cheap Russian crude has proved to be a Sanjeevini, a wonder herb, for Indian refiners, which, on one hand, were hemmed in by directions to keep pump prices flat, and, on the other, faced surging crude levels. Russia is now the biggest supplier of crude to India, accounting for around 37 per cent of total crude shipments in March, and sold at sizable discounts compared to the rates India pays its traditional West Asian suppliers.

But in a surprise move last week, the Organisation of Petroleum Exporting Countries (Opec) put pressure on this cheap source of crude. Led by Saudi Arabia, Opec announced that it would slash output, threatening to send crude prices higher to $100 a barrel levels this year, analysts say. High crude prices will create further obstacles for Indian refiners to procure discounted Urals crude after the December round of G-7 sanctions set a price cap for sales of Russian oil at $60 a barrel.

The risks to Indo-Russian oil trade escalate when Russian crude starts trading above the cap. 

In addition, the level of the cap is itself at risk after the G-7 deferred a change in the level of the cap at last month’s meeting, despite pressure from some EU nations to reduce the level to $40 a barrel. Some EU members such as Poland are demanding a much lower level to slash Russian revenues and force a quick end to the war. Moscow's war is currently sustained largely by funds that it accrues from selling oil to China and India.

Last month, the price for Urals export blend averaged around $48 a barrel, trading at a discount of $31 a barrel to European benchmark Brent crude, according to data from the Russian energy ministry. This month, Dated Brent was assessed at $85 a barrel in March, and Urals at a $32 a barrel discount to Brent, according S&P Platts price assessments. That prices Urals at $53 a barrel, according to calculations based on Platts assessments.

Urals is still trading below the price cap, giving India access to western ships and insurers, and enabling payments in dollars, according to the Centre for Research on Energy and Clean Air (CREA), a Finland-based think tank. The price cap is applied on the FOB value of crude, excluding shipping costs and other margins, said Lauri Myllyvirta, an analyst with CREA. It applies to shipments aboard tankers that are owned or insured in the EU or G7. In the most recent month of CREA’s data (21 Jan – 21 Feb 2023), 65 per cent of crude oil shipments were transported by ships owned and/or insured by EU and G7 countries.

Urals, a crude similar to some West Asian grades that suit Indian state-run refineries, constitutes 65-75 per cent of the Russian oil imported to India. It is typically priced off Brent. The share of Urals was a sizeable 37 million barrels in March, or 64 per cent of the 58 million barrels of Russian oil that came to India last month. In fact, Urals alone constituted 24 per cent of the total crude India imported in March.

European crude benchmark Brent futures surged to $86 a barrel soon after Saudi Arabia and other OPEC+ oil producers announced last week oil output cuts of around 1.16 million barrels a day, adding to the 2 million barrels a day of cuts already in place until December 2023. Prices of Brent have oscillated over $120 a barrel last June to around $70 a barrel in March 2023.

US investment bank Goldman Sachs raised price forecasts for Brent for December 2023 to $95 a barrel, and that for December 2024 to $100 a barrel. Mukesh Surana, CEO of Ratnagiri Refinery & Petrochemicals and former chairman HPCL, said he does not expect oil to surge beyond $90 a barrel levels. As the Goldman Sachs report explained, that in a market short of crude, cutting production can lead to further escalation in prices. Any further output cuts in a tightening crude market coupled with signs of rising Chinese oil demand creates upward risks for crude prices.

Urals starts trading above the $60 G-7 cap if Brent futures rise above $90 a barrel, and Urals is offered at $30 a barrel discount. Moscow is trying to restrain discounts offered on Urals to around $26 a barrel. Current discounts for Urals range from $27 a barrel to $32 a barrel depending on the demand for the crude. Going by overall market assessments, Urals may start trading above the price cap in the second half of this year.

The consequences of buying Russian oil above the cap are severe. Indian firms are not directly sanctioned but if an Indian refiner buys oil at a price above the cap, sanctions apply on the tanker that carries the oil, CREA’s Myllyvirta said. That means Indian refiners, which, unlike China, lack adequate transport and storage infrastructure, have to depend on a shadow fleet of old vessels of unclear ownership, which furtively ply the seas, to receive crude. Sanctions also apply on insurers and banks that facilitate oil trade so most Indian banks will stop facilitating payments. Dollar payments will not be possible once the cap is exceeded.  

Currently Indian refiners are protected from sanctions for a large part of their Russian oil trade because 70 per cent of their purchases fall below the price cap. Another 10 per cent of state-ONGC sourced Sokol grade crude from its interests in Russian fields is settled in rupees. For the rest, refiners have used payments in dirhams and roubles, and have availed of fleets of shipping upstarts such as Mumbai-based Gatik Ship Management to move cargoes to India, industry officials said.

In the rare event that crude climbs above $90 a barrel, Vandana Hari, a Singapore-based oil expert and founder of Vanda Insights suggests that traders can safely bet that the EU-G7 will revise the cap upwards.

“If Indian refiners start backing away from Urals because it is above the price cap, that adds to the upward pressure on global oil prices – the  last thing the western allies want,’’ she explained. “So refiners may back off a bit but be back in the game once the cap is revised.”