KSE: Bold measures are needed as Russia’s oil is slipping beyond G7 reach

Following Russia’s full-scale invasion of Ukraine in 2022, the EU, US, UK and other allies, imposed sanctions on Russian oil exports, including, the G7/EU price cap, which took effect in December of last year. This measure hinges on Russia’s need for shipping and insurance services from G7/EU countries and mandates that such services can only be provided if the oil is sold under $60/barrel. Almost a year later, Russia relies on a “shadow fleet” of vessels not owned and/or insured by G7/EU companies for more than 70% of its seaborne crude oil exports, and even where it does use G7/EU services it does in violation of the price cap. Thus it is no surprise that Russia’s export earnings as well as budget revenues from oil are rising again.

Bold action is urgently needed to make the existing price cap system work, including investigating transactions, strengthening access to credible pricing information, and maintaining the price cap’s leverage by preventing circumvention via the shadow fleet. The Working Paper of the International Working Group on Russian Sanctions details all critical measures necessary to enforce the energy sanctions. In the light of the recent findings, we would highlight the necessity of the following measures:

(1) G7/EU authorities should ensure that Price cap coalition service providers have sufficient proof of oil sales prices and can effectively implement the price cap.

(2) EU coastal states leverage geographical “choke points” to limit Russia’s use of a “shadow fleet” of tankers not subject to the price cap.

(3) Price cap coalition countries step up penalties on entities that violate the price cap or facilitate such violations.

Recent data suggests that price cap violations became widespread, …

Information on prices for Russian crude oil, including from the IEA as well as Russia’s Ministry of Finance, has raised concerns about the level of price cap compliance in recent months as global oil prices rose and discounts on Russian exports shrunk considerably. For instance, Russia reported an average Urals price (i.e., exports from Baltic and Black Sea ports) of $81.52/barrel in October, which means that, under the assumption of 100% compliance with the price cap for the 39% of volumes shipped with G7/EU participation, the remainder would have been sold at above $95/barrel – very unlikely given that this would represent a premium to Brent.

KSE Institute’s analysis shows that, in fact, more than 99% of seaborne crude oil exports took place at a price above the $60/barrel threshold in October 2023 – a situation that appears to be consistent across different regions/ports (Figure 1).

On average, Urals prices (i.e., Baltic and Black Sea exports) at $77.0/barrel are somewhat lower compared to ESPO prices (i.e., Pacific Ocean exports) at $83.0/barrel, and those for crude types shipped from Arctic Ocean ports ($85.0/barrel). Altogether, we estimate that total seaborne crude oil exports reached an average FCA/FOB price of $79.4/barrel last month.

1123 Russia oil price distribution by region October 2023 OOTT KSE

​We believe that a problem previously identified for a segment of crude oil exports (i.e., shipments from the port of Kozmino) – “attestations fraud” – has spilled over into the broader market for Russian oil. Close to 30% of all seaborne crude oil was shipped with P&I (i.e., protection and indemnity) insurance from G7/EU countries or relying on other G7/EU services (e.g., vessel ownership and/or management). Under the assumption that the data accurately reflects sales prices as well as physical shipments, this points to widespread violations of the price cap regime in the form of “attestations fraud.” This means that oil traders/brokers are likely providing falsified pricing information to G7/EU service providers on the attestations that are required under the price cap regime. Many of the entities attesting to compliance are either direct subsidiaries of Russian oil companies or suspected to be linked to them, which represents a key challenge for effective enforcement.

… and that the price cap’s leverage is shrinking considerably.

Russia is increasingly using a “shadow fleet” of vessels that are neither owned nor insured by G7/EU and, thus, do not fall under the price cap. As of October, KSE Institute estimates that 28.5% of total seaborne exports of Russian crude oil took place with G7/EU participation in October (Figure 2), a noticeable decline compared to H1 2023 (51%) or H2 2022 (58%). The share of G7/EU services differs considerably across export regions (Appendix Table): It was highest for Black Sea (41%) and Baltic Sea (39%) shipments, followed by Arctic Ocean (23%) and Pacific Ocean exports (12%). Differences can be partially explained by oil price dynamics in 2023: The price for Urals stood significantly below $60/barrel for most of the year before rising above in H2, meaning that no strong incentives existed to move away from G7/EU services for these exports. At the same time, ESPO consistently traded above the threshold, making the investment worthwhile.

Interestingly, we do not observe the same dynamics for oil product exports. This could be a result of different conditions in the market for used products tankers and/or stem from product price caps that are relatively close to market prices for premium and discounted products respectively, which creates smaller incentives for price cap circumvention. After all, the acquisition of the “shadow fleet” is a costly endeavour which can eat up a significant portion of oil export earnings as the US Treasury Department has rightfully pointed out.

1123 Russia oil export G7/EU participation, crude oil exports by region October 2023 OOTT KSE

Russia’s increasing reliance on a shadow fleet creates significant environmental risks to coastal states. First, this fleet largely consists of relatively old tankers (78% of vessels used to transport Russian oil in September were older than 15 years) that are not insured by reputable maritime insurance providers.

In the case of an oil spill, for instance in the Baltic Sea or Mediterranean, there are serious doubts about the involved companies’ ability to cover clean-up costs, which can easily reach above $1bn, according to the experts' estimates. Such an incident almost took place in May 2023, when an 18-year old shadow tanker, fully laden with 340,000 barrels of crude oil lost engine power in the Baltic Sea and nearly ran aground one mile (1.6 km) off the coast of Denmark.

The 2002 Aframax Prestige disaster off the coasts of France and Spain serves as a direct parallel to potential mishaps involving vessels from the Russian ‘shadow fleet. At the time of the catastrophe, the ship was 26 years old, and investigations failed to ascertain the ultimate beneficiaries of either the vessel or the transported oil. Moreover, the vessel had evaded critical inspections at the departure port, namely the Russian city of Saint Petersburg. The aftermath of the oil spill required several years of remediation efforts and incurred a staggering cost of over €2.5bn.

Bold and rapid action is needed to preserve the effectiveness of oil sanctions.

The October data suggest that problems with price cap implementation and enforcement are much bigger than previously expected. Not only does the price distribution point to very low compliance levels and, thus, a spreading of the “attestations fraud” issue to the broader market for Russian crude oil. But the sharp decline in G7/EU involvement means that the price cap’s leverage is increasingly under threat. To ensure that sanctions continue to constrain Russia’s ability to wage its war of aggression on Ukraine – and that the coalition’s efforts to do so preserve their credibility – additional steps urgently need to be taken.

Fundamentally, to maintain pressure on Russia, the coalition countries face the choice of either making the existing price cap system work – by preserving its leverage and stepping up enforcement – or considering much broader sanctions. Below we outline three critical measures that can tackle Russian efforts to evade sanctions.

(1) G7/EU authorities should ensure that price cap coalition service providers have sufficient proof of oil sales prices and can effectively implement the price cap, including by:

a) leveraging the involvement of G7/EU banks and other financial institutions in the Russian oil trade and their knowledge of important transaction details;

b) requiring attestations to be provided by reputable entities defined via transparent criteria and subject to sanctions in the case of violations; and/or

c) stepping-up of documentary evidence requirements for G7/EU service providers under the current system.

Financial institutions are already part of the regulations (as “tier 2 actors”) but not subject to expanded reporting requirements.

(2) EU coastal states should leverage geographical “choke points” to limit Russia’s use of a “shadow fleet” of tankers not subject to the price cap by requiring proper spill insurance for vessels’ passage through their territorial waters, including in the Baltic Sea and Mediterranean. Importantly, this will also help address important environmental risks that have emerged due to the increasing use of old and under-insured tankers. For this purpose, establish a system to allow for timely and efficient verification of insurance information and/or make use of the already existing (public) insurance database by the P&I clubs.

(3) Price cap coalition countries should step up penalties on entities that violate the price cap or facilitate such violations. For G7/EU companies, this should include tougher monetary penalties and expanded lockout periods. For third-country actors, price cap coalition countries should impose “direct” sanctions (e.g., SDN listing in the United States or use of the European Union’s anti-circumvention tool established in the 11th package) and consider the application of extraterritorial (“secondary”) sanctions by the US, leveraging the continued critical importance of its financial system for internationally operating businesses.

1123 Russia oil export G7/EU participation crude oil exports by region table  OOTT KSE

The Kyiv School of Economics (KSE) is a bne IntelliNews media partner and a leading source of economic analysis and information on Ukraine. This content originally appeared on the KSE website here.