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Oil and Gas Price Caps: The folly of energy sanctions

Oil and Gas Price Caps: The folly of energy sanctions

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IN THE unfolding war between Russia, on the one hand, and the US-led G7 group of countries through the agency of Nato, energy occupies the centrepiece of the economic version of its intensity, writes Bheki Gila.

First, there was the banning of the importation of crude oil through ocean-going tankers, which duly took effect on November 5, instantly. The exemption was only contemplated in respect of countries receiving pipe-borne crude oil through the Druzhba pipeline.

The proscription against purchasing Russian crude oil affected only European Union member countries and those volunteering to do so who are not members of the beleaguered Union of 27 constituent members. This included the United States, Canada, Japan, Australia, South Korea, New Zealand and the United Kingdom.

In quick time, there was a realisation that for a profound and far-reaching impact, the sanctions ought to extend beyond the EU sphere of political and diplomatic influence. The European talking heads first sought to coerce India and China with undisguised threats to stop purchasing Russian crude oil.

Seeing their disobliging demeanour, they hatched a different plot. In their frustration, tacitly accepting that a complete ban on purchasing Russian crude oil was not easily achievable, they prescribed to disincentivise the shipping and insurance companies from carrying Russian crude oil beyond certain sanction-determined price thresholds.

This would mean that crude oil coming from Russia would only be priced at a certain minimum, as determined by the G7 member countries. As a consequence, any value above such price threshold shall not be insurable and would expose the shipping and insurance companies to excessive legal risk.

Awhile, some odd developments which caught so many by surprise began manifesting themselves in perverted ways that could not neatly fit into the sanctions group think. Saudi Arabia began importing large quantities of Russian fuel oil for their furnaces ostensibly on account of deep discounts from Moscow thereby allowing their own crude oil to fetch eye watering margins from the prevailing high prices.

India was thought to process significant volumes of Russian crude oil in order to sell refined products to the United States. At other times, some reports whose veracity remains untested suggested that the crude oil sold to France dispatched from the UAE port of Fujairah also came from Russia.

As for Hungary, the only EU member state that strenuously fought to be exempted from sanctions was said to be selling approximately half of the crude oil they import from Russia to their other EU brethren who could not be seen to be buying crude oil directly from Moscow.

In the case of the US, the approach was different. The Biden administration, in a bid to look and act tough, resorted to draining copious volumes of crude oil from their Special Petroleum Reserve, generally known as the SPR, and converting so much of it to diesel and, where the economic imperatives demanded, into petrol and jet fuel. So frequent has been such reliance on the SPR that the carvens have reached a 40-year low. To date, it is reported that the US has diesel reserves of less than 25 days.

The Druzhba pipeline has been sabotaged and rendered inoperable by actors that the affected EU member countries are less than willing to investigate. The blanket ban on purchasing Russian crude oil was slated to take effect on November 5. For those states that do not depend on the insurance and shipping contracts from Lloyd’s of London, the effects of these sanctions would be significantly attenuated.

If indeed this banning order is successful, notwithstanding how each individual country would find ways to insulate themselves against this draconian measure, there is a consensus prognosis that the price of oil would rise sharply.

And so, in a perverted way, the very outcome that the sanctions proponents are seeking to prevent, Russia would make even more money. After all, since the beginning of the Special Military Operation in Ukraine, Russia has made more money from higher prices compared to equal volumes sold during the same period last year.

In order to regulate crude oil prices, the most strategic lever available and frequently used by Opec is the determination of the production quotas. Higher production means the lowering of the prices. The opposite equally holds true, as production cuts inexorably lead to higher prices.

If a significant portion of Russian crude oil production is suddenly cut off from the market, such shock will be immediately reflected in the price uptick. Regrettably, however, the countries that could substitute such volumes are themselves under an asphyxiating regime of unilateral US sanctions.

With all the necessary ingredients of another bruising oil price skirmish in place, the US mid-term elections entered the fray. If the oil price caps would do what they are expected to do, that is, to increase gasoline prices at the pump, the Democrats are sure to lose both congress and the senate.

Biden has now asked the Secretaries of the Treasury and of Energy jointly to postpone the Russian oil price cap initiative. Specifically, he has determined that any contract of carrying Russian crude oil entered into before November 5 must be fully delivered before January 22, 2023.

Between now and then, a lot of political headwinds may have blown toward the US and the EU. Arguably, if the Republicans win the mid terms, it may be unstrategic for them to be the instruments of higher gas prices at the pump and the new drivers of inflation. As for Europe, who knows, another leader may have fallen at the sword of self-inflicted energy wars.

To our collective dismay, the proposed cap on Russian oil prices has been interrupted by another more raucous discussion, the cap on gas prices. At first, it seemed as if the ire of Europe was directed at Russia. Surprisingly, however, proposals from the European Commission suggest that any gas imports entering Europe, no matter their origin, should be subject to price caps.

This proposition has irritated west Asian suppliers and other market bullies alike. The Americans who dominate the European LNG supply lines after the terrorist attacks on the Nordstrom 1 and 2 gas pipelines are mortified by such European ingratitude.

Qatar is on record saying the implementation of the gas price caps would result in them sending their LNG to other Asian destinations. China, a country that has been supplying LNG to Europe, may be disinclined to send them in that direction just so to be price slaughtered for glee if for nought else.

Japan, a critical US and Nato ally, is against this proposition. Italy, Spain, Serbia, Turkey and a growing number of other European countries are set to oppose it. Norway is even accused of price gouging by the inflation-battered economies within the continent.

With so much uncertainty, the prices of energy are bound to go higher, in line with the predictions of Opec Plus. At this point, it is not inconceivable that Nopec, the anti-cartel bill approved both by Congress and the Senate, may be signed into law by the White House, no matter who is majority either in Congress or the Senate or both.

Ambassador Bheki Gila is a Barrister-at-Law. The views expressed here are his own.

Sunday Independent

Original Article

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