The implications will become known in the coming weeks
Firms need to plan for possible extreme volatility in oil prices in the coming weeks and months, with the potential for worsening Europe’s energy situation and exacerbating the ongoing recession this winter. Concerns are to the downside that Russia simply stops exporting large volumes of oil or otherwise may not be able to successfully divert the exports once destined for Europe to Asia in such a short period. Alternatively, with the price cap sufficiently elevated, Russian oil will continue to flow and keep global energy markets roughly in balance as the West fully transitions away from Russian oil.
Overview
- On December 5, an EU ban on imports of Russian shipped oil (~two-thirds of Europe’s oil imports from Russia) as well as a G7-EU price cap on Russian shipped oil came into effect.
- The price cap agreed upon is at US$ 60/bbl., above which Western nations are forbidden from providing shipping and insurance services for Russian counterparts.
- The vast majority of the world’s energy shippers and insurers are Western based.
- Germany and Poland will end piped oil imports from Russia by year’s end, in total then banning 90% of Russian oil flows.
- The Kremlin has proposed a presidential decree to ban the export of oil products to those nations signed up for the price ceiling.
Our View
The world is witnessing one of the most epochal transitions in global energy markets in recent history with the effective cutoff of the vast majority of Russian oil and gas flows to the West, and it is occurring within the space of several months, creating many possible bouts of oil price volatility. As implemented, our base-case expectation is that there should be limited volatility in prices, as the EU internally negotiated a more elevated price to assuage all parties. With the Urals oil price currently roughly around this price cap, Russia can still sell its oil without losing much on price—and profitably. Still, with Russian piped oil banned by February 5, 2023, there exists further potential for volatility the rest of the winter.
As it pertains to Europe, the threat of far higher oil prices—matched with accelerating gas prices over the winter—will cause a more serious downturn. With the EU registering 0.2% YOY growth in Q3, the slowdown is evident and has worsened in Q4 thus far: retail sales were in contraction in October, while sentiment in services, construction, and manufacturing are likewise in negative territory. While unemployment to date remains low, with businesses anticipating more hiring, further pressure on input costs across the value chain will dampen moods.
Meanwhile, regarding the impact on Russia, the coming drop in both oil and gas revenues to the Russian budget will be damaging, with only the severity of the drop in question. Innumerable variables, including the average price of Urals oil sold, Russia’s oil output capacity under sanctions, and the level of the ruble—all of which are highly fluid and hard to predict with certainty—will determine how reduced Russian energy revenues will be in 2023, thus dictating the cut in public spending. Under our base-case expectation, Russia will receive considerably less than the RUB 8.9 trillion in energy exports (already less than 2022 record-high revenues) planned, demanding a cut in spending in real terms by ~15%. Should the government allow the ruble to depreciate more than budget expectations (68 to the US$), then budget revenues would be better protected, while higher inflation and interest rates would worsen the impact on consumers and businesses.
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