EU embargo and price cap: what is happening to the oil price now

As of today, what is probably the toughest sanction against Russia to date has come into force: the EU embargo on Russian oil. How exactly does it work? What are the consequences for the world market – and at the gas station? Answers to some questions.

What are the new oil sanctions?

At the end of May, the EU heads of government and state agreed on an oil embargo against Russia as part of the sixth sanctions package. After a six-month transition period, the first part of the embargo applies from today. Officially, however, it only affects tanker oil: This will prevent Russian oil deliveries to the European Union by sea. However, the transport of the raw material via pipelines is exempt from this and is therefore still permitted, which was seen as a concession to Hungary. At present, a good two thirds of the imported Russian oil comes to the EU via tankers, the rest via pipelines.

Shipping companies in the EU are also only allowed to transport Russian crude oil if it is sold at prices below or at the new G7 price cap. This also applies to insurers, reinsurers or other financing of the oil business. All 27 EU member states agreed to a price cap of $60 a barrel over the weekend.

Since the US and Europe dominate the insurance market for oil tankers, non-Russian ships could also have problems insuring their cargo. For example, a large part of all ship transport is insured via the insurance marketplace Lloyd’s of London, while German companies play a major role in reinsurance.

Are there exceptions?

Because of its geographical location, Bulgaria may continue to import crude and mineral oil products by sea until the end of 2024. Croatia may also authorize the import of Russian vacuum gas until the end of next year.

What happens to the second stage of the embargo?

From February 5, 2023, refined mineral oil products will also be affected by the European embargo. EU member states that continue to purchase Russian oil from pipelines will no longer be able to resell it to other EU countries or third countries from February for reasons of competition.

How is Germany dealing with the oil embargo?

Before the start of the Ukraine war, oil imports from Russia covered around 35 percent of Germany’s requirements; within a few weeks after the war began, the share fell to twelve percent. Around a third of this came by tanker, two thirds flowed via the Druzhba pipeline to the eastern German refineries in Leuna and Schwedt. Although these are exempt from the oil embargo, Germany and Poland do not want to make use of the exception. From January onwards, therefore, Russian imports via the Druzhba pipeline are to be stopped.

As a result, the supply of crude oil could become scarce, especially in the PCK refinery in Schwedt. Schwedt is currently under German trusteeship, but continues to belong to the Russian state-owned company Rosneft. However, the port of Rostock and the pipeline to Schwedt are not sufficient to adequately utilize the capacity of the refinery in Schwedt. The refinery also relies on supplies via the Polish port of Gdansk and the pipeline system there. Last week, Germany and Poland signed a joint declaration of intent. In the future, the PCK refinery in Schwedt should be able to obtain crude oil via the port in Gdansk.

How is the embargo affecting the Russian economy?

Until March, Russia was the third largest oil producer in the world and was responsible for around twelve percent of global oil production. The energy market in Russia accounts for around 30 percent of the entire Russian gross domestic product. The embargo is therefore likely to hit the Russian economy hard. The EU Commission is even assuming “considerable” effects. Overall, the European Union’s oil imports from Russia are to be reduced by around 90 percent by the beginning of 2023.

Almost half of all Russian oil exports go to the EU. In 2021, member states imported 48 billion euros worth of crude oil and 23 billion euros worth of refined oil products. The extent to which the embargo will affect the Russian economy will largely depend on whether Russia can find buyers who will cover the European losses.

What are the consequences of the oil embargo on the world market?

The petroleum trade association Fuels und Energie points out that market and price developments depend on many factors, including the dollar exchange rate and decisions made by the major producing countries. However, the International Energy Agency (IEA) assumes at least that the sanctions imposed by western industrialized countries will lead to a slump in Russian oil production.

The ING Bank recently wrote in an analysis that the Russian offer has held up better than many had expected, at least so far. With the oil embargo now in force, the key question is whether India and China can buy even larger quantities of Russian oil than they already have. There are limits to how much oil India and China can absorb, according to the Center for Strategic and International Studies. Russia may not be able to divert all of the 1.6 million barrels a day of ocean freight exports it previously sent to Europe.

Due to the shortage of oil supply on the world market, ING Bank assumes that crude oil will be traded more expensively in the coming year than today. For 2023, the Epxerten expect a price for a barrel of North Sea Brent of 104 dollars. It is currently around $87. If the US manages to replenish its strategic crude oil reserves, this could support the market.

What does that mean at the gas station and for heating oil prices?

Experts disagree on how consumer prices for petrol and heating oil will develop in the coming months. The Austrian energy expert Walter Boltz expects that the embargo could drive up prices by up to 20 percent for a few weeks. “It cannot be ruled out that we will have higher prices for some products such as diesel, petrol and heating oil for one to two months,” said Boltz.

Thomas Benedix from Union Investment refers in particular to February 5th. From that day on, the import of petrol and diesel from Russia will be banned: “This could again become a factor where we can see turbulence and volatility in oil prices.” However, many would have stocked up on heating oil for the winter.

Why is a price cap necessary in addition to the oil embargo?

The oil embargo could mean that world prices continue to rise because of increasing demand for non-Russian oil – which would be good for Kremlin ruler Vladimir Putin and bad for consumers and the economy in all countries that have to import oil. In the G7 countries it is therefore currently considered better if third countries continue to purchase Russian oil. But this should be kept artificially cheap. That is why the EU and its G7 partners have decided on an oil price cap of 60 dollars per barrel. That would be a good ten percent less than the market price of 67 dollars for Russian Ural oil on Friday. China has already announced that it will not participate in the price cap.

With the price cap, the West wants to force Russia to sell oil at a significantly lower price to large buyers such as India in the future. This is to be achieved by no longer allowing Western ship transport or insurance for oil that is sold at a higher price. The hope is that this will ease the markets. In addition, it should be ensured that Russia no longer benefits from rising oil prices and can thus fill its war chest. However, it is not yet clear whether Russia will react to this by reducing supply.

How are oil prices reacting?

Oil prices rose slightly this morning: a barrel (159 litres) of North Sea Brent costs 87.10 US dollars, around 1.70 US dollars more than on Friday. The price of a barrel of West Texas Intermediate (WTI) rose to $80.42.

DIW President Marcel Fratzscher considers the moderate development in oil prices to be a good sign: “The price of oil has fallen in recent months and has not risen noticeably despite this threat,” Fratzscher told the news agency Reuters: “Thus, the price cap for Russian oil should prove to be a successful tool to stabilize global prices.”