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How the G7’s price cap on Russian oil could affect crude prices

Although prices are returning to levels seen before Russia’s invasion of Ukraine, crude remains volatile due to ongoing uncertain market fundamentals. The G7 leaders proposed a price cap on Russian oil with a view to reducing Russia’s oil revenues. A possible drop in non-OPEC supply and Europe’s ongoing energy crisis continue to keep prices volatile.

The Group of Seven nations – the US, Japan, Germany, Britain, France, Italy and Canada – and the European Union are working to set a price cap on Russian oil. The expected price range is USD 40-60 per barrel. This would limit Russia’s ability to finance its military action in Ukraine. The unprecedented move, which will begin on December 5, will cut Russia’s oil revenues without reducing its exports to the global market.

The group would like to include India and China, but this is highly unlikely as both countries are snapping up Russian oil at heavily discounted prices. After the West’s embargo on Russian oil, Russia maintains its oil revenues through increased sales to India and China.

However, the cap on prices will help to propel global oil prices in the long run but could see extreme volatility in the coming months.

Russia has said it will take retaliatory measures against countries that enforce the cap. They can withhold oil shipments to those countries or use some other creative means to punish participating countries.

Meanwhile, according to the latest OPEC monthly report, the producers’ cartel forecasts robust demand growth for oil this year and into 2023. This is due to better-than-expected signs of recovery in major economies despite headwinds such as inflation. Higher energy prices and the outbreak of Covid in China have capped global oil consumption since the first half of the year.

In contrast, the International Energy Agency expects a lower price target for crude oil in the fourth quarter of the year. The agency expects a shortfall in demand due to the ongoing economic slowdown and modest Chinese demand.

However, OPEC Plus countries, which include Russia, have been increasing oil production since the beginning of this year. A cartel of producers had previously cut production sharply as the pandemic cut demand.

The European Union is struggling to get its energy crisis under control. Russia is cutting gas exports to the European Union to force it to lift sanctions. High gas prices are causing a widespread shift from gas to oil for heating purposes.

In March, benchmark NYMEX crude prices hit a 14-year high of USD 130 as Russia launched military operations in Ukraine. The Western threat of a Russian oil embargo jolted global energy markets as the country plays a large role in the global energy market. However, it lost momentum when Russia began to gradually increase its oil production following sanctions-related sanctions.

Looking ahead, prices will continue to be volatile, possibly $122-68 a barrel in the near term. The European energy crisis, the embargo on Russian oil and the production levels of the US and OPEC plus countries remain hot topics. However, traders are probably more cautious due to ongoing uncertain fundamentals.

(The author is Head of Commodities)

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