Why Markets Shrugged at New Russian Fuel Sanctions

For oil companies, the fact that prices haven’t spiked because of the sanctions could be seen as a problem. But with crude near $80,, producers are still making large margins. And refiners are still making large spreads on diesel because of broader global shortages. The
Energy Select Sector SPDR Fund
(XLE) was down 0.5% on Monday, but is up 1.4% this year and 23% in the past year.

The market’s tepid response to the sanctions is a sign that investors are becoming skeptical of major price impacts. Traders want to see more evidence that buyers will shun Russian fuel products. Similar predictions of price spikes were made in early December before Russian crude oil was sanctioned, and prices didn’t move much then either. In fact, Russia has been able to export even more crude than it did before those sanctions. Russian seaborne crude shipments hit a six-month high last in the first half of January, according to S&P Global.

Like those crude sanctions, the new rules will both ban Russia from exporting fuel to Europe and other G-7 countries, and put a price cap on Russian fuel exports elsewhere. Countries enforce the rules through Western service-providers like shipping companies and insurance companies. Diesel, gasoline and kerosene are capped at $100 per barrel, about $10 to $20 below where diesel has been trading on the open market. Lower-quality products have lower caps. Countries will review the sanctions every two months to determine if the prices need to change.

“I think right now the market is kind of in show-me mode,” said RBC Capital Markets analyst Helima Croft, in an interview. 

The sanctions were designed to avoid price shocks. The caps on crude were high enough that the U.S. and other countries expected Russia to continue producing about as much fuel as it did before the sanctions.

“The White House made a calculation that if you set prices high enough for crude that Russia would play along,” Croft said. “They wouldn’t cut off customers that paid at the cap or below.”

Instead of barrels of crude going to Europe, they are now going to India and China, and other countries that are outside the G-7 and haven’t agreed to ban Russian supplies. If total supply stays about the same, then the price impact is minimal.

There is a difference between the crude and product sanctions, however, that could eventually make the latest sanctions more effective, Croft said. While countries like China and India are happy to import lots of Russian crude at a discount, they have less need for diesel and other fuel supplies because they have their own refineries to turn crude into products. So those products may have to go to other countries in Africa or South America. In the end, not all Russian fuel may find a home, decreasing total global supplies. It will take a few weeks to see if that happens. Until then, the markets for diesel and other fuels are likely to be relatively stable, absent some other shock.

Write to Avi Salzman at avi.salzman@barrons.com