How will EU ban and West's price cap on Russian diesel work?

How will EU ban and West's price cap on Russian diesel work?

FRANKFURT, Germany (AP) — The European Union is taking another big step toward cutting its energy ties with Russia. The 27-nation bloc is banning Russian refined oil products like diesel fuel and joining the U.S. and other allies in imposing a price cap on sales to non-Western countries.

Europe’s ban takes effect Sunday following its embargo on coal and most oil from Russia. The move is meant to further slash reliance on Russian energy and payments into the Kremlin’s war chest as the anniversary of the invasion of Ukraine nears.

The newest energy sanctions have risks: Diesel prices have already jumped since the war started on Feb. 24, and there’s uncertainty about how the EU embargo and price cap by the Group of Seven major democracies will affect the market for a fuel crucial to the global economy.

Most things people buy or eat are transported at some point by trucks, which mostly run on diesel. It also powers farm equipment, city buses and industrial equipment. The higher cost of diesel is built into the price of almost everything, helping push up inflation that has made life harder for people worldwide. 

Companies have already felt the pain. “We’re leaving money in the road to provide our services,” said Hans-Dieter Sedelmeier of the family-run German bus and travel company Rast Reisen.

Here are key facts about the sanctions on Russian oil products:

HOW WILL THE EMBARGO AND PRICE CAP WORK?

European importers have had months since the ban was announced in June to line up new supplies. They have already cut Russia’s share of EU imports to 27% in December from more than half before the war began.

US suppliers have stepped up shipments to record levels, from 34,000 barrels a day at the start of 2022 to 237,000 barrels per day so far in January, according to S&P Global.

New refinery capacity coming on line this year in Kuwait and Saudi Arabia and next year in Oman also could help. India is another potential source.

Russia, on the other hand, would have to find new customers.

The price cap plays a key role in the embargo: It’s designed to keep Russian diesel from disappearing from the global market and causing a price spike for everyone, while still cutting into the income that supports Moscow’s military.

The cap is enforceable because it bars Western companies that largely control shipping and insurance from handling diesel priced above the limit as it heads to countries like China and India. Evasion is possible but requires setting up alternative insurance or organizing a fleet of off-the-books tankers.

The cap was set at $100 per barrel for diesel and other products made from crude, such as jet fuel, in an agreement by the G-7 countries — the US, UK., Japan, Canada, France, Germany and Italy — plus the EU and Australia.

The price ceiling is $45 per barrel for other products that are made from crude but trade below the price of oil, such as fuel oil used in power station boilers and industry.

WHAT WILL HAPPEN TO DIESEL PRICES?

If the cap works as advertised, global diesel flows should reshuffle, with Europe finding new suppliers and Russian diesel finding new customers, without a major loss of supply.

In practice, markets will have to adjust, and there could be a brief spike. For one, tankers would have a longer journey to Europe from the U.S., Middle East or India than from Russia’s Baltic Sea ports, stressing shipping capacity.

“When Russian exports are constrained, for whatever reason, that would of course cause some trouble in this whole reshuffle process,” said Hedi Grati, head of fuels and refining research for Europe at S&P Global Commodity Insights. “Europe would be competing with other big importers, and that would cause upward pressure on pricing.”

WHAT DOES THE PRICE CAP ACCOMPLISH?

The hope is to reproduce the effect of the West’s $60-a-barrel price cap on Russian crude oil. Russia has said it won’t sell oil to countries observing the limit, but the cap and falling demand from a slowing global economy has meant customers in China, India and elsewhere can buy Russian oil at steep discounts, cutting into the Kremlin’s revenue.

The goal is the same with the diesel cap: “It is likely that Russia will have a harder time finding new buyers of its diesel than it did for crude oil and will be forced to accept discounts when doing so,” said Simone Tagliapietra, an energy policy expert at the Bruegel think tank in Brussels.

Once they’re in place, the caps could be tightened to increase pressure on Russia.

WHAT HAPPENS IF DIESEL GETS MORE EXPENSIVE?

Fuel prices have been a major factor behind painful inflation in Europe that has robbed consumers of purchasing power and slowed the economy.

Rast Reisen, the bus and travel company near Freiburg im Breisgau in southwestern Germany, has seen diesel fuel rise from 12%-15% of costs to 20%-25%.

Because 15 of its 25 buses are part of the regional public transport network, the company can’t automatically raise fares, and government increases so far are “a droplet on a hot stone,” said Sedelmeier, managing director for public transport.

Rast Reisen had to add a 10- to 15-euro ($11 to $16) diesel surcharge to trips to popular destinations like northern Germany’s island of Sylt or Croatia’s coast because prices spiked after catalogues were printed. Next year, prices for trips will simply be higher.

Diesel prices at the pump have swung from 1.66 euros per liter ($6.43 a gallon) to 2.14 euros per liter ($8.29 a gallon) in the course of a year.

“That is a gigantic increase,” said Christopher Schuldes, the third generation of his family to run German trucking company Schuldes Spedition.

The company has 27 diesel trucks and 50 employees in the small town of Alsbach-Haehnlein between Frankfurt and Heidelberg in southwest Germany. It already has cut fuel costs by equipping trucks with efficient engines, ensuring trucks leave fully loaded and training employees in fuel-efficient driving.

“We did all that a long time ago, long before Russia invaded Ukraine,” Schuldes said. “There’s no more room for optimization.”

To ease the extra diesel costs, the company tried negotiating higher prices with customers who have long-term contracts. Some agreed, some didn’t. Even if a contract allows prices to rise with diesel costs, there’s a two-month lag.

Regarding the embargo, “I am of two minds about it,” Schuldes said. “I have to see that the company is in good shape, and that our purchasing is as economical as possible. On the other hand — on the personal level — I say Russia must not be supported.”