Measuring the Shadows
Measuring the Shadows
Moscow’s Strategies for Evading Oil Sanctions and How to Stop them from Succeeding
August 2023
This analytical report assesses on-going Russian efforts to circumvent the price cap and recommends high-impact measures for implementing oil sanctions more effectively.
Oil sanctions have been taking a toll on Russia, but Moscow has been hard at work on strategies for circumventing them. With Russian oil now trading above the price cap, the effectiveness of those strategies is being put to the test. Western policymakers have the sanction tools needed to thwart Moscow’s evasion efforts and further erode Russia’s economic resilience. But only if specific measures are taken to improve how those tools are used. If measures aren’t taken, sanctions could be at risk of unraveling.
Abstract
After some early success, oil sanctions are now being put to the test as Urals rises above the $60 price cap.
In recent months, oil sanctions have been taking a toll on Moscow’s revenues. The EU/G7 embargo has profoundly disrupted markets for Russian oil, forcing exporters to offer unprecedented discounts to secure large-scale demand. But prices have firmed up over the summer. And with Urals now quoted above $60, the effectiveness of the price cap is being put to the test.
Moscow has been hard at work on developing circumvention strategies. Its shadow-fleet strategy has made progress, but faces significant challenges.
For months, Moscow has been developing strategies aimed at circumventing the price cap. Chief among these is an effort to assemble a fleet of shadow tankers able to transport oil with impunity, regardless of price, and large enough to keep Russia’s export volumes whole. The fleet has expanded substantially, but Moscow’s shipping needs are immense; the fleet currently at Moscow’s disposal has reached only a third of the capacity that Russia requires for full export autonomy. Gathering a shadow fleet big enough to keep exports whole will likely be very expensive and take years to amass.
A complementary strategy of price attestation fraud, however, has the potential to substantially subvert the sanctions regime.
In parallel, Moscow has also been developing a complementary strategy of price attestation fraud. It seeks to use mainstream, sanction-compliant tankers to transport oil priced above the cap by exploiting known vulnerabilities in the sanction compliance regime. Policymakers are aware of this strategy, and have taken preliminary steps to counter it, though it’s not clear whether these measures will be adequate. If left unchecked, pricing fraud could substantially subvert the sanctions regime.
The high-stakes option of oil weaponization has now become a remote risk.
Moscow’s push to develop these circumvention strategies followed its decision last winter to quietly back away from earlier threats to weaponize oil exports by withholding volumes and engineering a supply crisis. For Moscow, weaponization was a high-risk option that amounted to playing dice with its all-important oil revenues. The resulting price surge could have proved short lived, leaving support for Ukraine undiminished and Moscow in a far weaker position, with revenues down, OPEC relations strained and shut-in production capacity steadily decaying. Moreover, as Moscow approached its decision point late last year, its broader risk environment was rapidly deteriorating, with its gas weaponization strategy faltering, energy prices tumbling, and military setbacks mounting. Customary Kremlin conservatism kicked in, dampening Moscow’s appetite for a high-stakes gamble. And that appetite looks unlikely to return anytime soon.
Policymakers possess the sanction tools needed to counter Moscow’s evasion efforts but must take specific steps to improve how sanctions are implemented if they are to succeed.
EU/G7 policymakers now have the necessary sanction tools to counter Moscow’s circumvention strategies and further constrain Moscow’s access to critical windfall revenues. But to succeed, they must improve how current sanctions are being implemented. With finite enforcement resources, they should focus on high impact measures that will both intensify the economic impact on Moscow and safeguard sanctions from Moscow’s efforts to unravel them.
This report details four such measures:
ratcheting down price caps, which could actually reduce inflationary pressure;
reducing the risk of price attestation fraud by whitelisting traders allowed to charter price-cap compliant, mainstream tankers;
cracking down on the involvement of EU/G7 entities in the sale of used tankers to Russian or undisclosed buyers;
requiring ships transiting EU/G7 territorial waters to verify that their spill liability insurance is adequate and current, which can sharply reduce both shadow tanker activity and the risk of a catastrophic accident.
Oil sanctions are worth the extra effort to get right, because of the unique and indispensable role that periodic oil windfalls play in the political economy of the Putin regime. They renew regime vitality, strengthen cohesion of elites and restore appetite for risk. Oil sanctions, if assertively implemented, can dim Moscow’s hopes for future windfalls and increase risk aversion. In turn, heightened caution can hasten the day Moscow recognizes a retreat from Ukraine has become its best option.
Table of Contents
A note on terms and data.
Measuring the Shadows: Introduction
Part 1: Moscow’s “physical” evasion strategy: assembling a sanction-proof fleet
Chapter 1: Russia’s peculiar shadow fleet—evading sanctions through immunity, not subterfuge
Chapter 2: Measuring the Shadows—how big is the sanction-proof fleet in Russia?
Chapter 3: How many shadow tankers does Moscow need in all?
Chapter 4: Can Russia close its “tanker gap?”
Part 2: Moscow’s “paper” evasion strategy: engaging mainstream tankers using fraudulent pricing information
Part 3: Moscow’s strategy for boosting prices
Chapter 6: Moscow contrives to have OPEC solve its oil price problem
Part 4: Helping Moscow fail faster
Conclusion: No more oil windfalls—hastening Russia’s retreat from Ukraine
Appendix: A brush with disaster in the Danish Straits—shadow tankers menace the Baltic
Recommended resources on Russian oil sanctions
Acknowledgements
Endnotes
A note on terms and data
Throughout this report, the term “oil” refers to both crude and refined products together. So, “Russian oil export volumes” would mean the combined export volumes of Russian crude and refined product.
The terms “EU/G7” and “price-cap alliance” are shorthand for the alliance of countries participating in oil sanctions against Russia. In addition to EU and G7 member states, these include countries such as Norway, Australia, and South Korea.
Except where otherwise noted, the analysis in this report is based largely on shipping, ownership and insurance data that are current as of early July 2023.
Executive Summary
Late last year, Moscow abandoned the idea of weaponizing oil exports in response to the introduction of EU/G7 oil sanctions. It opted, instead, to develop strategies for circumventing the price cap. As Urals tops the $60 per barrel price cap, the robustness of EU/G7 oil sanctions will face their first major test in face of Moscow’s circumvention strategies.
The first of Moscow’s two circumvention strategies involves assembling a fleet of “sanction-proof” shadow tankers.
Moscow’s evasion efforts have centered around two complementary strategies. The first of these involves assembling a fleet of “sanction-proof” shadow tankers able to disregard the price cap openly and with impunity. To enjoy immunity from sanctions, however, these tankers need to be neither owned, financed nor insured by EU/G7 entities. Otherwise, they face significant legal or commercial consequences for violating the price cap. The pool of such sanction-proof tankers, however, is very limited. Some 95% of the global tanker fleet arrange their mandatory oil spill liability (“P&I”) insurance through the non-profit International Group of P&I Clubs (the “IG”), which is centered in Europe and requires covered vessels to observe Russia sanctions. Much vessel financing and many charterers require IG P&I policies since there is no comparable alternative in the market. Because of the broad global footprint of hard-to-replace EU/G7 marine insurance, however, some 95% of the global fleet faces significant legal and/or commercial consequence for violating sanctions. That leaves only a small pool of vessels suitable for the shadow-tanker business model (see Executive Summary Figure 1).
This fleet has grown substantially since last summer…
Since last summer, the cohort of shadow tankers active in Russia has grown substantially. Their capacity has increased by nearly 12 million deadweight tons, the equivalent of around 110 Aframax class tankers—the most widely used tanker class in the Russian trade (see Executive Summary Figure 2).
… primarily through purchases from the mainstream fleet, not recruitment from the global shadow fleet…
Moscow’s shadow fleet appears to be primarily “bought” not recruited. Few of these tankers come from the broader global shadow fleet. Only 11%, for example, appear to have been engaged in the Iran trade. Instead, some 82% of these tankers have changed hands since March 2022, with most having recently been aging tankers in global mainstream fleet. Once sold to new, anonymous owners, they were stripped of any ownership and insurance ties that could make them vulnerable to sanctions and put to work in the Russia trade.
…but so too have Russia’s shipping needs, as the EU/G7 embargo forces its oil to more distant markets.
At the same time Moscow’s shadow fleet has been expanding, so too has its need for tanker capacity. The EU/G7 import embargo has displaced over 70% of Russia’s seaborne exports, forcing most of it to be rerouted from destination ports in Europe to more distant, less familiar markets East of Suez (see Executive Summary Figure 3).
The net effect has been to roughly double the amount of tanker capacity Moscow needs just to maintain the same level of daily deliveries. Through June 2023, Moscow has maintained daily exports of oil (crude plus refined products) at six million barrels per day or above since February 2022. To sustainably keep exports whole going forward while completely circumventing the price cap, Moscow would need a standalone, sanction-proof fleet of some 68 million deadweight tons of capacity—equal to around 637 Aframax tankers (see Executive Summary Figure 4).
The sanction-proof fleet active in Russia covers only a third the size it needs to be to keep exports whole and free from price-cap constraints.
When the capacity of Moscow’s active shadow fleet is combined with that of Russia’s state-owned shipping company, Sovcomflot, it totals around 22 million deadweight tons, equal to some 205 Aframax tankers (see Executive Summary Figure 5). This is roughly double that of a year ago, but still comes to less than a third of Moscow’s need. The result is a “tanker gap” equal in size to some 432 Aframax tankers.
The resulting “tanker gap” will be hard to close.
The prospects for closing this large gap anytime soon are dim, owing to structural impediments. Despite significant efforts, Moscow only managed to reduce its tanker gap by some 20% from July 2022 to June 2023 (see Executive Summary Figure 6).
Used market prices have soared…
The aggressive buying activity in the cohort of 16-to-20-year-old tankers—which provides most of the tonnage for the shadow fleet—has caused record high valuations in the used tanker markets. Prices for 15-year-old Aframaxes have more than doubled owing to constrained supply (see Executive Summary Figure 7).
…and supply is constrained…
To substantially close the tanker gap would put immense additional upward pressure on used tanker prices. Even after the recent heavy buying in the market, Moscow’s sanction-proof fleet currently accounts for just 17% of the carrying capacity of all 16-to-20-year-old tankers worldwide in the relevant classes. To close the tanker gap, that figure would have to quadruple to 69% and require an accelerated acquisition campaign of unprecedented scale (see Executive Summary Figure 8).
…weakening the economic rationale of the program, which may help explain the recent slowdown in shadow fleet expansion.
At today’s valuations, that program would easily exceed $15 billion and already calls into question whether such a high upfront price tag is justified by future, risk-adjusted returns. But given the limited liquidity in the tanker markets, any effort to buy this many tankers on a compressed time scale would push the ultimate price tag far higher, further eroding the economic rationale behind Moscow’s tanker expansion program. More simply put, Moscow’s shadow tanker strategy has pushed used tanker prices so high that further expansion is getting hard to justify on economic grounds. That may help explain the sharp slowdown in shadow fleet expansion observed since May (see Executive Summary Figure 2 above).
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Moscow’s second circumvention strategy seeks to fraudulently ship non-compliant cargoes on mainstream tankers by exploiting a known price-cap compliance vulnerability.
Moscow’s second strategy for circumventing sanctions seeks to secure capacity on mainstream tankers for cargo priced above the cap. This involves exploiting a known vulnerability in the price-cap compliance regime. Owners of mainstream tankers must obtain a “price attestation” from traders stating that the cargoes they are shipping comply with the price cap. Many of the traders now handling Russian exports are based outside EU/G7 jurisdictions and have close ties to Russian exporters. This means they face no sanction risk for dealing in oil priced above the cap. It also means if a Russian cargo can be sold above the price cap, but no shadow tanker is available to lift it, these traders have an incentive to fraudulently secure capacity from mainstream vessel by providing a price attestation that falsely claims the cargo is price-cap compliant.
Due diligence by ship owners is supposed to prevent this bad-actor scenario from occurring…
This scenario—bad actors committing price-attestation fraud—is a known vulnerability in the price-cap compliance regime and was flagged by policymakers in guidelines to market participants last fall (see Executive Summary Figure 9). To avert it, policymakers advised ship owners to perform due diligence when taking on customers and provided red flags to watch out for.
…but it doesn’t appear to have worked adequately on exports from Kozmino in the early months of sanctions…
On its own, this advice does not appear to have been sufficient to prevent price-attestation fraud. Russia’s ESPO grade crude, which ships primarily out of the Pacific port of Kozmino, has consistently been quoted above the price cap since December. Available data appear to show that traders shipped large volumes of oil priced above the price cap on mainstream tankers, quite likely by providing fraudulent price attestations. After this came to the attention of sanction enforcement officials, the U.S. Treasury issued a warning in April. Since then, the volume of Kozmino exports lifted by mainstream tankers has fallen below 10% (see Executive Summary Figure 10).
…and it’s not clear that adequate measures are yet in place to prevent price attestation fraud from recurring today as Urals surges above the price cap.
It is surprising that price-cap compliant tankers were lifting large volumes from Kozmino in the early months of sanctions, since so many of the traders active in the Kozmino trade would likely have triggered one or more due diligence red flags. And it’s not entirely clear what’s behind the more recent retreat of the mainstream fleet from Kozmino. Is the result of more exacting diligence standards by ship owners? Or is it a decision by traders and Moscow to deploy additional sanction-proof tankers to the lucrative Kozmino trade, most of which goes to nearby China and thus requires only a small number of dedicated tankers to maintain. This becomes a very relevant question as the Urals grade crude surpasses the price cap, since the Urals trade requires a far larger amount of tanker capacity to maintain (see Executive Summary Figure 11).
Moscow opted for the low-risk strategy of price-cap circumvention instead of the high-risk strategy of oil weaponization.
Moscow adopted these two, low-risk circumvention strategies in lieu of the high-risk strategy of oil weaponizing that it had been previously threatening. Weaponization would have involved engineering a global supply crisis by slashing export volumes. That, however, would have been an extremely high-risk strategy, gambling as it does with Russia’s all-important oil revenues. It had a significant chance of backfiring if the resulting price surge proved short lived and Ukraine’s supporters remained resolute in the face of market turmoil. Moscow would have then ended up in a weaker position, with export volumes sharply reduced, revenues down, market share lost, OPEC relations damaged and shut-in production capacity steadily deteriorating. Its decision to forego weaponization was likely influenced by the deteriorating risk environment of late last fall, as Moscow’s gas weaponization strategy faltered, energy prices tumbled, and military setbacks mounted.
Nonetheless, the impact on Russia’s budget has been painful, with the 2023 budget plunging into deficit while its estimated fiscal breakeven oil price jumped by 77%.
Moscow’s circumvention strategy combined with the rising costs of its war on Ukraine have placed strains on the Russian budget. Budget revenues from oil were down 47% year-on-year in 1H 2023, despite Brent averaging only 25% lower, owing in part to a significant widening in the discount at which Urals trades to Brent. Historically, discounts had been in the $1 to $2 range, but under sanctions have routinely ranged from $20 to $30. The discount, in turn, has been driven by Moscow’s loss of pricing power, as India has emerged as the only reliable buyer in size for its diverted Urals flows and used its quasi-monopsonist leverage to extract painful discounts from Russian exporters. This collapse in oil revenues has helped push Russia’s 2023 budget into the red, with a ballooning deficit that by the end of April was already 17% ahead of full-year 2023 forecasts. Accumulated surpluses from 2022 are being consumed. The discount and war costs have also caused the estimated 2023 fiscal breakeven price to skyrocket to $114, up 77% over pre-February 2022 levels, and greatly exceeding that of the OPEC+ cartel’s other leading producer, Saudi Arabia (see Executive Summary Figure 12).
Moscow’s third anti-sanction strategy has been to contrive to have OPEC lift prices with cuts while avoiding any reduction in its own exports
In the face of the painful discount, Moscow could have unilaterally reduced Urals exports to regain some pricing power. But throughout the winter and spring, it remained highly reluctant to unilaterally cut output, and export levels remained at or above levels of January and February 2022 (see Executive Summary Figure 13). Instead, Moscow contrived to have its OPEC partners raise prices by cutting output, while avoiding any export cuts of own.
This radical shift in price sensitivities along with other consequences of Russia’s war on Ukraine appear to have strained relations between Moscow and OPEC.
This, however, proved a challenge. Moscow’s war on Ukraine has strained its relations with OPEC in many ways, and not just because of the radical realignment of oil price sensitivities. The deep discount at which Moscow has been selling Urals to India has depressed pricing more broadly for Gulf exporters in the Indian Basin. The doubling of Moscow’s tanker usage has pushed freight rates up for all exporters. By weaponizing of gas and grain, and threatening to do the same with oil, Moscow has roiled global energy and food markets, creating additional challenges for the cartel and its member states. By suppressing standard oil industry data disclosures and using oil tanker locational “spoofing” and other forms of subterfuge to obscure export flows, Moscow has made it more difficult for OPEC to monitor Russian production and export activity. And OPEC producers do not appear pleased by the development of a novel sanction designed to constrain oil export revenues—the price cap—which Russian atrocities precipitated.
OPEC has seen through Moscow’s deceptive efforts to manipulate the cartel into rebalancing the market while avoiding any real cuts itself.
To maintain support of OPEC in the face of these growing strains and induce them to cut, Moscow has pursued a strategy of scaremongering and deception. They have misrepresented the price-cap as a “buyers’ cartel”—an absurdity, since EU/G7 countries are forbidden from buying Russian oil—and claimed Washington intends to use it against all OPEC producers. And they announced in February what appears to have been a sham unilateral output cut, intended to induce other OPEC partners to cut as well. But OPEC has seen through Moscow’s charade and required an actual cut in exchange for reciprocal support. A reduction in Russian crude exports appeared to be underway in July. But with the substantial recent rise in Russian refining runs, it’s likely that the cut in crude exports will be largely offset by an increase in product exports.
* * *
High oil prices will now put the robustness of EU/G7 sanctions to the test.
Moscow’s complementary circumvention strategies—expanding its sanction-proof fleet to the extent it can and falsifying price attestations to ship non-compliant cargoes on mainstream tankers when no shadow tankers are available—have yet to be put fully to the test. But this may soon change as Urals prices rise above the price cap. Despite their weaknesses, Moscow’s circumvention strategies retain the potential to severely undermine sanctions. Fortunately, however, EU/G7 policymakers now have in place the legal framework needed to render both these strategies largely ineffective and further constrain Moscow’s access to critical windfall revenues.
To avoid wholesale subversion of sanctions, specific adjustments need to be made to how the sanctions framework is being implemented.
But to work effectively and avoid wholesale subversion, specific adjustments need to be made around how that framework is being implemented. If made, these adjustments can significantly increase fiscal and psychological pressure on the Kremlin leadership—all without increasing inflationary pressures in the energy markets. But if policymakers do not move swiftly to make adjustments, they risk seeing the full-scale subversion of Russian oil sanctions and unleashing further upward pressure on energy prices.
These four measures can make a substantial difference.
Drawing on detailed analysis of the first half year of sanctions, this report recommend four specific, high-impact adjustments to the current framework that can help assure sanctions are effective, not subverted.
Recommendation #1: Lower the price cap
The arguments in favor of a lower price cap are overwhelming, while the rationale behind the higher cap has now fallen away.
Last autumn, the main argument against setting a lower price cap was that Moscow might retaliate by engineering a supply crisis that would spur inflation and potentially trigger a recession. This, in turn, would erode support for Ukraine. Since then, however, the risk of oil weaponization has greatly receded (see Introduction), removing the main argument in favor of a higher price cap. At the same time, additional arguments supporting a lower cap have only gotten stronger, namely:
sanctions have been having a tangible impact;
Moscow has routinely been willing to export at prices far below $60 a barrel;
the ruble’s recent collapse lowers Russia’s breakeven oil price, making it easier for producers to cover costs at lower oil prices;
Moscow’s large tanker gap means most of Russia’s seaborne exports remain exposed to the price cap; exposure levels could rise above 80% if insurance verification is implemented (see recommendation #4);
a higher price cap has, contrary to intent, ended up increasing Moscow’s incentive to cut output to push up prices, rather than decreasing it.
As weaponization risk receded over the winter, and the discount pushed market prices for Urals down to $40, an unexpected thing happened. The high, $60 price cap, that was intended to reduce incentives for Russia to cut output ended up, perversely, increasing them (see Executive Summary Figure 14). The high price cap gave Moscow unrestricted upside potential of $20 per barrel. Put otherwise, if the market price rose from $40 to $60, Moscow would be able to capture 100% of that $20 upside, since the high price cap ensured access to mainstream tankers for cargoes priced up to $60.
Had, by contrast, the price cap been lowered, say, to $35, it would have limited Moscow’s ability to capture upside value from rising prices, since its sanction-proof fleet was only large enough to move a fraction of its exports at full market prices. The rest would have to be transported by mainstream tankers at the capped price. With less to gain from higher market prices, Moscow’s incentive to cut its own output (and badger OPEC to do likewise) would have been significantly weaker.
The same would hold true today. If price caps were dropped to $35, it would weaken Moscow’s incentive to keep any cuts in place. Moscow might revert to doing what it did last time it faced low effective prices and maximize output.
Recommendation #2: Combat price attestation fraud by developing a “whitelist” of approved traders.
It makes little difference at what level the price cap gets set if price attestation fraud goes unchecked. Moscow would have enough unrestricted access to mainstream tanker capacity to keep export volumes whole, regardless of price. That, in turn, would create even greater incentives for Moscow to push for higher pricing, since it could capture 100% of revenues at any price.
This makes price attestation fraud by bad-faith brokers as great a threat to sanctions as the shadow fleet—perhaps even greater. Policymakers need more effective measures for preventing pricing fraud. Lessons should be drawn from the apparent use of fraud at Kozmino earlier this year.
The critical task of screening out bad-faith traders should not rely solely on “know-your-client” due diligence by mainstream tanker owners.
The crux of the problem is that the burden of identifying potentially bad-faith traders is left to ship owners. They are required to conduct their standard “know-your-client” due diligence when engaging customers and provided red-flag guidelines on what to watch out for.
This approach is unworkable. Standards of due diligence and the resources for conducting it will vary significantly from one ship owner or operator to the next. So too do the potential consequences of grossly negligent diligence. Invariably, some bad-faith traders will remain in the mix, potentially a large number.
Enforcement agencies should pro-actively develop whitelists of allowed traders.
To effectively combat attestation fraud, enforcement agencies need to play a more proactive role in screening out bad actors. They could start by developing a “whitelist” of broker/traders authorized to provide pricing information. This whitelist could be made up of well-established commodity trading groups based in EU/G7 countries, and therefore subject to legal action for violating sanctions and providing false pricing information. Moreover, as EU/G7 entities, they would be required to retain and, if necessary, disclose underlying transaction documents to authorities.
For a mainstream EU/G7 owned or insured tanker to transport Russian oil, it must receive its price attestation from a whitelisted trader. Failure by ship owners to obtain price attestations from a whitelisted trader would be considered a violation of sanctions. Many EU/G7 traders have extensive experience trading out of Russia and some may welcome the opportunity to re-engage, if clear guidelines are provided by enforcement authorities. That might not eliminate bad-actor risk entirely but should go most of the way.
Recommendation #3: Crack down on the involvement of EU/G7 entities in the sale of used tankers to Russian or undisclosed buyers
One way to limit the expansion of Russia’s shadow fleet is by further constraining supply. Shadow tankers are often purchased from mainstream operators—many based in the EU/G7—during the process of fleet renewal. There is plenty of consternation among some ship brokers about lack of compliance by more risk-friendly competitors. As one commented: “So people who think they can ignore the rules and still go out and do business, I say ‘more fool them’, and I hope they have a lot of sleepless nights and wake up with a knock on the door.”1
Enforcement agencies should crackdown on the involvement of any EU/G7 entities in the sale of used tankers either to Russian or undisclosed buyers. This should include not only the sale of EU/G7 owned tankers but the involvement of any EU/G7 brokers, banks or other advisors in such sale. Authorities should encourage whistleblowing to help generate leads. Investigating a case would have a chilling effect on the trade, especially if its results in a substantial fine or conviction.
Even with such prohibitions and stepped-up scrutiny, sales by EU/G7 ship owners into the used market will likely continue to find their way into the Russia shadow trade. But these deterrent efforts can slow down the transaction flows and increase costs for Russian buyers by introducing a risk premium and additional intermediaries.
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Conclusion of Executive Summary: No more oil windfalls—hastening Russia’s retreat from Ukraine
Together, all these recommended measures aim to do one thing: tightly constrain Moscow’s access to windfall oil revenues. Like other sanctions, this will help erode Russia’s economic resilience, diminishing its means for financing its war of aggression against Ukraine.
At the same time, Russian oil sanctions are different from other sectoral sanctions and have the potential for a qualitatively greater impact. Periodic oil windfalls play a unique and indispensable role in the political economy of the Putin regime. They renew regime vitality, restore appetite for risk and help maintain cohesion among fractious elites.
Oil sanctions, if assertively implemented, can dim Moscow’s hope for renewed access to oil windfalls. That would unsettle Kremlin leaders and help increase their risk aversion. Such heightened caution was on display last December, when Moscow chose not to weaponize oil. And it was on display more recently, during the Prigozhin Affair, when Putin shied away from direct confrontation. It can also hasten the day Moscow changes its calculus and recognizes that a withdrawal from Ukraine has become its best option. That prospect makes it worth taking pains to ensure oil sanctions work as well as they can.
Measuring the Shadows
Introduction: The safe bet—Moscow opts to counter oil sanctions with circumvention, not weaponization
Last December, Moscow decided against weaponizing its oil exports in response to new sanctions, opting instead for a lower-risk strategy of circumvention. Now, as Russian oil rises above the price cap, EU/G7 policymakers have the tools needed to counter Moscow’s evasion efforts and enhance the impact of sanctions, but only if they take specific measures to improve how sanctions are implemented.
The “diskont”
“You need to sort out this discount problem, so it doesn’t cause any problems with the budget.” Those were the instructions Vladimir Putin gave last January to Alexander Novak, his deputy prime minister in charge of energy. Novak had been briefing Putin on the painful $30+ discounts that Russian exporters were then having to offer to secure firm demand for Urals grade crude. This “diskont”—as Putin referred to it—was many times greater than the one-to-two-dollar spreads to benchmark Brent typical in the past. With oil revenues the single largest contributor to the Russia’s budget, Putin was right to be concerned.2
“You need to sort out this discount problem, so it doesn’t cause any problems with the budget.” — Vladimir Putin to Alexander Novak, January 2023
The discount was largely the result of the abrupt ending to Russian oil’s 145-year romance with its most important export market, Europe. Over many decades, Russia had built out a massive infrastructure of pipelines and ports to deliver crude and refined products to a sprawling European customer base. Following Russia’s full-scale invasion of Ukraine, however, European customers gradually began shunning Moscow’s oil—culminating in a full-scale embargo this past winter.
An historic shift in global trade patterns ensued. Hundreds of tankers loading each month at Russia’s Baltic and Black Sea terminals no longer set course Hamburg, Rotterdam, or Augusta. Instead, in search of new buyers, they embarked on long voyages to distant markets, mostly East of Suez. As Novak would explain to Putin, shippers were taking advantage of the tainted status of Moscow’s oil to gouge Russian exporters on freight rates. Shippers were reportedly charging as much as $15 a barrel to transport Russian crude from the Baltic to West Coast India, ten times what it would have cost a year earlier.3
But high shipping costs weren’t the only thing behind the discount. In addition to being much further away, the markets still open to Russia were smaller, less familiar and more concentrated. The bulk of Russia’s dislocated crude was going to a single buyer, India. Such a concentrated market weakened Russia’s pricing power, allowing Indian traders to drive hard bargains. Unless Moscow could reduce the glut of Russian oil now pouring into the Indian Ocean basin, or find a broader range of buyers for it, the dreaded diskont looked destined to persist.
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Last year, Moscow struggled to develop a strategy for countering oil sanctions
The EU/G7 sanctions pose the greatest potential threat to Russia’s oil industry since Soviet times. The discount is just one of numerous vexing, often unanticipated problems thrown up by it. The sanctions have forced hard choices on Vladimir Putin, decisions he will not have taken lightly, given oil’s unique place in the political economy of Russia. Oil is the largest contributor to the Russian budget. Russian energy exports generated record revenues in 2022, providing a momentary fiscal buffer against broader sanctions. By contrast, in the first half of 2023, weak oil and gas revenues—down 47% year on year—helped drive a ballooning budget deficit.
But for Putin, Russia’s oil industry is about more than just balancing the budget—it provides the very lifeblood of this authoritarian system of rule. Throughout Putin’s tenure in power, Russia has, from time to time, reaped massive windfall revenues from periods of high oil prices. Putin has single mindedly promoted these windfall opportunities and covetously consolidated control over the hundreds of billions of dollars in surplus revenues they have generated. Oil windfalls provide him the means to buy the loyalty of elites, bully enemies and paper over failures of an otherwise anemic economy. Oil windfalls have also bank-rolled adventurism abroad, including Russia’s war of aggression against Ukraine. The Kremlin’s appetite for such adventurism is never higher than when its coffers are flush with petrodollars.
For many months, Moscow has struggled to develop a coherent strategy for countering sanctions. When oil sanctions were first mooted by the EU in the Spring of 2022, Kremlin officials were scathing, branding sanctions as “suicidal” for Europe. They confidently asserted that Moscow would build new pipelines and ports and reroute Russian oil to more promising markets. But their bravado soon faded over the summer, as Kremlin officials came to grips with just how deeply dependent Russian oil exports were on EU/G7 markets and marine transportation services. If sanctions went ahead, there would be no quick or easy fixes.
With no quick fixes to hand, the Kremlin began threatening to weaponize oil exports…
Soon, Kremlin officials were adopting a different, more menacing tone as they made thinly veiled threats to weaponize oil exports. These threats echoed what was already happening with Russia’s European gas exports. For months, Moscow had been methodically engineering a gas supply crisis in Europe, sending markets into a panic. By late summer, European gas prices had skyrocketed to 30 times recent averages. An anxious Europe braced for a cold, dark winter.
In the months leading up to sanctions, Moscow looked poised to weaponize oil, just as it was doing with gas (and grain). Analysts projected price spikes to $350. Economists feared a supply shock could tip the global economy into recession. Markets watched anxiously to see how Moscow would respond as the December sanctions deadline approached.
…but eventually backed away from this high-risk option.
Then something remarkable happened. As crude sanctions came into force on December 5th, Moscow fell silent. Days passed and then weeks, with no formal response. Conflicting rumors circulated of draft decrees containing various retaliatory measures. But when a presidential decree was eventually issued at the end of December, it proved underwhelming. It did little more than forbid the mention of price caps in sales contracts. It included no measures that would in any way constrain the supply. Analysts scratched their heads, markets yawned, Urals slumped, and Russian export volumes continue to ship unabated.
Moscow’s climbdown came in the face of a rapidly deteriorating risk environment—too many things were going wrong all at once.
For policymakers in charge of Russian oil sanctions today, understanding the significance of Moscow’s December climbdown is essential for making good policy decisions going forward. And for those responsible for Kremlin threat assessment more broadly, Putin’s response to the challenge of oil sanctions makes for a valuable case study in his diminishing appetite for risk.
Last December’s strategic decision not to weaponize oil exports was made against the backdrop of a rapidly deteriorating risk environment for the Kremlin. Things had started going wrong across a number of fronts. First, Moscow’s gas weaponization policy—which looked so promising in the early autumn—by December was backfiring badly, thanks largely to European resourcefulness, resilience, and unity. Strategic gas partnerships stretching back 50 years were torched overnight. Gas prices were tumbling. The Russian budget—which ran a surplus for the first eleven months of 2022—suddenly lurched into deficit.
As for the oil industry, it wasn’t just the discount that was causing trouble. As crude sanctions came into force, concerns over the price cap caused Chinese state-owned, Greek, and other mainstream tankers to abruptly stop loading at Russia’s largest Pacific port. Russian exporters struggled to mobilize the modest number of shadow tankers needed to fill the gap. Pacific export volumes collapsed by half. While the mainstream fleet continued to call on Russia’s major western ports, events in the Far East were an unsettling sign of how heavily dependent Russia remained on EU/G7 marine transportation.
Meanwhile, Moscow’s covert effort to buy up second-hand oil tankers was bumping up against constrained supplies. The price for a 15-year-old Aframaxes class vessel had climbed nearly 130% over the preceding 12 months. To top it off, Putin’s hopes that OPEC would boost slumping oil prices at its December meeting were dashed when the cartel opted not to cut. In a revealing moment of discord, OPEC ministers chose, instead, to wait and see whether Moscow might save them the trouble of cutting by following through on threats of a large, unilateral cut. On top of all this, on the battlefield, military setbacks were mounting, forcing a mobilization that was both unpopular and poorly executed
Weaponizing oil was a high-risk move that could easily go wrong—just as gas weaponization had—but with far more serious consequences for regime resilience.
It was against this backdrop of spiraling risk that Kremlin leaders were being forced to respond to the imposition of sanctions. In the best of circumstances, weaponizing oil would be a high-risk option. Without OPEC firmly on board and global oil demand robust, a unilaterally engineered price spike could quickly falter and fade. And when it did, Moscow would be left in a far weaker position, with revenues down, market share lost, OPEC ties strained and shut-in production capacity steadily deteriorating. Moscow’s failed gas gambit has just demonstrated how easy it was for an engineered supply shock to go wrong. What’s more, the leverage Russia enjoyed over European gas markets was far stronger than over global oil. To gamble, and lose, with Russia’s gas industry was a painful act of hubris. But to then play dice with Russia’s indispensable oil industry was a potentially fatal act of folly.
Putin would well understand that getting oil policy wrong in the middle of a war could jeopardize the regime’s stability, as the Soviet leadership had demonstrated in spectacular fashion. In the face of mounting risk, customary Kremlin conservatism kicked in, dampening the appetite for a confrontational, high-stakes gamble with oil. And that appetite looks unlikely to return anytime soon.4
Moscow opted, instead, to pursue a lower-risk, anti-sanction policy centering around circumvention rather than confrontation.
Having set aside weaponization as too risky, Moscow decided instead to pursue a much lower-risk policy of circumvention. This involves maximizing output and then trying to sell as much as possible outside of the price cap regime. This strategy does not pack the potential recession-triggering punch of weaponization, but nor does it run the risk of backfiring spectacularly.
In pursuit of circumvention, Moscow and its trading affiliates have experimented with a range of tactics. Some of these are clandestine in nature—such as “dark” ship-to-ship transfers and the locational “spoofing” of tankers. These methods of subterfuge at sea—a curious blend of steampunk and cyberpunk with a bit of Bond thrown in—have captured the public imagination—and understandably so. But when measured against the immensity of Russia’s export volumes, such clandestine operations are marginal at most. They simply don’t offer scalable solutions for circumventing the price cap. Consequently, they’re not the strategies Moscow is banking on.5
Moscow’s 3 core strategies for circumventing sanctions
Instead, Moscow has been focusing the main thrust of its efforts on three core anti-sanction strategies.
The first involves assembling a stand-alone, “sanction-proof” fleet of oil tankers. This fleet, made up of state-owned Sovcomflot oil tankers along with an expanding roster of “shadow tankers,” relies mainly on effective immunity from sanctions—rather than subterfuge—to circumvent the price cap. The great challenge Moscow faces is: can it assemble a large enough fleet to meet Russia’s immense tanker capacity needs?
The second strategy, which is complementary to the first, focuses on exploiting the global mainstream, price-cap-compliant fleet. It seeks to use mainstream tankers to carry cargoes priced above the cap by providing ship owners with fraudulent pricing. It relies on a known vulnerability in the price-cap compliance regime that can result in mainstream ship owners relying on pricing information from bad-faith oil traders. If left open, this loophole could allow Moscow to fully subvert the price cap. The challenge for Moscow, however, is that stepped-up enforcement of existing price-cap rules could quickly close this loophole.
The third strategy is not really a new one, but dates back to Moscow’s 2016 decision to collaborate with OPEC to manage global oil prices. Moscow is continuing to rely on OPEC collaboration to regulate prices, rather than pursuing an aggressive, value-over-volume policy involving large, unilateral cuts. What’s changed, however, is the sudden upward jump in Russia’s fiscal breakeven oil price, along with Moscow’s more aggressive use of cynical scaremongering and deception against its OPEC partners. Moscow was contriving to get the producer cartel to cut, while Russia maintained full output, but OPEC has strong armed Moscow into making cuts as well…or so it seems.
With Urals now trading above the cap, Russia’s circumvention strategies are now being put to the test…
In recent weeks, these coordinated cuts by OPEC+ have tightened oil markets, narrowing the Urals discount and pushing market prices above the $60 price cap. Moscow’s circumvention strategies are now being put to the test. EU/G7 policymakers possess the sanction tools needed to thwart Moscow’s evasion efforts. That’s thanks in large measure to extraordinary levels of multilateral collaboration and innovation among alliance countries last year.
…and EU/G7 policymakers must improve how sanction tools are being used to ensure they remain effective.
But for those tools to work effectively, lessons must be drawn from the first half year of oil sanction, and specific adjustments must be made in how these tools are used. If made, alliance countries can counter Moscow’s evasion efforts and further erode Russia’s economic resilience. And they can shake confidence inside the Kremlin by dashing hopes in future oil windfalls to revitalize the regime. If, however, lessons aren’t drawn and adjustments not made, sanctions could be at risk of unraveling.
* * *
Contents of the report
Measuring the Shadows explores each of these strategies in detail and assesses their potential for subverting the effectiveness of sanctions. It also offers policymakers a set of specific recommendations—based on lessons learned over the last half year—for improving the implementation of the existing sanctions framework.
The report is broken into seven chapters. The first four concern Moscow’s effort to assemble a sanction-proof fleet.
Chapter 1 examines the central role shadow tankers play in Russia’s circumvention strategy, and how their immunity to the legal and commercial deterrence of sanctions is far more important to Moscow than any subterfuge operations they may occasionally conduct.
Chapter 2 measures the size of the sanction-proof fleet currently active in Russia.
Chapter 3 estimates the number of sanction-proof tankers Moscow would need to keep exports whole and fully sheltered from the price cap. This quantity, it turns out, far exceeds the number of sanction-proof tankers active in Russia. The result is a substantial shortfall—or “tanker gap”—amounting to some two-thirds of the total volume Moscow needs for full export autonomy.
Chapter 4 assesses Moscow’s prospects for closing this tanker gap through recruitment and acquisition. It concludes that closing the tanker gap in any reasonable timeframe is highly unlikely, owing to limited supply, rising costs and a steepening treadmill of attrition.
Chapter 5 examines Moscow’s second, complementary evasion strategy. It traces how, in the early months of 2023, Russian exporters managed to engage mainstream tankers to carry cargoes priced above the price cap apparently by providing them with fraudulent pricing information.
Chapter 6 explores Moscow’s efforts to manipulate its OPEC partners into cutting output to boost oil prices while trying to avoid any substantive cuts of its own.
Chapter 7 details four specific recommendations to safeguard existing sanctions and help them function more effectively:
lowering the price cap, which both reduces Moscow’s oil revenues while also reducing its incentives to cut volumes to boost prices;
combating price attestation fraud by developing a whitelist of approved traders;
cracking down on the involvement of EU/G7 entities in the sale of used tankers to Russian or undisclosed buyers;
requiring ships transiting EU/G7 territorial waters to verify that their spill liability insurance is adequate and current, which can sharply reduce both shadow tanker activity and the risk of a catastrophic accident.
This report concludes that the recent rise in the existing sanctions framework provides policymakers with the tools they need to thwart Moscow’s strategies and impose much greater economic costs on the Kremlin, but only if these tools are used more effectively.
Measuring the Shadows is part of on-going analytical research into Russian oil sanctions. Its key conclusions are based in part on detailed modelling of Russian shipping patterns using open-source data. Its judgements are informed by the author’s 25-year career in the global financial markets—including extensive professional exposure to Russian oil executives and government officials—as well as prior academic training in Russian and Middle Eastern languages and history.
Part 1: Moscow’s “physical” evasion strategy: assembling a sanction-proof fleet
Chapter 1: Russia’s peculiar shadow fleet—evading sanctions through immunity, not subterfuge
The shadow fleet active in Russia today differs from shadow fleets elsewhere. Instead of relying primarily on subterfuge operations to circumvent sanctions, Russia’s “sanction-proof” tankers rely on immunity from the legal and commercial deterrence.
Not all shadow fleets are the same. Moscow’s fleet relies primarily on sanctions immunity rather than subterfuge to circumvent the price cap.
Since last summer, Moscow has been trying to assemble, through chartering and outright acquisition, a fleet of tankers capable of circumventing price-cap restrictions. These tankers would allow Moscow to receive the full market value for its oil when market prices are above price-cap limits set by the EU/G7 alliance. The core of this sanctions-circumvention fleet consists of tankers from Russia’s own state-owned shipping company, Sovcomflot (SCF). Supplementing them is a swelling roster of shadow tankers that have begun lifting oil from Russia over the last twelve months.
Moscow’s shadow fleet is similar in some respects to shadow fleets found elsewhere…
Much has been written about the shadow fleet in Russia. It is often assumed to be similar to the shadow trade in sanctioned oil elsewhere in the world, such as Iran. The comparison is valid, but only to a point. Shadow tankers operating outside of Russia tend to have four distinguishing features:
1. they are old,
2. anonymously owned,
3. focus on sanctioned oil and
4. seek to evade sanctions monitors by engaging in deceptive shipping practices.6
Nearly all shadow tankers active in Russia share the first three characteristics—advanced age, anonymous ownership, and focus on sanctioned oil.
… except it does not rely on subterfuge as its primary means of evading sanctions.
But the fourth characteristic—subterfuge—is not a defining feature of the Russian shadow trade. That’s because, unlike elsewhere, shadow tankers active in Russia do not need to rely on subterfuge to circumvent sanctions. To be sure, some shadow tankers transporting Russian cargoes are involved in subterfuge operations. This has been documented by valuable reporting on incidents of “dark” ship-to-ship transfers, AIS “spoofing” and other deceptive shipping practices.7 And in some cases, these practices are likely being used to smuggle Russian oil into closed markets, like the EU.
But it’s important to keep the scale of these clandestine operations in perspective. The aggregate volumes involved in such physical subterfuge operations normally represent only a few percentage points of Russia’s total seaborne exports. In the greater scheme of Russia’s circumvention strategy, subterfuge operations are, at most, of marginal significance. Moscow is primarily using the shadow fleet in a very different, quite overt way to evade sanctions. And as EU/G7 authorities consider how to allocate limited enforcement resources on Russian sanctions, focusing on tanker subterfuge at sea is unlikely to be the best option. Taking steps to limit overall shadow-tanker activity and combat fraudulent pricing information will have a much higher impact (see Chapter 7).
Most Russian oil transported by its shadow fleet is carried overtly, with no effort at concealment.
The simple reason is that, unlike elsewhere, subterfuge is simply not required to sidestep the sanctions imposed on Russia. Most Russian oil transported by shadow ships today in circumvention of the price cap is carried overtly, with no effort whatsoever at concealment. There are no ship-to-ship transfers, AIS signals remain switched on and undistorted, and cargoes are easy to track from loading to landing.
Many sanctions regimes include a “secondary” sanctions feature, like U.S. sanctions on Iran. That means all parties to a transaction, regardless of their jurisdiction, are subject to sanctions, thus creating a shared need for concealment and subterfuge.
The reason subterfuge is not needed arises from a fundamental difference between the oil sanctions imposed on Russia versus those imposed elsewhere, such as Iran. The Iran sanctions have a secondary component. This allows punitive measures to be taken against third-party entities around the world. The U.S. Treasury can, for example, impose sanctions on third-country importers if they are caught dealing in sanctioned Iranian oil. So, to reduce their risks, third parties handling Iranian oil seek to obscure its origins. Consequently, stealth and subterfuge have become the stock-in-trade of the shadow fleet active in Iran.
But Russian oil sanctions are “primary” sanctions only, with a focus on EU/G7 entities; they thus create an opportunity for third-country entities to openly import Russian oil free from sanctions risk.
But the Russia shadow trade is different. Russia sanctions are primary only. Unlike Iranian sanctions, they apply only to entities based in the EU/G7+ sanctioning countries themselves—not to third-country businesses. So, an importer from a non-sanctioning country faces no legal risk of direct sanctions for trading in Russian oil.8
For Moscow, what matters most is not a tanker’s capacity for stealth, but whether it is immune to the deterrent force of sanctions—whether it has the ability to disregard the price cap openly and with impunity.
Consequently, when it comes to assembling its shadow fleet, the attribute of greatest interest to Moscow is not a tanker’s stealth and subterfuge. It’s something more mundane: it’s a tanker’s immunity to the deterrent force of sanctions—an immunity that renders it “sanction proof.” This quality gives a tanker the ability to openly and reliably transport Russian cargoes priced above the price cap without concern for legal or commercial repercussions. In short, they can disregard the price cap with impunity. Together, these tankers form what can be called Moscow’s “sanction-proof fleet.”
Deterrence takes two forms: legal and commercial.
In the scheme of Russian oil sanctions, deterrence comes in two forms: legal and commercial. Whether a ship is subject to these deterrents depends on two things: (1) where their owners are based and (2) who provides their critical marine services—especially mortgage finance and liability insurance.
(1) Legal deterrence is limited to EU/G7 ship owners; violating sanctions can land them in court.
Ship owners based in the EU or G7 are subject to legal deterrence. If they violate the price cap, they are violating the law of the country in which they are based. If caught, they will likely end up in court.
(2) Commercial deterrence affects any ship owner worldwide who relies on EU/G7 entities for key marine services, such as ship financing and insurance.
Ship owners based outside price-cap alliance countries don’t face legal action for violating sanctions. But they can face painful commercial consequences. Most ship owners based in non-sanctioning countries rely on EU/G7 entities for certain critical marine services. If those ship owners violate the price cap, their EU/G7 marine service providers are obligated by law to terminate their service arrangement.
In some cases, those services might be easy to procure from providers outside the EU/G7. But not all. For example, EU/G7 banks have a broad global footprint in the ship mortgage sector. If a non-EU/G7 ship owner funded by a European bank violates sanctions, they could find themselves forced into a painful loan restructuring. For some ship owners, the prospect of a loan restructuring will be sufficient to deter them from violating sanctions.
The EU/G7 service sector with the broadest global footprint is marine insurance, which provides mandatory spill liability (P&I) coverage to some 95% of the global fleet through the Europe-headquartered International Group of P&I Clubs
As significant as EU/G7 may be in ship financing, the EU/G7 marine service sector with by far the broadest global footprint is marine insurance (see Figure 1). Specifically, it’s the highly specialized area of oil spill liability (“P&I”) insurance, which is mandatory for oil tankers. Some 95% of the global tanker fleet obtain their P&I insurance through a quasi-monopolistic network of not-for-profit, mutual assurance societies called the International Group of P&I Clubs (the “IG”).
Comparable alternative coverage at scale does not exist, creating a strong commercial deterrent to violating sanctions…
Because nearly all the principal clubs are based in EU/G7 countries, the IG requires all insured vessels to comply with Russian sanctions as condition of insurance. And because comparable alternatives to IG P&I coverage simply don’t exist at scale, the IG enjoys a near-monopolistic grip on the mainstream tanker market. IG coverage is often compulsory for securing loans from mainstream banks, entry to key ports and charter opportunities with large oil concerns. Consequently, fear of losing it acts as a powerful commercial deterrent to violating the price cap.
…which may help to explain why China’s state-owned tanker fleet, which is insured through the International Group, has—apparently out of an abundance of caution—stopped lifting oil from Russia since the introduction of sanctions.
As an illustration of this, consider the case of COSCO, China’s state-owned shipping giant. COSCO has China’s largest tanker fleet, which it insures through the IG. In 2019, however, COSCO went through a painful ordeal when OFAC imposed sanctions on a key subsidiary of its tanker business in connection with the Iran trade. The subsidiary’s business was severely disrupted as Western banks, traders and P&I insurers temporarily withdrew services. After eight months of back and forth, sanctions were dropped. Memory of that painful experience may help explain the conservative approach COSCO is taking to the Russia trade. Prior to sanctions, COSCO tankers regularly carried Russian oil cargoes. Since December 5, it’s hard to find a single COSCO tanker that has lifted from a Russian port.
Tankers either owned or financed by EU/G7 entities will also usually be insured by the IG. That, at least, is the case for pretty much any of the medium-to-large-size tanker classes (i.e., over 25,000 deadweight tons) that handle nearly all the Russian export trade. Mainstream European or American lenders will be reluctant to lend without proper insurance. Without taking on large amounts of debt, EU/G7 ship investors cannot get the levered returns they seek.
But for EU/G7 ship owners, having an IG P&I policy isn’t just enabling levered returns. It’s also about managing catastrophic risk. These investors are based in countries with relatively robust legal systems able to impose large punitive damages on ship owners for catastrophic spills. And under international conventions, ship owners bear ultimate liability for oil spills. So, to take on ownership risk, EU/G7 investors will want to be sure their insurance provides bullet-proof protection from unlimited liability. When it comes such protection, along with related matters such as track record of payouts, financial transparency, capital adequacy and good corporate governance, there is simply nothing comparable to P&I coverage from an IG club.
The small segment of the global fleet not insured by the International Group possesses the immunity to sanctions that Moscow seeks for its shadow fleet…
Those tankers not insured by the IG, then, tend also to be neither owned nor financed by EU/G7 entities. For Moscow, that’s a charmed combination. This lack of ownership and service ties to sanctioning countries endows these tankers with the effective immunity to sanctions that Moscow seeks. It’s these tankers that can carry cargoes priced above the price cap—no questions asked—and face no legal or commercial consequences for doing so. They are the “sanction-proof” tankers Moscow seeks to assemble into a fleet large enough to transport all Russian oil exports free from price-cap exposure.
…making insurance status a fairly accurate litmus test for distinguishing between mainstream and sanction-proof tankers in the Russia trade.
For those observing tankers loading out of Russia and wanting to distinguish which are sanction-proof and which are not, the vessel’s insurance provides an easy, nearly foolproof, litmus test. If a tanker is insured for P&I through the IG, it’s almost certainly a mainstream, price-cap compliant tanker. If it doesn’t carry IG P&I, it’s very likely to be a sanction-proof tanker able to transport non-price-cap-compliant cargoes without regard for sanctions
Chapter 2: Measuring the Shadows—how big is the sanction-proof fleet in Russia?
Despite substantial growth over the last year, Moscow’s fleet expansion program remains far from its goal of export autonomy and appears to be slowing in the early summer.
Can Moscow assemble a large enough fleet to close the “tanker gap?”
This chapter examines a critical question for the Kremlin—and EU/G7 policymakers, too: can Moscow assemble enough sanction-proof tankers to meet most of or all its export needs? We’ll start by measuring how many sanction-proof tankers are already active in Russia. Next, we’ll estimate how many Russia would need to form a stand-alone fleet capable of sustaining recent export volumes free from any price cap limitations. As we shall see, there is a sizeable capacity gap between what Moscow currently has and what it needs. Finally, we’ll assess Moscow’s prospects for being able to close this “tanker gap” in any practical timeframe. Among other things, this assessment will consider aggregate costs and available supply in the used tanker markets.
Two categories of tankers make up Russia’s sanction-proof fleet: state-owned Sovcomflot tankers and “shadow fleet” tankers.
Since February 2022, most tankers loading in Russia continue to be from the mainstream fleet. They are either EU/G7 owned, financed, or insured—in some cases all three. This means they will have strong legal and commercial incentives to observe sanctions by being price-cap compliant.
Apart from this mainstream, price-cap compliant fleet, a parallel “sanction-proof fleet” has been active in growing numbers in the Russia trade since the summer of 2022. It’s made up of two categories of tankers: those from state-owned Sovcomflot and the so-called “shadow fleet” (see Figure 2).
The capacity of Sovcomflot tankers active in the Russia trade has remained stable over the last year, averaging the equivalent of around 70 Aframax tankers.
Prior to Russia’s full-scale invasion of Ukraine, tankers from Russia’s state-owned shipping company, Sovcomflot (SCF), were part of the mainstream fleet. They were insured by the IG and financed by Western banks. But when SCF was sanctioned in March 2022, the IG cancelled their insurance and Western banks pulled their loans.
Now, with no residual ties to EU/G7 service providers, SCF vessels are able to transport non-price-cap-compliant cargoes with impunity. Over the past year, the capacity of SCF vessels involved in the Russia trade has remained stable and equivalent, on average, to the capacity of 70 Aframax tankers (see Figure 3).9
The source of growth for Russia’s sanction-proof fleet has come from a surge in “shadow tankers” into the Russia trade.
In addition to Sovcomflot tankers, the second category of tankers making up Russia’s sanction-proof fleet are shadow tankers. The roster of shadow tankers engaged in Russia has expanded significantly since the summer of 2022. Like SCF, they have no apparent reliance on EU/G7 finance or insurance. Unlike SCF, however, their ultimate beneficiary ownership remains largely anonymous. Their owners of record are typically single-ship shell companies, registered in off-shore tax havens, whose ultimate beneficiary ownership is difficult to determine based on publicly available information.
Shadow fleet tonnage active as of June 2023 equaled that of some 135 Aframax tankers
Since summer 2022, the capacity of shadow fleet tankers active in the Russia trade has expanded significantly, by the equivalent of some 110 Aframax tankers. By mid-June 2023, the total carrying capacity of Russia’s active shadow fleet equaled around 14.5 million deadweight tons, or the equivalent of 135 Aframax tankers.10 This capacity is distributed among some 163 different shadow tankers currently active in Russia, with deadweight tonnage ranging from 30,000 to 165,000 tons.
Shadow tankers active in Russia have had a mixed record of consistent dedication to the Russia trade.
Moscow will be aware that the shadow tankers engaged in the Russia trade have a mixed track record of consistent engagement. Among tankers active in Russia through mid-June 2023, well over half (57%) had loaded only once or twice in Russia since mid-March 2022. And fewer than a third (29%) had built anything resembling a solid track record of dedication to the Russia trade by lifting at least four times or more, with only a handful lifting ten or more times over this period (see Figure 5).
The low percentage of tankers with established track records can’t just be explained away by the relative novelty of shadow tanker activity in Russia. As Figure 6 shows, there is a weak correlation between the number of months a shadow tanker has been engaged in Russia and the number of Russian cargoes it has loaded (R2 = 0.2859). Some tankers have managed a dozen loads in fewer than 7 months. Others started lifting over a year ago but have managed only two or three loads since.
This lack of consistent dedication to the Russia trade comes both from the opportunistic pursuit of business in other markets…
What explains this lack of consistency? Part of it appears to be the opportunistic nature of some of the shadow tanker owners. Russia is just one of several places where they seek business, and they move in and out of the Russia trade as it suits them. Many appear to avoid time charters—long-term leasing arrangements—preferring to charter on a spot basis.
And the Russia trade simply may not suit some shadow tanker owners, even if the rates are lucrative. It can, for example, pose certain risks and burdens not found in the Iranian trade. Routes can be long and demanding, exposing crews and vessels to harsh winter conditions and ice hazards in the Baltic. By comparison, voyages from Iran to India or even China can be far less taxing. Lifting from Russia’s Western ports also brings shadow vessels into European territorial waters, which may expose them to greater risk of seizure if they have fallen afoul of secondary sanctions imposed on Iran or other regimes.
…and unexpected operational interruptions that shadow tankers are prone to.
But this lack of consistency is also driven, in part, by the high incidence of unexpected operational interruptions to which shadow tankers seem to be prone. These incidents range from collisions to detentions to scrapes with the law. Here is just a sampling of things that have gone wrong in recent months for shadow tankers engaged in the Russia trade:
An 18-year-old Cook Islands-flagged tanker, fully loaded out of Vysotsk, lost power in May while navigating the treacherous Danish Straits, straying from the narrow channel and nearly running aground a mile off the pristine coast of Langeland (see Appendix: A brush with disaster in the Danish Straits—shadow tankers menace the Baltic).
a 20-year-old Panamanian flagged Aframax, laden with Russian oil, lost control and collided with a cargo ship last fall in the congested Strait of Malacca. No spill was reported. It was dispatched to China for repairs where it remains ten months on;
a Vietnam flagged tanker was detained in port by Spanish authorities in February, possibly in connection with banned Russian-origin cargo, and later released;
a 19-year-old Indian registered tanker went into dry dock in Dubai last fall for repairs shortly after unloading its Russian cargo, only to languish there for seven weeks before resuming operations;
a 17-year-old Liberian flagged Aframax began regularly lifting oil from Russia following a seven-week detention in a European port early this year, after extensive deficiencies were uncovered during in a port-state inspection;
and then there’s the case of the 20-year-old, Liberian flagged Suezmax that had just finished unloading its Russian cargo in Sicily last November when the US Treasury imposed sanctions on the vessel and its owner for financing Hizballah and the Iranian Revolutionary Guard. The vessel managed to slip out of port and avoid detention, but has remained at anchor in the Eastern Mediterranean ever since.
Such frequent troubles are no mere coincidence. As we shall see below, it’s the inevitable result of a business model built around a high appetite for risk and an aggressive attitude towards compliance-related cost-cutting. So long as Russia choses to rely on the shadow fleet, it will need to factor in an elevated level of unreliability into its plans.11
To ensure more tankers dedicate themselves exclusively to the Russia trade, Moscow appears to be covertly funding the acquisition of shadow tankers rather than relying on market forces to ensure an adequate supply of shadow tanker capacity.
It is in Moscow’s interest to reduce this risk of unreliability and inconsistency. Normally, exporters could manage this risk by engaging tankers in long-term time-charters. That option, however, may not be widely available in the shadow tanker market.
But there is an alternative to time charters when it comes to ensuring availability of tankers: owning these vessels outright. Senior Russian officials have long been discussing the need for Russia to assemble a proprietary fleet as well as the formidable financing needs this would entail.12
It’s very likely Moscow has begun acting on these plans. A remarkably high percentage of tankers active in Russia—some 82%—have changed hands since March 2022 (see Figure 15 below). How many of these sales represents covert Russian buying can’t be determined from publicly available information. Some sales were almost certainly to non-Russian buyers and conducted in the normal course of shadow fleet renewal. By its nature, the shadow fleet has high rates of turnover. But it’s likely that at least some of these purchasers—perhaps a large portion of them—are covert Russian buyers, an observation echoed by some ship brokers. If so, it would represent Moscow’s efforts to secure higher levels of shadow fleet commitment to the Russia trade by gaining control of tankers through direct ownership (a more detailed discussion of the costs and challenges of Moscow’s apparent acquisition program can be found in Chapter 4 below).
The pace of shadow-fleet expansion was highest over the winter but has slowed significantly since May.
It’s notable, however, that after a strong surge in numbers over the winter, the rate of shadow fleet expansion has slowed significantly from May into July 2023 (see Figure 4 above). This could be just a momentary downturn. But it may also reflect deeper structural impediments that Moscow’s fleet expansion program has begun to encounter, such as a decline in the availability of suitable tankers and rising costs. In Chapter 4, we shall examine these structural impediments in greater detail. First, however, we must estimate a key quantum: how many tankers does Russia need to keep its exports whole and untouched by the price-cap?
Chapter 3: How many shadow tankers does Moscow need in all?
The EU/G7 import ban has doubled Russia’s shipping needs. The Sovcomflot and shadow tankers currently active in Russia covers barely a third of the capacity Moscow needs for a stand-alone, sanction-proof fleet. The result is a gaping “tanker gap.”
Prior to Russia’s full-scale invasion of Ukraine, some 75% of seaborne oil exports went to EU/G7 countries, principally in Europe.
It’s hard to overstate the significance of the EU/G7 ban on Russian oil imports. They abruptly terminated a 145-year history of Russian oil exports to Europe that has endured through revolutions and world wars. In recent years, Russia’s oil sales to the EU had become what is likely the largest bi-lateral, single-commodity trade in the history of global commerce. And then suddenly, in under a year, it all but disappeared. Such a seismic shift was bound to pose huge challenges to Moscow, and it has.
Chief among these has been the need to find new buyers in markets that are smaller, more concentrated, much more remote, and far less familiar. Prior to Russia’s full-scale invasion of Ukraine, some 75% of Russia’s seaborn exports flowed to EU/G7 countries. Most of these exports were shipped through Russia’s highly developed export hubs on the Baltic and the Black Sea to nearby destination ports in the EU, UK, and Turkey. Only a trickle flowed East of Suez (see Figure 7).
The EU/G7 ban on Russian imports has forced exports to reroute to new markets East of Suez, nearly doubling Russia’s shipping capacity needs.
From March 2022 through February 2023, the map of Russian exports gradually but profoundly shifted (see Figure 8). In the early months, voluntary self-sanctioning by some importers drove the trend, with the imposition of hard sanctions eventually completing the transformation.
Sanctions have had the smallest impact on Asia-bound flows through Russia’s capacity-constrained ESPO pipeline. Most of these continue to end up in China either directly overland or shipped by sea via Russia’s Pacific ports.
Russia’s much larger westbound flows, by contrast, have been profoundly disrupted. The immense seaborne flows, previously destined for European destination ports, are still exiting Russia via its western ports in the Black Sea and the Baltic. But now they sail past Hamburg and Rotterdam, continuing on to distant markets located mostly East of Suez. These seaborne flows have been augmented by barrels formerly shipped overland to Central Europe via Russia’s Druzhba pipeline. Most of these—some half million barrels a day—have now been rerouted to Russia’s Baltic or Black Sea ports for shipping by sea to new markets far beyond Central Europe. The longer distances to market have roughly doubled the tanker capacity Russia needs to keep it exports whole.
Most of Russia’s dislocated oil has gone to India or Asian trading hubs, with less than 10% going to China
Over half of Russia’s dislocated oil has gone either to India or trading hubs in the UAE and Singapore. Contrary to some reports, however, only a small portion—less than 10%—reaches China (see Figure 9). Several things explain this.
First, Russia’s straitjacket of pipelines and ports forces most dislocated oil westward, making freight costs to distant China unattractive. Russia’s constrained East Siberian pipeline system doesn’t allow significant amounts of dislocated oil to be moved overland to China or the Pacific coast.
Second, China seeks to diversify supply. With Moscow already one of its top two suppliers (alongside Saudi Arabia), appetite for incremental Russian oil is likely limited.
Finally, Moscow itself is trying to reduce its dependence on mainstream tankers. Shipping from western ports to China requires two-thirds more tanker capacity than to India. And the more tankers Russia needs to keep exports whole, the more exposed it becomes to the risk of price-cap limitations.
To sustain current export levels fully sheltered from the price cap, Moscow would need a fully dedicated, stand-alone, sanction-proof fleet equal in capacity to 637 Aframax tankers…
Russia’s seaborne export levels have remained stable, averaging over 6 million barrels a day of crude and refined products in recent months, despite the fundamental shift in Russian export patterns. Currently, most Russian seaborne oil is transported by mainstream tankers, which are obligated to comply with the price cap. For Moscow to completely avoid exposing any of its exports to price caps, it would need to rely on a stand-alone fleet of sanction-proof tankers. To keep fleet size to a minimum, Moscow would want every tanker in it dedicated exclusively to the Russia trade, with no one working part time for other exporters. At any given moment, a fleet tanker would need to be either laden with Russian oil and outbound to its destination port, or in ballast returning to a Russian port to lift a new cargo (see Figure 10).
To transport Russia’s full export volumes on a sustained basis, free from any price cap restrictions, Moscow would need a fully dedicated, sanction-proof fleet with an estimated capacity equal to 637 Aframax tankers, based on analysis of recent shipping patterns (see Figure 11).13
Currently, Moscow’s active sanction-proof fleet covers less than a third of these needs…leaving a yawning “tanker gap” equal to some 432 Aframax tankers.
The combined capacity of Russia’s current sanction-proof fleet—Sovcomflot vessels plus shadow fleet—comes to 21.9 million deadweight tons, the equivalent of some 205 Aframax tankers. That covers just 32% of Russia’s total capacity requirements for a stand-alone, sanction-proof fleet (see Figure 12). The result is a large shortfall in capacity—a “tanker gap”—of around 46.2 million deadweight tons, or some 432 Aframaxes.
To fully circumvent the price cap on a sustainable basis, Moscow will need to close this yawning gap. But until it does, Moscow will remain heavily dependent on the ample supply of mainstream tankers ready to transport oil from Russia, provided it’s price-cap compliant.14 In the next chapter, we examine Moscow’s prospects for closing the tanker gap.
Chapter 4: Can Russia close its “tanker gap?”
Full export autonomy for Russia looks years away as structural factors in the tanker markets—constrained supply, rising costs and high levels of attrition—impede Moscow’s efforts to quickly close the remaining gap.
Despite a year of effort, Moscow has managed to reduce last summer’s tanker gap by only 20%.
Moscow’s prospects for quickly closing this yawning tanker gap are not good. Despite a major push over the last year, which included gathering much low-hanging fruit, Moscow only managed to reduce its tanker gap by a mere 20% (see Figure 13). At that pace, it will take years for Moscow to reach its goal of a stand-alone, sanction-proof fleet. But even last year’s modest pace of expansion looks unlikely to be sustainable.
The reason: the shadow fleet in Russia is mostly purchased, not hired. Moscow is finding that it can’t rely on the spot charter market to provide the kind of fully dedicated shadow tanker capacity it needs. Instead, a large portion of the shadow fleet now active in Moscow appears to have been purchased in the second-hand tanker markets specifically for the Russia shadow trade—much of it likely financed with Russian money.
Three formidable structural challenges will impede Russia’s efforts to expand its shadow fleet: constrained supply, rising prices and high attrition.
But a fleet expansion program of Russia’s magnitude that relies on buying up used tankers faces formidable challenges that can impede growth. These include:
(1) constrained market supply: a constrained supply of tankers in the global fleet that are suitable for conversion to the shadow trade;
(2) rising prices: sharply rising costs for acquiring these tankers; and
(3) high levels of fleet attrition due to age: as Russia’s shadow fleet expands, attrition rates rise, requiring an increasing portion of acquisition spending to go towards fleet renewal rather than further expansion.
It appears the impediments of short supply and rising costs may already be at work, judging from the sharp slowdown in shadow fleet expansion over May and June (see Figure 4 above).
* * *
Historically, Moscow relied on the spot chartering markets to meet most of its tanker supply needs.
When it comes to securing tanker capacity, exporters have three basic options they can turn to:
(1) Spot chartering: hiring vessels on a voyage-by-voyage basis, akin to hailing a taxi to take you to the airport;
(2) Time chartering: leasing a tanker for a longer period of time and using it for multiple round trips; and
(3) Vessel ownership: owning the tanker outright.
Historically, Russia has done all three. It owned a fleet of tankers through Sovcomflot, and some exporters leased vessels on a time-charter basis. But by far the largest source of tonnage prior to sanctions (and still today) was from spot charters. As mainstream vessels deliver cargoes from exporters around the world to destination ports in Europe or China, they would then tender for spot charters at a nearby Russian port. It’s much like a taxi dropping off a departing passenger at the airport and then picking someone up from arrivals. The proximity of Russia’s export terminals to the two largest importing markets in the world assures Russia a large, steady, competitive supply of mainstream tankers on tap.
The spot chartering model works well when there is an overabundance of available vessels. But when there’s a very limited supply of vessels—as in the case of the shadow fleet—the spot chartering model works poorly. If a Russian exporter doesn’t want to charter a price-cap compliant, mainstream tanker, it could be left waiting a long time for a shadow tanker to become available for a spot charter. As we shall see in Part 2, that’s exactly what happened at the Russian port of Kozmino last December, when mainstream tankers stopped loading in the weeks immediately following the introduction of crude sanctions (see Figure 21).
The spot charter market has not worked well for recruiting shadow tankers from the pre-existing fleet; only 11% of shadow tankers active in Russia, for example, have also participated in the Iran trade.
Commentators had expected Russia would succeed in recruiting many shadow tankers from the global shadow fleet that had grown over the years to service Iran, Venezuela and other sanctioned regimes. That simply hasn’t happened. Only 11% of Russia’s active shadow fleet, for example, appears also to have participated in Iran’s large shadow trade (see Figure 14).15
Russia’s struggle to hire shadow tankers on a spot charter basis may explain much of the trouble it has had with shadow tanker commitment (see Figure 5 and Figure 6 as well as the discussion in Chapter two). Many third-party shadow tanker owners simply appear unwilling to dedicate their vessels full time and exclusively to the Russia trade. Nor do many appear ready to lease out their vessels on a time charter basis. One can speculate on why so few shadow tankers switched from the Iran to the Russia trade, but it’s hard to know with any certainty.
Consequently, Russia’s shadow fleet is mostly being bought not hired. Tankers are purchased—mostly from the mainstream fleet—rather than recruited from the pre-existing global shadow fleet.
Given the challenges of chartering fully dedicated shadow tankers from the existing global shadow fleet, a growing number of shadow tankers have entered the Russia trade as the result of outright sales. Some 82% of shadow tanker capacity active in Russia has changed ownership since March 2022 (see Figure 15). Most of those purchases have been from mainstream sellers. The new owners, typically opaque shell companies registered outside the EU/G7, dropped IG P&I coverage for their new vessels, thus rendering them effectively sanction-proof and fit for the Russian shadow trade.
Buying used tankers for conversion to the shadow trade is nothing new. The shadow fleet business model centers around buying mainstream tankers cheaply and then sweating them for cash.
This pattern of buying tankers from the mainstream fleet for conversion to the shadow trade is nothing new. For years it has been core to the shadow fleet business model. This business model involves purchasing aging tankers cheaply and sweating them for cash during their few remaining years of service. Costs are cut by slashing expenditures on maintenance, safety, and spill liability insurance. Revenues are enhanced by pursuing lucrative cargoes of sanctioned oil. The shadow fleet model often also involves moving the vessel’s registration to a “black-listed“ or “grey-listed” flag state—one known for lax enforcement of international standards of safety and insurance when certifying ships on their registers.
The challenge for Moscow is this: its demand for shadow tankers is unprecedented in size, while the global supply of vessels suitable for the shadow trade is constrained.
The main challenge for Moscow’s fleet expansion program is the sheer magnitude of sanction-proof tanker capacity it needs. It’s many times greater than what previously sanctioned exporters have required. That’s a function of both Russia’s larger volumes and the longer average voyage times compared, say, to an exporter like Iran. But the supply of mainstream vessels worldwide suitable for conversion to the shadow trade is constrained. That begs the critical question: are there enough suitable tankers available at economically rational prices to meet Russia’s sanction-proof shipping needs?
The tanker industry’s need for large amounts of capital while exposed to catastrophic spill risk binds most of the global fleet in a web of compliance obligations incompatible with the shadow fleet business model.
To understand the reasons for the constrained supply, it’s necessary to understand a unique challenge facing the global tanker fleet: how do you finance a highly capital-intensive industry in the face of massive oil spill liability exposures that are many times greater than the value of the ships and cargoes themselves? Over the decades, ship owners, banks, insurers, and regulators have negotiated a solution that is imperfect but functional. It involves binding the vast majority of tankers in the global fleet in a web of compliance obligations aimed at protecting investment capital from catastrophic risk. Compliance involves spending significant sums both on safety and maintenance designed to reduce the risk of spills as well as quality insurance needed to limit liabilities when spills occur. These compliance obligations are costly to uphold and can last for years, making most tankers unsuitable for conversion to the shadow trade for most of their service life.
Three factors in particular interact to create these compliance obligations: debt, insurance and statutory inspections.
1. Debt. First, the global fleet of oil tankers must be continually renewed through the construction of new vessels. To finance newbuilds, which can cost $100 million or more, ship owners rely extensively on specialist bank lending. This financing often takes the form of a ship mortgage, secured against the vessel and its future cashflows, and other forms of structured finance. Capital markets have also been planning a larger role.16
2. Insurance. Second, for mainstream bankers to lend, they need protection against the risk of a catastrophic spill that could prevent repayment of the loan. As a condition of the loan, they will require that the tanker complies with costly statutory safety and maintenance requirements and carries quality P&I insurance, with IG insurance being standard for the industry.
3. Inspections. Third, to help reduce the risk of spills in the first place, regulatory bodies and quality insurers require a range of regular safety inspections. By far the most consequential are those conducted as part of the Enhanced Survey Program (ESP), which is overseen by the International Maritime Organization (IMO), shipping’s supranational governing body. Under the ESP, a tanker must undergo extensive structural surveys every 5 years as a condition of recertification, with levels of scrutiny rising over time.
Together, these three factors impose a three-phase lifecycle on most tankers which includes a narrow window, late in life, when vessels become suitable for the shadow trade (see Figure 17).
Phase 1, up to 15 years old, is the “high compliance” mainstream phase.
The first phase is largely driven by the maturity schedule of ship mortgages. With loans typically extending 10 to 15 years, tankers will be bound by lending and insurance conditions to remain highly compliant with regulatory requirements throughout this period. They’ll need to spend enough on maintenance to make certain they pass the ESP recertification surveys at year 5, 10 and 15. And since the International Group will generally be providing the P&I insurance coverage, ships will be prohibited from taking up the sanctioned oil trade during this period. Most mainstream lenders will also impose covenants prohibiting any trade in sanctioned oil. These highly compliant ships make up what can be called the “mainstream fleet” or “compliant fleet.” By extension, all these ships are obligated to be “price-cap compliant.”
Phase 2, the “shadow fleet window” runs between ages of 16 to 20 years, when compliance obligations ease…
At 16, however, with the initial mortgage paid down, the third renewal survey passed and a fresh recertification in place, compliance obligations on a tanker ease significantly. At this point, a typical tanker has only a few years of service left. It still retains some residual value in the second-hand market, but hull fatigue and the ravages of time are taking their toll. By the time the tanker turns 20, it often makes more economic sense to sell the vessel for scrap than attempt to pass a fourth recertification survey.17
It’s during this phase, between the ages of 16 and 20, that mainstream operators often opt to sell off these aging vessels and use the proceeds to fund fleet renewal. These sales provide a steady supply of tankers to the secondary market. The buyers of these vintage vessels tend to be niche, end-of-service-life operators. Some pursue the mainstream fleet business model—but not all.
…making tankers well suited for purchase and conversion into shadow service.
Tankers in this age cohort make ideal candidates for conversion to the shadow fleet. With only a few years of expected service life, they are typically cheaply priced. They are likely unencumbered with debt, which means quality insurance can be dropped in favor of coverage from an often obscure, low-transparency provider of indeterminate quality. And since owners have little expectation of eventually submitting the vessels for its fourth recertification survey at age 20, maintenance costs can be slashed to the bone.
Instead, once the vessel reaches 20 years, these exhausted tankers will typically get beached with a favorable tide at one of the sprawling ship breaking yards at Chittagong—the graveyard of the global fleet. There, they are sold for scrap. These hulking carcasses can lie on the sands for months, leaching toxic heavy metals into sediments and water, while low paid workers laboring in Dickensian conditions strip them of metal parts which are dispatched to nearby steel mills for recycling.18
Phase 3, from 21 years on, is marked by high rates of attrition and scrapping.
The final phase comes after age 20. Many vessels will already be scrapped by this point. When freight rates are exceptionally high, however, strong cash generating potential can justify the expenditures needed to pass a fourth recertification survey. In time, age will cause utilization rates to decline. Very few tankers will make it to a fifth recertification survey.
The shadow fleet active in Russia exhibits the same characteristic clustering of tankers in the 16-to-20-year-old age group as the global shadow fleet; 87% of the tonnage is above the age of 15.
Vessels younger than 15 or older than 20 can and do get bought for conversion into the shadow trade. But between the higher upfront costs for younger vessels and the limited remaining service years for older ones, the economics can be challenging. So, it’s no surprise, then, that the average age of shadow tankers active in Russia exceeds 18 years, with some 87% 16 years or older. What is also notable and typical is the very sharp step down in the vessel count between ages 20 and 21—a result of recertification attrition (see Figure 16).
On paper, the global supply tankers of suitable age and class is sufficient to cover Russia’s shadow-tanker needs, but not by much; Russia needs an extraordinary 69% of this cohort—four times current levels.
On paper, the global supply of 16-to-20-year-old long-haul tankers in classes suitable for loading in Russia is sufficient to cover Russia’s tanker gap—but not by a large margin. Russia’s active sanction-proof fleet already represents some 17% of this worldwide cohort of 16-20-year-old tankers from the relevant classes. To cover Russia’s tanker gap, that figure would need to rise four-fold, to an extraordinary 69% (see Figure 17).19 And to maintain the current ratios among tanker classes used in the Russia trade, some 100% of Aframaxes and 78% of Suezmaxes worldwide in this age bracket would need to be operating as shadow tankers exclusively dedicated to the Russia trade.
The Russian shadow trade under sanctions has driven a large demand surge in the used markets for second-hand tankers—up 71% year on year.
There is an active global market in used oil tankers. During the twelve months following Russia’s full-scale invasion of Ukraine, second-hand markets saw a 71% year-on-year surge in sales of the tanker classes suitable for the Russian export trade. Most of that incremental volume—some 73% of it—was driven by tankers that were subsequently deployed into the Russian shadow trade (see Figure 18).
Higher demand has caused market prices to rise sharply. Prices for vintage Aframaxes, for example, are up 130% year-on-year.
As you would expect, this surge in demand has had a knock-on effect on asset values, especially for the vintage vessels favored in the Russian shadow trade. Over the same twelve months through February 2023, for example, the market value for a 15-year-old Aframax—the workhorse of the Russian trade—ballooned from $16.5 million to $38 million—a dizzying 130% rise in value (see Figure 19).20
Limited liquidity in the used tanker markets means any effort to quickly close the tanker gap will only put further upward pressure on prices...
This asset price sensitivity to increased demand sets up a real challenge for Moscow. As large as the Russian buying splurge was in the 12 months up to February 2023, it pales in comparison with Russia’s need going forward. Russia’s current tanker gap is so large that it exceeds the combined capacity of all tankers of relevant classes sold worldwide during the 12 months to February 2023, across all age groups combined (see Figure 20). Most of those trades involved Greek and/or Chinese counterparties and had nothing to do with the Russian shadow trade. For Moscow to buy more than a fraction of what it needs over the next twelve months would put further upward pressure on asset valuations.
At recent valuations, all-in acquisition costs for Moscow’s fleet expansion campaign could easily approach $20 billion. Any effort at quickly closing the tanker gap could push the price tag much higher.21
This begs two more questions: who has the balance sheet to fund such a large acquisition program? And can the potential economic benefits of a stand-alone fleet justify such a massive up-front investment? Traditional shadow fleet investors lack access to large-scale, mainstream ship finance, and it’s unlikely they have anything approaching the financial firepower to fund such a program. The acquisition costs are just too great. Even if they could cobble together funding, their business model is very value conscious. They would likely be put off by escalating asset values. And given the short payback periods required under the shadow fleet model, and the high volatility of freight rates, they will be especially cautious about overpaying for acquisitions.
…weakening the investment case underpinning the acquisition program and creating financing challenges.
This leaves the Russian state as the most likely source of funding. It has both the motivation to put capital at risk as well as the financial means needed, through a combination of budgetary resources, state bank credits and oil exporter balance sheets. It’s widely speculated within the shipping broking community that Russian money may be behind many of the recent purchases around Russia’s shadow fleet.22
As asset prices rise, the investment case becomes increasingly hard to make. For Russian producers, the economic case for investing in highly priced tankers with short remaining lives is very challenging. A large majority of any resulting windfall revenues will get taxed away by the state. The only party for whom it makes sense to fund such a program is the state itself, since it would be the primary beneficiary. But to generate enough incremental tax revenue over the course of a year simply to cover acquisition costs at today’s valuations, FOB crude prices would need to average $16 a barrel over the price cap for that entire period. Possible? Yes. Likely? Far from certain. And that’s simply to break even. Moreover, as we saw above, limited liquidity in the used tanker markets is likely to push acquisition costs much higher if Russia presses ahead with an aggressive acquisition campaign. And that means Moscow would need an even higher windfall margin to have certainty of payback in a meaningful period.
The final impediment to fleet expansion: the steepening treadmill of attrition.
As Russia’s aging shadow fleet expands, fleet attrition becomes an issue, with new acquisitions increasingly used for replacing attritted capacity rather than for fleet expansion.
It’s not only constrained supply and asset inflation weighing on Moscow’s expansion program. Many of the acquired vessels have very limited remaining service lives (see Figure 16 above). As Russia’s shadow fleet grows, an increasing number of newly purchased tankers will simply be replacing tankers lost to attrition, rather than expanding the size of Moscow’s fleet. Thus, we can expect the interlinked constraints of supply and cost along with the treadmill of attrition to greatly impede Russia’s ability to quickly assemble a stand-alone, sanction-proof fleet.
* * *
A year into its fleet expansion program, Moscow now likely recognizes the formidable structural impediments it faces. This realization will add impetus to efforts at finding alternative ways to circumvent the price cap. In Part 2, we examine Moscow’s most promising alternative method, one with the potential to completely subvert sanctions if policymakers don’t take adequate steps to address it.
Part 2: Moscow’s “paper” evasion strategy: engaging mainstream tankers using fraudulent pricing information
Chapter 5: The Kozmino Mystery: How did mainstream, compliant-fleet tankers end up transporting Russian oil priced above the cap?
In parallel to its “physical” strategy of assembling a sanction-proof fleet to circumvent sanctions, Moscow appears to have been developing a “paper” strategy as well. It works by exploiting known vulnerabilities in the price-cap compliance regime. The aim is to fraudulently engage mainstream tankers to carry cargoes priced above the price cap by providing them with inaccurate pricing information.
Price attestation fraud appears to have been used to secure mainstream tankers at Kozmino following the introduction of sanctions.
Because most grades of Russian oil have traded below their price caps for most of the time since sanctions came into force, the robustness of price-cap monitoring and enforcement has not yet been widely put to the test. The recent surge in Urals prices will change that. Until July 2023, however, there was only one major export stream which was routinely quoted above its price cap: ESPO blend crude exported from Russia’s Pacific port of Kozmino. As such, it provides a useful case study in the deployment of Moscow’s “paper” circumvention strategy and efforts by sanction authorities to counter it.
Mainstream tankers mostly dropped the Kozmino trade in early December, causing export volumes to collapse…
Before the introduction of crude sanctions in early December 2022, 75% of Kozmino exports were routinely lifted by mainstream tankers. These included a core group of Chinese state-owned and Greek-owned vessels that transported some 45% of Kozmino flows. In the weeks immediately prior to the sanctions deadline, Urals grade crude—which ships primarily from Russia’s western ports—fell far below the $60 price cap. But not ESPO, which continued to be quoted well above it. As the sanctions came into force, most mainstream tankers, including the core group, abruptly stopped loading at Kozmino—apparently over price cap concerns. With the sudden withdrawal of the mainstream fleet, export volumes out of Kozmino plunged and a capacity crisis appeared in the making (see Figure 21).
Russian traders appear to have anticipated a looming capacity crunch at Kozmino. Accordingly, November and December saw a surge in shadow tankers arriving at Kozmino Bay to help cover the expected shortfall. As sanctions kicked in, however, not enough shadow and SCF tankers had gotten enlisted into the Kozmino trade. The numbers weren’t even close to what was needed. By mid-month, exports were down 55%, helped by heavy weather.
Then a curious thing happened. Throughout December, a trio of Turkish- and Indonesian-managed mainstream tankers had continued lifting oil from Kozmino. Because they were insured by the International Group, they were obligated to observe the price cap as a condition of their P&I coverage. Indeed, all IG P&I clubs were requiring that any covered tanker doing business in Russia had to submit a special, written representation that they would comply with the price cap or forfeit their P&I coverage.23
In addition to that, for every cargo they lifted from Russia, they were obligated under G7/EU sanction rules to obtain a “price attestation”—written confirmation that the cargo was not priced above the price cap. This price attestation would normally be provided by the tanker’s charter customer. In practice, this price attestation would typically be coming from the trader or broker chartering the vessel. It would appear that the three IG insured tankers we obtaining such price attestations. Failure to do so would have lead to cancellation of their IG coverage, but as of July 2023, all three remained covered by the IG.
…but by mid-January, many had returned.
The continuous operation of these few mainstream tankers at Kozmino likely did not go unnoticed. And it seems word soon got around the market that price attestations were being provided to IG-insured vessels lifting oil from Kozmino confirming that cargoes were price-cap compliant. In early January, other mainstream tankers began to return to Kozmino and by the second half of January, even Greek ships were loading once again. Come February, the share of mainstream tankers in the Kozmino trade had largely recovered, briefly reaching 60%, before tapering back down to around 40% for much of the spring.
Throughout this period, the quoted ESPO price at Kozmino remained well above the price cap. Which leaves us with the following mystery: did Moscow really cut prices on some of its ESPO export barrels to secure capacity on mainstream, price-cap compliance tankers? Or were the price attestations fraudulently underreporting the value of the cargo?
It appears they were duplicitously engaged to carry non-compliant cargoes by bad-faith traders providing fraudulent price attestations.
When EU/G7 policymakers were developing the price cap, they identified a potential vulnerability in the price-attestation regime: the reliability of the pricing information depended on the truthfulness of the traders providing it. A bad-faith trader could fraudulently under-report a cargo’s value to secure the services of a mainstream tanker. To manage this risk, policymakers urged ship owners to exercise due diligence when taking on clients and detailed red flags to watch out for. The U.S. Treasury even provided a diagram to illustrate the bad-actor risk (see Figure 22).24 But is due diligence by ship owners and operators sufficient to root out bad-faith traders?
Many traders now handling the Russia trade are immune from sanction risk, with little to deter them from misleading shippers.
Historically, top tier global commodity trading groups played a significant role in handling exports out of Russia. These included the trading arms of major oil companies, the commodities trading teams at bulge bracket investment banks, and global commodities trading houses. All these groups have deep commercial interests in EU/G7 countries. Not surprisingly, most have now largely or completely withdrawn from the Russia business, owing to a mix of legal and reputational concerns.
The resulting vacuum has largely been filled by third-tier players based primarily outside EU/G7 jurisdictions. Consequently, this new cohort of traders is largely immune from sanctions. They face no significant consequences for handling trades priced above the price cap or providing fraudulent price attestations. Moreover, a number of these traders also have attributes that would trigger red flags detailed by policymakers in their guidelines to the EU/G7 marine transportation industry.25
Evidence suggesting attestation fraud includes…
Proving attestation fraud is difficult without access to underlying contractual information on a ship-by-ship basis. But there are two sources of evidence that strongly suggest traders have been duping mainstream tankers into carrying oil priced above the price cap by providing fraudulent information.
…sales contract data…
First, there are published data that appear to include details from sales contracts between Russian producers and traders for crude exports out of Kozmino in late 2022 and early 2023. Nearly all these contracts indicate sales prices at Kozmino that are well above the price cap.26 The data do not associate any specific tankers with specific contracts. But the aggregate volumes reflected in the contracts are large enough that some of these non-price-cap-compliant cargoes would have ended up being transported by mainstream, IG-insured tankers active at Kozmino under sanctions.
…and the notable failure of Chinese state-owned tankers to resume the Kozmino trade.
The second piece of evidence is the continued absence from Kozmino of Chinese state-owned tankers following the introduction of sanctions. Prior to sanctions, they had been a mainstay of the Kozmino trade. Unlike the Greek shippers, however, they did not return to Kozmino after the introduction of sanctions. Instead, they stayed away, even as other mainstream tankers returned to Kozmino and the ESPO volumes being shipped to China grew.
There are several plausible explanations for the enduring absence of state-owned Chinese tankers. But one seems especially compelling: alone among mainstream tanker owners, Chinese state-owned shippers are in a position to know the underlying prices of most Kozmino export cargoes, since most end up in China. These cargoes are being bought by Chinese importers and contractual information is being gathered by Chinese state customs officials. Given COSCO’s painful ordeal with sanctions in 2019 (see Chapter 1 above), they would be reluctant to jeopardize their P&I insurance by accepting a price attestation they know to be fraudulent.
The potential price-cap fraud at Kozmino came to the attention of sanction authorities early on. In April, the U.S. Treasury issued a warning to mainstream shippers about the risk of fraud at Kozmino and urged them to exercise adequate diligence.27 In the weeks that followed, the mainstream fleet’s share in the Kozmino trade went into sharp decline, falling below 10% by June, with price-cap compliant vessels increasingly yielding to sanction-proof vessels. For the moment, at least, this direct challenge to the effectiveness of the price cap seemed in retreat.
Sanction enforcement officials have urged shippers to exercise vigilance, but it’s unclear whether sufficient measures are in place to substantially reduce the risk price certification fraud.
While attestation fraud may be in retreat at Kozmino, that shouldn’t be taken as a sign that it has been effectively neutralized as an evasion strategy. Moscow doesn’t need to rely on price attestation fraud to shelter its Kozmino exports from the price cap. The Kozmino-to-China route is among Russia’s shortest export voyages, utilizing only 7% of Russia’s total capacity needs. That makes it small enough for Moscow to easily service it with a fraction of the sanction-proof fleet at its disposal. And with sanction-proof vessels now lifting over 90% of Kozmino volumes, its displacement of the mainstream fleet is nearly complete.
The Urals trade, however, is another matter altogether. The tanker capacity needs to keep Urals and other crudes flowing from Russia’s western ports is far greater than the capacity needed at Kozmino—more than eight times greater (see Figure 23). It’s very unlikely Moscow will be able to manage all its Urals flows only with sanction-proof vessels. If Urals remains above the price cap for long, Moscow is likely to resort once again to price attestation fraud, rather than cutting prices, to keep export volumes whole.
So far, not enough appears to have been done to prevent future attestation fraud. The U.S. Treasury announcement in April was a shot across the bow to EU/G7 owned and/or insured tankers, but it did not address the underlying problem. So long as mainstream tankers are allowed to rely on pricing information from suspect trading groups—ones that fail to meet red flag guidelines laid out by the enforcement agencies themselves—the price cap remains at risk of unravelling completely.
Part 3: Moscow’s strategy for boosting prices
Chapter 6: Moscow contrives to have OPEC solve its oil price problem
Moscow has used scaremongering and deception to try to manipulate OPEC into rebalancing the market while Russia avoids any real cuts itself. But the export cartel appears to have seen through Moscow’s charade.
The EU/G7 embargo of Russian oil has significantly weakened the bargaining power of Russian exporters, especially for Urals blend cargoes.
Oil sanctions have been imposing costs on Russia by causing many Russian cargoes to be sold at extraordinary discounts. Throughout the first half of 2023, Putin has been focused on reducing the discount and propping up oil prices, and understandably so.28 Since the start of Russia’s full-scale invasion of Ukraine, extraordinary discounts on crude alone have deprived Russia of tens of billions of dollars in lost revenue. These lost revenues likely exceed those directly attributable to the price caps, which, until recently, have mostly been well above market prices.
The underlying cause of the discount is Moscow’s abrupt loss of access to coalition export markets—European markets in particular. Urals blend crude accounts for roughly a third of Russian seaborne exports and is shipped almost exclusively from Black Sea and Baltic ports. Over the last fifty years, it had been sold almost entirely to European refiners. The import ban has forced Moscow to seek out new buyers, mostly East of Suez, in markets that are smaller, farther, and less familiar (see Figure 7 and Figure 8 above). To secure firm demand at scale, Moscow has relied heavily on the only readily accessible large buyer—India (see Figure 9 above). Since December, India’s dominant position among Urals importers has weakened the bargaining power of Russian exporters, enabling Indian traders to impose deep discounts.
Moscow’s circumvention strategy relies on OPEC to support slumping Russian oil prices.
Moscow’s third anti-sanction strategy takes aim at this painful and persistent problem by trying to shore up oil prices. The obvious solution to the problem is to generate greater competition among buyers of Urals. Moscow has sought out alternative buyers, but with limited success. As discussed in Chapter 3, Chinese demand for cargoes from Russia’s western ports faces multiple constraints—higher freight costs, greater need for tanker capacity and China’s policy of supply diversification. The next rational step to close the discount would be to cut supplies of Urals.
Moscow has been highly reluctant to reduce exports unilaterally. Instead, Moscow has contrived to enlist its OPEC partners in the effort to solve its pricing problems. Relations between Moscow and its OPEC+ partners—Saudi Arabia in particular—are often more fraught than public displays of bonhomie might suggest. Their interests are often misaligned, and sanctions have only exacerbated this misalignment. To obscure the misalignment, Moscow has been conducting a campaign of scaremongering and deception against its OPEC partners in hopes of both maintaining cartel support for Russia and manipulating OPEC into making additional cuts for Moscow’s benefit.
Yet sanctions—and Moscow’s reaction to them—have harmed the interests of leading OPEC producers...
Russian oil sanctions—and Moscow’s response to them—have hurt the interest of leading OPEC producers in several ways. First, there is Russia’s aggressive push into new markets East of Suez. Much of Russia’s growing market share in places like India has come at the expense of OPEC’s Gulf producers. To gain market share in the large sizes it needs, Russian exporters have offered deep discounts on Urals. This, in turn, has softened regional prices for OPEC exporters, too. Russian competition in East of Suez markets has forced OPEC’s Gulf producers to reroute some of their barrels to more distant markets in Europe. The longer distances mean higher freight costs. And these cost increases have been compounded by the sharp jump in global freight rates resulting from the dislocation of Russian exports from Europe. That’s good for shippers, but less so for producers.
Apart from turf battles over market share and higher freight costs, Moscow’s war of aggression has led to the development of a novel sanctions scheme—the price cap. No major oil exporter can be pleased with that development.
…and vastly increased Russia’s sensitivity to oil price levels relative to other leading OPEC producers.
Oil sanctions have also vastly increased Russia’s breakeven oil price relative to other leading OPEC producers, such as Saudi Araba. By early 2023, the high costs of Russia’s war of aggression coupled with weaker pricing power for exports has caused Russia’s fiscal breakeven oil price to jump 77% (see Figure 24).29
To distract from these issues and shore up OPEC support for Russia, Moscow has resorted to scaremongering, falsely claiming the price cap is a “buyers’ cartel” aimed at all OPEC producers.
Moscow has sought to distract from the harm it has done to OPEC’s interests and shore up OPEC support for Russia by scaremongering. This has taken the form of trying to persuade OPEC members that the price-cap is a buyers’ cartel intended to dictate oil prices. A buyers’ cartel is, of course, the stuff of an OPEC ministers’ nightmares. And to ratchet its partners’ anxieties even higher, Moscow has claimed Washington intends to deploy the price cap against all OPEC producers—with Russia simply the first in line.
EU/G7 sanctions, of course, do not even remotely resemble a buyers’ cartel. To start with, the countries imposing this can’t even buy Russian oil. Non-sanctioning countries, by contrast, are free to buy as much as they wish at whatever price they negotiate. The price cap is a primary sanction targeting EU/G7 marine transportation services exclusively—nothing more. All this notwithstanding, Moscow exploited early confusion about the novel price cap to portray it in a way calculated to play on OPEC fears.
Initially, at least, Moscow’s scare tactics appear to have gotten some traction. In October 2022, OPEC announced a surprise October 2022 cut which was seen by some as a sign solidarity with Moscow in the face of pending sanctions. Then, in mid-March 2023, shortly after meeting with his Russian counterpart, Saudi Arabia’s oil minister publicly warned that any attempt to impose price caps on producer states would lead to “counter-responses with intolerable consequences.”30
Moscow has tried to manipulate OPEC into cutting output by dubiously claiming Russia had led the way with its own unilateral cuts, when available data indicated otherwise…
Scaremongering was just a prelude to a broader attempt by Moscow to contrive to have OPEC cut output while Russia maintained full production. At its December meeting, shortly before crude sanctions came into effect, OPEC refrained from making any cuts, despite declining markets. Ministers preferred to wait to see how Moscow responded to sanctions. In February, Moscow announced a half million-barrel cut in March, though details were sketchy. It then began intensively lobbying OPEC partners to follow suit. The problem, however, was that Moscow’s supposed March cut wasn’t being reflected in export levels. Despite the Kremlin’s repeated assurances that cuts had been made, as of June overall exports numbers appeared, if anything, to be rising (see Figure 25).31
…and additional data was being suppressed or manipulated.
Meanwhile, Moscow had begun suppressing domestic production data on the grounds of “national security.” This reduced OPEC’s ability to monitor Russian production trends. Then tankers lifting out of Russia were then caught “spoofing” their AIS signals to conceal loadings at Russian ports.32 This only further undermined the credibility of Moscow’s supposed cuts.
OPEC appears, however, to have seen through Moscow’s charade.
By early July, Moscow’s campaign of scaremongering and its charade of apparently faux production cuts seemed to be straining relations with OPEC. At that point, Saudi Arabia appears to have strongarmed Moscow into announcing a “additional” 500,000 b/d cut, while pledging to extend its own existing cuts by a mere month. In the kabuki of OPEC+ pronouncements, this can be read as a face-saving way of forcing Moscow to finally make the cuts it claimed to be making back in February. As of late July, it appears Moscow may finally be reducing its Urals flows, helping to boost Urals prices and reduce the Brent spread.
Part 4: Helping Moscow fail faster
Chapter 7: Improving sanction implementation. Four high-impact recommendations for safeguarding sanctions and strengthening their impact
With Urals now trading above $60, the price cap is being put to the test. Policymakers have the sanction tools needed to safeguard sanctions and strengthen their impact, but only if specific improvements are made in how those tools are used. This report details four high-impact improvements informed by lessons learned over the last half year of sanctions.
Moscow opted against weaponizing oil in favor of a strategy of maximizing exports while developing ways to circumvent the price cap—a strategy that has met with mixed success.
Over the winter, Moscow made a fundamental strategic decision not to respond to sanctions with an engineered supply crisis, but to maximize output while expanding its capabilities to circumvent the price cap. This strategy of maximization and circumvention has met with mixed success. Russian tax receipts on oil in the first half were down 47% year-on-year, off an average Brent price that was down by only 25%, with sanctions—largely thanks to the wide Urals discount.
The main thrust of its circumvention strategy has been to expand its fleet of sanction-proof tankers. After a year of intense endeavor, Moscow has effectively doubled the size of the sanction-proof tankers at its disposal. But that increase was off a low base, and a yawning “tanker gap” remains. Moscow still relies on the price-cap compliant, mainstream fleet for some two thirds of its shipping capacity. Formidable obstacles of supply, cost and attrition make it unlikely Moscow can close this gap any time soon.
Moscow does appear to have had some success in fraudulently securing mainstream tankers to carry non-price-cap compliant cargoes by exploiting vulnerabilities in the compliance regime. But sanction authorities are alert to the challenge; if they step up enforcement of existing guidelines, it could sharply curtail this practice. If they fail to act, however, it could seriously undermine the effectiveness of sanctions. Finally, Moscow’s campaign of scaremongering and deception directed at its OPEC partners appears to be faltering. If Moscow wants OPEC’s help in boosting prices, it will need to share the pain of real cuts.
EU/G7 policymakers should be applauded for their collaboration and innovation in developing the sanction tools needed. But it’s still too early to say whether they will prove effective…
As for the effectiveness of sanctions, it’s still too soon to render a verdict. EU/G7 policymakers should be applauded for collaborative achievement of designing and rolling out an innovative sanctions framework—the price-cap—with little disruption to the market. Europe’s bold decision to end its 145 years of oil imports from Russia has significantly weakened Russia’s pricing power for Urals, forcing it to accept deep discounts to find firm demand. And the price cap has added risk to any dealings with Russian oil, which has likely contributed to the discount, at least at the margins. But with the recent reduction in Urals exports, the discount is narrowing. Improved market knowledge by Russian exporters might also be helping reduce the discount.
…since they are only now facing their first real test as Urals rises above the cap.
The high levels at which the caps were set means, until very recently, they have remained mostly untested in their ability to constrain Russia’s ability to capture full market prices. Where they were put to the test—at Kozmino—they showed vulnerability to attestation fraud.
Much depend on whether improvements are made in how sanction tools are used…
Now, with Urals trading above the price cap, the effectiveness of sanctions is going to be put to the test. On paper, the tools available to EU/G7 sanction officials appear sufficient to do the job intended. But much comes down to how effectively these tools are employed. If steps are taken to improve their use, they can thwart most of Moscow’s efforts at circumvention and painfully constrain Russia’s access to oil revenues. If no additional steps are taken, however, oil sanctions will be at risk of unravelling.
…based on lessons drawn from the first half year of the price caps.
The last six months of sanctions have provided many useful lessons on how their implementation can be improved. Given the finite resources of sanction enforcement agencies, however, it’s important to focus on those with the highest impact. The following four recommendations seek to do just that:
Four high-impact recommendations for better implementation.
The following are four specific recommendations improving how these sanctions are employed. They draw on lessons learned during the first half year of sanctions.
Recommendation #1: Lower the price cap.
Last autumn, the main argument against setting a lower price cap was that Moscow might retaliate by engineering a supply crisis that would spur inflation and potentially trigger a recession. This, in turn, would erode support for Ukraine. Since then, however, the risk of oil weaponization has greatly receded (see Introduction), removing the main argument in favor of a higher price cap. At the same time, additional arguments supporting a lower cap have only gotten stronger, namely:
sanctions have been having a tangible impact: they are eroding Russia’s economic resilience as the recent collapse of the ruble and the emergency rate hike shows. A more assertive price cap will dial up the fiscal pressure.
Moscow has routinely been willing to export at prices far below $60 a barrel: Moscow has demonstrated a willingness to maximize exports at prices below $40 a barrel.
the ruble’s recent collapse lowers Russia’s breakeven oil price, making it easier for producers to cover costs at lower oil prices. Today’s $60 price cap for crude is more than double estimated full-cycle costs of producing Russian oil. The recent collapse of the ruble will only lower the breakeven oil price for Russian producers (and the federal budget)—making them less sensitive to a lower price cap.
Moscow’s large tanker gap means most of Russia’s seaborne exports remain exposed to the price cap; exposure levels could rise above 80% if insurance verification is implemented (see recommendation #4). Over half Russia’s seaborne exports are currently exposed to the price cap, owing to Russia’s shortage of sanction-proof ships. If European coastal states require insurance verification from oil tankers, as Turkey has done, it could sharply curtail Russia’s shadow trade (see recommendation #4, below). The share of seaborne exports exposed to the price cap could rise to over 80%.
a higher price cap has, contrary to intent, ended up increasing Moscow’s incentive to cut output to push up prices, rather than decreasing it. As weaponization risk receded over the winter, and the discount pushed market prices for Urals down to $40, an unexpected thing happened. The high, $60 price cap, that was intended to reduce incentives for Russia to cut output ended up, perversely, increasing them (see Figure 26). The high price cap gave Moscow unrestricted upside potential of $20 per barrel. Put otherwise, if the market price rose from $40 to $60, Moscow would be able to capture 100% of that $20 upside, since the high price cap ensured access to mainstream tankers for cargoes priced up to $60.
Had, by contrast, the price cap been lowered, say, to $35, it would have limited Moscow’s ability to capture upside value from rising prices, since its sanction-proof fleet was only large enough to move a fraction of its exports at full market prices. The rest would have to be transported by mainstream tankers at the capped price. With less to gain from higher market prices, Moscow’s incentive to cut its own output (and badger OPEC to do likewise) would have been significantly weaker.
Lowering the price cap today would weaken Moscow’s incentives to keep any cuts in place.
The same would hold true today. If the price caps were dropped to $35, it would weaken Moscow’s incentive to keep any cuts in place. Moscow might revert to doing what it did last time it faced low effective prices and maximize output. Moreover, if shadow fleet activity is reined in by the introduction of an insurance verification requirement—thus widening the tanker gap (see below)—, it will further limit Moscow’s access to upside revenues from higher prices.
For anyone still concerned that lowering the price cap might spur Moscow to weaponize oil exports, consider the following two things. Ratcheting down the price cap in two medium-sized steps of, say, $15 each instead of one big step of $30 could reduce the risk of a confrontational response. It might also reduce the risk of an overreaction by a jittery market.
Second, expect Moscow to respond to any discussions of a lower price cap with saber rattling and threats—these are, after all, a core competency of Kremlin statecraft. But also recognize that the risk environment for Moscow is far more adverse today than it was in the fall of 2022, when it was last threatening to weaponize oil. If the Kremlin lacked the risk appetite to weaponize oil back then, it will be even less inclined to make such a high-risk gamble today.
Recommendation #2: Combat price attestation fraud by developing a “whitelist” of approved traders.
It makes little difference at what level the price cap gets set if price attestation fraud goes unchecked. Moscow would have enough unrestricted access to mainstream tanker capacity to keep export volumes whole, regardless of price. That, in turn, would create even greater incentives for Moscow to push for higher pricing, since it could capture 100% of revenues at any price.
This makes price attestation fraud by bad-faith brokers as great a threat to sanctions as the shadow fleet—perhaps even greater. Policymakers need more effective measures for preventing pricing fraud from taking hold. Lessons need to be drawn from Kozmino.
The critical task of screening out bad-faith traders should not rely solely on “know-your-client” due diligence by mainstream tanker owners.
The crux of the problem is that the burden of identifying potentially bad-faith traders is left to ship owners. They are required to conduct their standard “know-your-client” due diligence when engaging customers and provided red-flag guidelines on what to watch out for.
This approach is unworkable. Standards of due diligence and the resources for conducting it will vary significantly from one ship owner or operator to the next. So too do the potential consequences of grossly negligent diligence. Invariably, some bad-faith traders will remain in the mix, potentially a large number.
Enforcement agencies should pro-actively develop a whitelist of permitted traders who are EU/G7-linked and exposed to sanctions risk.
To effectively combat attestation fraud, enforcement agencies need to play a more proactive role in screening out bad actors. They could start by developing a “whitelist” of broker/traders authorized to provide pricing information. This whitelist could be made up of well-established commodity trading groups based in EU/G7 countries, and therefore subject to legal action for violating sanctions and providing false pricing information. Moreover, as EU/G7 entities, they would be required to retain and, if necessary, disclose underlying transaction documents to authorities. Ship owners could nominate additional candidates for the list, but they would be subject to vetting and approval by enforcement agencies.
Mainstream tankers would only be allowed to lift from Russia when a whitelisted trader is party to the sales transaction and provides the price attestation.
For a mainstream EU/G7 owned or insured tanker to transport Russian oil, it would need to receive its price attestation from a whitelisted trader. Failure to obtain price attestations from a whitelisted trader would be considered a violation of sanctions. For EU/G7 shipowners, this would trigger legal action. For non-EU/G7 owners of mainstream tankers, it would invalidate their International Group P&I insurance coverage and—depending on their banking syndicate—possibly be a breach of loan covenants.
If Russian exporters wished to use EU/G7 owned, financed or insured tankers to transport their oil, they would need to ensure that a whitelisted trader is party to the trade and can provide pricing attestations to vessel owners. Many of the leading EU/G7 commodity groups routinely lifted out of Russia prior to sanctions. They have extensive experience and relationships in Russia and should be able to smoothly slot back into the Russia trade if clear guidelines are provided by enforcement authorities.
Russian exporters would be certain to push back against this. But the only way to effectively manage the risk of price attestation fraud is to ensure that the party providing the information faces significant legal and commercial repercussions for price-cap violations. And that means an EU/G7 linked trader needs to be a party to any sale using capacity from mainstream tankers. What is more, the whitelisted trader will also retain information on shipping costs and other transaction related fees, which can help reduce the risk of price-cap manipulation through offshore transfer pricing. Whitelisting won’t eliminate bad-actor risk entirely but should have a major impact.
An important note. Whitelisting is best done in tandem with a reduction in the price cap. Because of their superior market knowledge and capabilities, top-tier traders will likely be able to negotiate higher realized prices for Russian oil when selling to importers than the third-tier traders currently handling Russian exports. It’s important that Moscow doesn’t benefit from these improved pricing (which, in effect, means a smaller discount to benchmark prices). The best way to prevent that from happening is to lower the price cap.
Recommendation #3: Crack down on the involvement of EU/G7 entities in the sale of used tankers to Russian or undisclosed buyers
One way to limit the expansion of Russia’s shadow fleet is by further constraining supply. Shadow tankers are often purchased from mainstream operators—many based in the EU/G7—during the process of fleet renewal. Policymakers should prohibit EU/G7 entities from selling used tankers either to Russian buyers or anonymous buyers. EU/G7 based shipping brokers should face similar restrictions.
To obscure the involvement of Russian money in a transaction, Russian buyers can, of course, arrange sham, back-to-back transactions through cutouts. Tracking down wrong doers is resource intensive. But there is plenty of consternation among some ship brokers about lack of compliance by more risk-friendly competitors. As one commented: “So people who think they can ignore the rules and still go out and do business, I say ‘more fool them’, and I hope they have a lot of sleepless nights and wake up with a knock on the door.”33 Enforcement agencies should encourage whistleblowing to help generate leads. Investigating a case will have a chilling effect on the trade; imposing penalties will do that even more.
Even with such prohibitions and stepped-up scrutiny, sales by EU/G7 ship owners into the used market will likely continue to find their way into the Russia shadow trade. But these deterrent efforts can slow down the transaction flows and increase costs for Russian buyers by introducing a risk premium and additional intermediaries.
Recommendation #4: Require tankers passing through EU/G7 territorial waters to provide verification that their mandatory spill liability insurance is adequately capitalized and remains current.
Turkey has used its coastal state rights to require tankers transiting its territorial waters to confirm their P&I insurance as a condition of passage. EU/G7 states should follow suit.
In December 2022, Turkey required that oil tankers transiting its territorial waters must, as a condition of passage, provide direct confirmation from their P&I insurers that the vessel was adequately insured. In doing so, the Turkish government was exercising its rights as a coastal state to deny passage to any tanker that could not verify it carried valid mandatory spill liability insurance required under international convention. European coastal states should follow suit by requiring verification of adequate insurance from tankers transiting their territorial waters.34
The insurance arrangements of many shadow tankers are notoriously opaque, with reports of ships carrying policies that are fraudulent or inadequately capitalized. Many of flag states of these vessels—responsible for ensuring compliance with international standards—have been grey-listed or black-listed for their poor track records of enforcement.35 If adopted, an insurance verification requirement could exclude non-compliant shadow tankers from EU/G7 waters and limit the total size of the Russian shadow trade to well under 20% of total seaborne volumes.
If Moscow has its way, nearly 300 shadow tankers, laden with Russian oil, will transit European territorial waters every month, creating a “potentially catastrophic” situation.
Coastal states around the world, but especially in Europe, face a growing environmental threat from Russia’s insatiable demand for shadow tankers. Some 300 vessels a month, laden with Russian oil, transit European waters. At present, only a minority are shadow tankers. If Moscow had its way, however, nearly all of them would soon be shadow tankers.
At the heart of the shadow fleet problem is a long-standing conflict between negligent flag states that fail in their duty to fully enforce international shipping standards and coastal states that suffer the consequences. Countries like Russia, that seek to expand the shadow fleet, make the problem worse by incentivizing lax enforcement. As the chairman of the Danish maritime pilots’ union recently observed, there has been “a drop in the standard of the tonnage that serves the Russian oil ports, both on ships and crew. The ships are older and the crew has a different standard than we are used to.” He went on to warn that the situation is “potentially catastrophic.”36
The shadow fleet business model increases spill risk by cutting spending on safety requirements, dropping quality insurance coverage…
As discussed in Chapter 4, the shadow fleet business model relies on generating quick returns by buying aging tankers cheaply and sweating them for cash in the final years of service. This typically includes slashing costs on safety requirements. It also involves dropping quality P&I insurance in favor of opaque insurance arrangements of indeterminate quality. Shadow investors may be less concerned than their mainstream counterparts over whether their insurer has adequate funds to cover claims. If insurance fails to pay out, shadow ship owners can fall back on their cloak of anonymity for protection from liability claims.
…and by registering with blacklisted flag states that certify them to operate while turning a blind eye to their deficiencies.
A ship’s “flag state” is responsible for certifying that it complies with international standards—including safety and insurance—and is fit to operate. But the flag-state system is notoriously problematic. There is often no inherent connection between flag states and the ships they register. They offer flags of convenience for a fee, and the relationship is purely transactional. Worse, standards of enforcement vary widely from state to state, with the worst offending flag states routinely included in “blacklists” maintained by multilateral regulatory bodies. Shadow tankers gravitate towards these blacklisted states, which allow them to maintain certification while cutting corners and avoiding scrutiny.
One shadow tanker has already broken down and nearly run aground in the treacherous Danish Straits.
The growing presence of shadow tankers has already caused one near disaster in European waters. In May, an 18-year-old vessel laden with 340,000 barrels of Russian oil, lost power as it was negotiating a treacherously narrow turn in the Danish Straits, just a mile off the pristine shores of Langeland. In distress and rapidly losing steerage, the vessel strayed out of the channel into shallow waters, just a few boat lengths away from a 10.8 meter shoal. Fully laden, the vessel drew 13 meters. Still making headway, a grounding and possible hull breach looked imminent. A full account of this harrowing episode can be found in the Appendix: A Brush with Disaster in the Danish Straits--Shadow Tankers Menace the Baltic.
Chokepoints routinely channel over 80% of Russian tanker traffic through the territorial waters of European coastal states…
Over 80% of Russia’s seaborne oil exports regularly transit EU/G7 territorial waters. These passages occur around several maritime chokepoints—most of them unavoidable for tankers loading in the Baltic and the Black Sea (see Figure 27. Map of navigational chokepoints where Russian seaborne oil must transit territorial waters of EU states or the UK). The chokepoints routinely channel maritime traffic within 12 nautical miles of the coasts of one or more of the following countries: Estonia, Finland, Germany, Sweden, Denmark, France, the United Kingdom, Spain and Greece.37
…giving them the right to impose certain conditions on oil tanker transit, just as Turkey has done.
By channeling tanker traffic so close to their shores, these chokepoints expose these states to a greater risk of ruinous harm from a shadow tanker spill. At the same time, the need for shadow tankers to transit their territorial waters also provides these coastal states with the authority under maritime law to take measures to stem the threat posed by these poorly maintained, questionably insured vessels.
European coastal states should require all transiting tankers to verify that their P&I insurance is current and adequately capitalized.
But regulatory action is required. Following Turkey’s lead, they should put in place a requirement that laden oil tankers wishing to transit their territorial waters must be carrying spill liability insurance mandated under international convention and that their insurers provide suitable verification that their policy remains in force and is adequately capitalized.
Fortunately, a pragmatic, transparent and satisfactory framework for P&I verification already exists. What is more, some 95% of the global tanker fleet already use it. This means that requiring verification as a condition of passage poses negligible risk to the normal flow of traffic. The only tankers whose right of passage would be impaired are those with opaque, inadequate or non-existent arrangements for their mandatory insurance.
A suitable disclosure framework is already in place and used by 95% of the global fleet.
Examples of this verification framework can be found on the website of the International Group of P&I Clubs and those of its member clubs. They include regularly updated vessel search functions and coverage details of all insured tankers. They also make it possible to assess the capital adequacy of each of the P&I clubs by regularly publishing independently audited financial accounts and maintaining investment grade ratings from leading credit rating agencies. With an IMO vessel number and a few keystrokes, coastal state regulatory authorities and members of the public can quickly determine the status of an IG insured ship as well as the capital adequacy of its insurer.
Verification would require insurers to provide four key disclosures.
EU/G7 coastal states should make such verification of insurance mandatory for all tankers claiming rights of innocent passage. Specifically, tanker owners would need to make certain that their P&I insurers provide the following public disclosures:
1. a searchable, on-line database of all vessels currently under cover by the insurer: ideally, this would be updated daily. It would include basic identifying details of the vessel under coverage, the kind of insurance coverage provided, expiration dates, status of policy, etc. This allows authorities and the public to verify in real time that a vessel’s coverage remains current and has not been dropped or cancelled. Any insurance company will already maintain such a database internally; making it public simply requires setting up a webpage.
2. financial statements conforming with international accounting standards and audited by a reputable international accounting firm (a list of approved accounting firms would be advisable);
3. An investment grade credit rating from a major credit rating agency, which would help provide comfort that the company is adequately capitalized; and
4. a history of payouts on all oil-industry related P&I claims in recent years.
Additionally, any tanker owner wishing to transport oil through EU/G7 waters would need to make the name of their current P&I insurer publicly available through Equasis, the EU-based, multilateral shipping transparency database. Equasis already lists P&I insurers for nearly every tanker worldwide, but not those in the shadow fleet.
The effect of this verification scheme would be to prevent uninsured or underinsured tankers from menacing coastal states in Europe. By barring their passage through European territorial waters, this would also reduce the risk of spills elsewhere, both on the high seas and in the territorial waters of non-European coastal states.
Verification isn’t just about providing adequate funds for clean-up and compensation but reducing the risk of spills in the first place.
A verification requirement will help make certain critical funds are available for spill mitigation, clean-up, and compensation. But its benefits go well beyond that. It also reduces the risk of a spill happening in the first place. Quality P&I clubs are usually mutually funded by large groups of ship owners. Club members have liability for claims made against any vessels in their club. Consequently, they are highly incentivized to make certain that all club members are made to adhere to international safety and maintenance standards.
Shadow tanker insurance arrangements are notoriously opaque. There are anecdotal reports of shadow tankers carrying undercapitalized or sham insurance policies.38 These opaque providers may end up lacking the funds to make a payout or simply refusing to pay at all, which has been known to happen. Such dubious, contingent arrangements reduce incentives to ensure all covered vessels comply with statutory safety and maintenance requirements. And lower compliance standards mean higher risk of accidents.
A verification regime would probably cause shadow tankers to stop loading at Russia’s western ports…
It's likely that the introduction of a verification regime would cause many shadow tankers to withdraw from European territorial waters, rather than arrange the necessary disclosures. Verification would require a level of transparency that is at odds with the shadow fleet business model. It would also likely require additional spending to secure adequate insurance and to meet higher standards of safety and maintenance—all of which are inimical to the economics of the shadow trade.
…which would limit their potential share in Russia’s seaborne exports to under 20%.
In place of these retreating shadow tankers, Russian exporters would need to charter compliant, mainstream tankers to lift oil from their Baltic and Black Sea ports. This could limit the shadow fleet to operating only out of Russia’s Pacific coast ports. That would limit the total amount of Russia’s seaborne oil handled by the shadow fleet to well under 20%. It’s likely, of course, that the Kremlin might consider enhancing its state-backed P&I insurance scheme to meet verification requirements and expanding it to include many or all the shadow tankers active in Russia—or at least those covertly owned by Russian money. But it’s unlikely Russia’s P&I scheme could meet the required disclosure requirements anytime soon.
If European policymakers don’t assert their maritime rights and a spill occurs, the public will ask why the environmental safety of their coastlines was entrusted to the sole discretion of blacklisted flag registries in remote countries.
As those familiar with maritime law will know, the need for coastal states to exercise their rights to safeguard their internal and territorial waters arises when flag state fail in their duties to ensure vessels on their registries comply with statutory international standards.39 European policymakers would be well advised to assert these coastal rights to their fullest extent in the face of the challenge posed by Russia’s expanding shadow fleet. If tomorrow, an uninsured shadow tanker spills Russian oil on their coastlines, the public will demand to know why their governments failed to exercise these rights and chose instead to entrust the safety of their shores solely to registry offices in blacklisted flag states like Cameroon, Comoros and Vanuatu.
If European policymakers don’t assert their maritime rights and a spill occurs, the public will ask why the environmental safety of their coastlines was entrusted to the sole discretion of blacklisted flag registries in remote countries.
Conclusion: No more oil windfalls—hastening Russia’s retreat from Ukraine
Together, all these recommended measures aim to do one thing: tightly constrain Moscow’s access to windfall oil revenues. Like other sanctions, this will help erode Russia’s economic resilience, diminishing its means for financing its war of aggression against Ukraine.
At the same time, Russian oil sanctions are different from other sectoral sanctions and have the potential for a qualitatively greater impact. Periodic oil windfalls play a unique and indispensable role in the political economy of the Putin regime. They renew regime vitality, restore appetite for risk and help maintain cohesion among fractious elites.
Oil sanctions, if assertively implemented, can dim Moscow’s hope for renewed access to oil windfalls. That would unsettle Kremlin leaders and help increase their risk aversion. Such heightened caution was on display last December, when Moscow chose not to weaponize oil. And it was on display more recently, during the Prigozhin Affair, when Putin shied away from direct confrontation. It can also hasten the day Moscow changes its calculus and recognizes that a withdrawal from Ukraine has become its best option. That prospect makes it worth taking pains to ensure oil sanctions work as well as they can.
Appendix: A brush with disaster in the Danish Straits—shadow tankers menace the Baltic
An 18-year-old shadow tanker, laden with Russian oil, loses power in the treacherous Danish Straits and nearly runs aground.
Disaster seemed imminent in the Danish Straits this past May, when an aging tanker, laden with 340,000 barrels of Russian oil, lost power and strayed out of the treacherously narrow shipping channel into shallow shoals just a few hundred meters off scenic Langeland (see Figure 28).
The vessel bore all the hallmarks of a shadow tanker plying the Russia trade.
The 18-year-old vintage tanker was en route from the Russian oil terminal at Vysotsk, not far from St. Petersburg, and would eventually signal Kalamata, Greece, as its destination. The waters off Kalamata had become notorious in recent months as a rendezvous for tankers conducting dangerous ship-to-ship transfers of Russian oil. The tanker had recently changed hands, selling for an eye-popping $21 million. That’s double what it would have gone for just a year earlier. Demand for aging tankers suitable for the Russian shadow trade has fueled a red-hot seller’s market.
Since the sale, the tanker was being managed out of the UAE and used for the Russia trade. Its new, anonymous owner reflagged the vessel to the remote Cook Islands—a grey-listed jurisdiction, ranked in the bottom 20% of flag states for ensuring that vessels in its registry comply with international safety, security, labor and environmental standards.40
It had recently dropped it International Group P&I coverage. Details of any replacement coverage were hard to come by.
Worryingly, but typical for Russia’s shadow fleet, the tanker had recently changed the provider of its spill oil liability (“P&I”) insurance. Under international convention, P&I insurance is mandatory for oil tankers and provides essential funds for cleanup, compensation, and wreck removal. Prior to its sale, this vessel carried spill liability insurance issued by the International Group of P&I Clubs (“IG”). The IG is a sophisticated network of non-profit, mutual assurance clubs made up of and funded by ship owners. As underwriters, members have a strong financial interest in assuring all vessels insured by the IG meet statutory safety standards. Thanks to its high transparency, investment grade ratings, and a strong track record of payouts, the IG provides P&I coverage to 95% of the global tanker fleet, with aggregate coverage totaling in the trillions of dollars.
We can only assume the new owner had obtained P&I coverage from an alternative provider, but confirmatory details are hard to come by. So, if the ship were to run aground, breaching the hull and spilling oil, local authorities and the public could not know with confidence that essential funding would be in place. If the new insurance turned out to be undercapitalized, or worse—a sham—local communities would not only suffer from catastrophic environmental damage, but would be left with the cleanup bill, too. Seeking compensation from the owner of record—a single-ship, shell company with a brass plate address in the Marshall Islands—could amount to little more than chasing phantoms. Opacity confers impunity.
340,000 barrels of oil, rudderless and adrift, in Denmark’s main maritime thoroughfare, with only a few meters of under keel clearance and just a mile off the coast.
As the decelerating vessel veered out of the deep, narrow fairway, it approached a warning beacon alerting mariners to the hazardous shoal beyond. The vessel, which drew 13 meters fully laden, was on course for a 10.8 meter shoal just a few boat lengths ahead. Within five minutes, the vessel would signal that it was “not under command,” meaning it had lost its ability to maneuver and posed a menace—340,000 barrels of oil, rudderless and adrift, in Denmark’s main maritime thoroughfare and just a mile offshore.
During those critical five minutes, the hulking vessel still retained some residual steerage. As a grounding appeared imminent, the ship managed to come about 90 degrees to starboard, cut directly back across the busy shipping channel then entered shallow waters to the east. For the next hour, the tanker drifted some two kilometers outside the channel, with just a few meters of under-keel clearance at time. Eventually, it reached deeper waters where it dropped anchor for repairs. Five hours later, it was back underway. Another 24 hours on, it finally exited from the tortuous channels of the Danish Straits, with its notorious topography of rocky shoals and shallow, sandy bays.
The falling standard of crew and vessels is “potentially catastrophic.”
Commenting on the incident to Danish TV2, the chairman of the Danish maritime pilots’ union voiced concern over falling standards out of Russia: “We have seen that there has been a drop in the standard of the tonnage that serves the Russian oil ports, both on ships and crew. The ships are older and the crew has a different standard than we are used to.” He went on to warn of the dire threat this posed: “Those of us who sail in the Great Belt know how busy it is… [with] potentially catastrophic consequences for the marine environment.”41
Recommended resources on Russian oil sanctions
Several research groups around the world are doing valuable work on Russian oil sanctions. The following list is by no means comprehensive but merely a starting point for those wishing to learn more.
The Kyiv School of Economics is producing a Russian oil tracker along with valuable analytical reports, such as this from July 2023.
Bruegel has, similarly, been publishing a Russian oil tracker and publishing valuable analytical reports, including this July 2023 report.
CREA, in Finland, has also been compiling valuable analytics and publishing separate reports.
Simon Johnson, Łukasz Rachel, and Catherine Wolfram have been applying econometrics to explain the working of the price cap as in this recent report.
Thane Gustafson, a veteran Russia watcher and the dean of Russian oil and gas studies, has been writing on Russian sanctions more broadly in his substack, The Devil’s Dance.
Other valuable reporting and analysis is being done by the investigative team at Lloyd’s List, Julian Lee’s team at Bloomberg, and TankerTrackers.com.
Do note that where different groups are quantifying similar metrics, such as export volumes, there are often deviations among results from one group to the next. This is attributable to a range of factors, including methodology, timing and the scope of data included.
Acknowledgements
This report has benefited from the generous input of many colleagues. My thanks go in particular to Thane Gustafson, Catherine Wolfram, Jacob Nell, Simon Johnson, Natalia Shapoval, Ben Hilgenstock, Elina Ribakova, Borys Dodonov, Vladyslav Vlasiuk, Dan Berkowitz, Isaac Levi, Lauri Myllyvirta, Meri Pukarinen, Michael McFaul, Bronte Kass, Richard Morningstar, Steve Hellman, Edward Chow, Edward Fishman, Chris Miller, Benjamin Schmitt, Mai Rosner, Tania Babina, Anna Vlasiuk, Tim Sellers, Andrew Meier, Cathy Mannick and many others. The views expressed in this report are mine alone.
Disclaimer: No Advice
The author of this substack does not provide tax, legal, investment or accounting advice. This report has been prepared for general informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, investment or accounting advice. The author shall not be held liable for any damages arising from information contained in the report.
© Copyright 2023, by Craig Kennedy. All rights reserved.
Endnotes
Tradewinds, 9 Mar 2023
For an historical perspective on Kremlin political culture and risk tolerance, see this classic essay which grew out of a 1970s study commissioned by the U.S. State Department: Keenan, Edward L. "Muscovite political folkways." The Russian Review 45.2 (1986): 115-181.
“Dark” ship-to-ship transfers involve the transfer of oil between two ships moored together at sea while their automatic identification system (AIS) transponders have been switched off to prevent the operation from being electronically logged and reported. “Spoofing” involves manipulating the AIS signal to misrepresent the location of the vessel. Both are prohibited under international shipping rules.
The investigative team at Lloyd’s List, which has done pioneering work on the global shadow fleet, sums up the four distinguishing features of a typical shadow tanker thus: “it is aged 15 years or over, anonymously owned and/or has a corporate structure designed to obfuscate beneficial ownership discovery, solely deployed in sanctioned oil trades, and engaged in one or more of the deceptive shipping practices outlined by US State Department guidance issued in May 2020.” See Lloyd’s List Daily Briefing, May 18, 2023.
“Dark” ship-to-ship transfers involve the transfer of oil between two ships moored together at sea while their automatic identification system (AIS) transponders have been switched off to prevent the operation from being electronically logged and reported. “Spoofing” involves manipulating the AIS signal to misrepresent the location of the vessel. Both are prohibited under international shipping rules.
The nature of Russian oil sanctions makes obscuring a cargo’s origin largely pointless. In addition, basic geography makes doing so highly challenging. Some 80% of Russia’s seaborne flows must transit highly monitored maritime chokepoints—the Danish and Turkish Straits. Apart from tankers carrying Kazakh oil, which are easy to identify, Russia is the only producer shipping large amount of oil out of the Black Sea and the Baltic. Consequently, no amount of signals manipulation can enable a transiting tanker laden with Russian oil to obscure the origin of its cargo. Beyond these straits, of course, efforts can and are sometimes made at obfuscation, mostly through back-to-back, ship-to-ship transfers in the Mediterranean. Some of those transferred cargoes may then be getting smuggled into the EU. But here it’s essential to keep volumes in perspective. It’s impractical to scale up such smuggling to a level that would make a material difference for Moscow. The amounts involved would be far too large to conceal. That makes it unlikely such smuggling will become a primary method of sanctions circumvention. Nonetheless, ship-to-ship transfers in the Mediterranean should be monitored and discouraged, especially given the environmental risks they pose.
Tankers come in a wide range of carrying capacities. To provide a like-for-like basis for comparing fleet sizes, this report often measures groups of vessels by their aggregate carrying capacity. In addition to expressing that capacity in units of barrels or deadweight tons, this report expresses capacity in terms of standard Aframax class tankers (each with an assumed capacity of 105,000 deadweight tons). In other words, a group of ships will be said to have a carrying capacity equivalent to “x” number of Aframax tankers. Aframaxes are by far the most important tanker class in the Russia trade, accounting for around 50% of total volumes. Hence its selection as the preferred unit of measure.
In this report, shadow tankers that are “active in Russia” include those that have loaded at least once at a Russian port during the preceding 12 weeks. If, for example, a shadow tanker loaded once or twice in 2022 and hasn’t transported Russian oil since, it’s not likely to be a vessel that Moscow will count on going forward for consistently and reliably carrying oil priced above the price cap. Consequently, it’s not considered part of the “active” count. A more detailed discussion on methodology is provided below.
The lack of demonstrable dedication to the Russia trade by many shadow tankers poses a methodological challenge when measuring the shadow fleet. In the following chapter, we estimate the total tanker capacity Russia needs to achieve sustainable export autonomy. That estimate assumes every tanker in Russia’s sanction-proof fleet is dedicated to the Russia trade exclusively and full-time—24 x 7 x 365—much as Sovcomflot tankers are. So, for the purposes of having a like-for-like comparison, our count of sanction-proof tankers available to Moscow would, ideally, be made up of vessels fully and exclusively dedicated to the Russia trade.
But reality isn’t that orderly. As we have seen, a minority of shadow tankers involved in Russia seem fully dedicated, but most don’t. Their track records are mixed. Which begs the questions: which tankers should be included in our count of sanction-proof capacity active in the Russia trade? Should a shadow tanker that last lifted from Russia way back in 2022 still be included in the count? Should the capacity of a tanker that still occasionally lifts from Russia but spends much of its time elsewhere be counted at full value, or somehow prorated? From Moscow’s perspective, a tanker that loaded once or twice many months ago and hasn’t returned to Russia since is not one it can rely on. Consequently, any methodology for assessing shadow tanker resources reliably available to Moscow should exclude such “drop out” vessels.
To avoid counting these “drop out” vessels, this report screens out shadow tankers that appear no longer “actively” engaged in the Russia trade. It does this by applying a simple test: if a vessel has loaded in Russia at least once in the preceding twelve weeks, it is considered “actively” or “currently engaged” and therefore included in the “active” count. The rationale behind 12 weeks is that nearly any vessel actively pursuing the Russia trade will have loaded at least once over the preceding twelve weeks, since the longest routes that shadow tankers routinely work out of Russia can be easily sailed there and back within 84 days. So, the 135 Aframax equivalent figure mentioned above represents the total capacity of individual shadow tankers that have loaded at least once in Russia in the 12 weeks up to mid-June.
This 12-week screening criterion will almost certainly exclude vessels that, after a long hiatus, soon decide to reengage in Russia. Nonetheless, the 12-week test likely overstates the amount of sanction-proof tanker capacity reliably at Moscow’s disposal. At mid-June, well over a quarter (29%) of the tankers included in the “active” category had loaded just one time in Russia since March 2022. But because that one loading happened to be in the twelve weeks up to mid-June 2023, it’s included in the active count. A full 57% of the tankers on our active list have lifted from Russia no more than two times since March 2022 (see Figure 5). That’s more than half that have yet to demonstrate anything approaching 24 x 7 x 365 dedication to the Russia trade. It’s quite possible many of these 57% will fall well short of that mark.
Nevertheless, it’s better to use a method that’s biased towards overstating the current size of Moscow’s shadow fleet than one that understates it. In any event, with each passing month, as track records continue to build, we should get an increasingly clearer picture of how much dedicated capacity Moscow really has at its disposal.
See, for example, comments made by Andrei Kostin, the head of state-owned VTB, Russia’s second largest bank, who noted in late October that Russia could need up to a trillion rubles ($16 billion at historical rates) to finance the expansion of Russia’s tanker fleet. He also noted that Russian state bank financing would play an important role, given the lack of available foreign financing and constrained oil company budgets. See Tass, 27 October, 2022.
Ideally, these tankers would be centrally dispatched, in operation 24 x 7 x 365, and achieve 100% utilization rates. As a practical matter, however, those ideals are almost certainly unobtainable. Russia’s export logistics are massively complex. To start with, Russia’s upstream production is not centralized but spread out among numerous companies, each of which coordinates its own exports. Nor is the trading function centralized. Exporting producers work with a range of competing trading groups. These trading groups will usually be the entities chartering tankers (or in a few cases, supplying tankers they own themselves). Next, the physical export points for Russian oil are broadly distributed. In a typical month, there will be some 350 or more tankers over 25,000 deadweight tons loading out of Russia. These loadings take place at some 20 main Russian export terminals situated across four seas and spanning eight time zones. Finally, the destinations of these exports flows are highly diversified and often irregular. From Russian ports, these cargoes will then be dispatched to over 100 destination ports located in over 40 countries, with round trips typically ranging from 4 days to 104 days. Such a complex system defies just-in-time logistics. To assure adequate shipping capacity, a stand-alone fleet would need some margin of redundant capacity to prevent unplanned shortfalls in tanker availability.
Recently, Russia’s sanction-proof fleet has been lifting close to 40% of daily seaborne export volumes from Russia. That’s substantially larger than the sanction-proof fleet’s roughly 32% coverage of total capacity needs. The reason for this has to do with average voyage lengths. Recently, Russia’s sanction-proof fleet has been concentrated on shorter routes, making their average voyage length lower than for Russia overall. Shorter trips mean it takes fewer tankers to maintain the same level of daily deliveries. For example, over 90% of Russia’s shortest major route—Kozmino to China—is now handled by sanction-proof tankers. This cherry picking of routes boosts the efficiency of the sanction-proof fleet. They’re able to manage a disproportionately large portion of exports for their overall capacity. But if Russia’s shadow fleet continues to expand, that will change. Newly added shadow tankers will be forced to take on increasingly longer voyages, and, in time, their efficiencies will trend back down to national averages. Thus, doubling the size of Russia’s current shadow fleet is won’t, ceteris paribus, double its share in Russia’s overall exports.
Based on a comparison of shadow tankers active in Russia with those included on an extensive list, compiled by United against Nuclear Iran, of tankers involved in the Iranian trade.
See Euronav, “Future capital access for tanker shipping: a new set of rules is emerging,” Special Report, 2019.
See Ali, Mir Mohammad et al. “Toxic metal pollution and ecological risk assessment in water and sediment at ship breaking sites in the Bay of Bengal Coast, Bangladesh.” Marine pollution bulletin vol. 175 (2022): 113274; Vidal, John, ‘This is the world’s cheapest place to scrap ships’ – but in Chittagong, it’s people who pay the price, The Guardian, 2 December 2017.
Author’s calculations based on data from the International Maritime Organization (IMO), Equasis.com and tanker tracking services. The cohort of vessels suitable for loading oil in Russia for long-haul export includes all tankers above 24,999 and below 200,000 deadweight tons. VLCCs are too large to load directly at Russia’s ports and, to date, have played only a minimal role in exports through the ship-to-ship transfer trade in Russian oil.
See Tradewinds, 24 February 2023
On 2022 second-hand markets, see Hellenic Shipping News, 3 March 2023.
Ship brokers are well aware that many recent sales pose compliance risks because of Russia sanctions. See, for example, Tradewinds, 22 March 2023 and Tradewinds, 9 Mar 2023.
See, for example, a template for this representation provided by the American P&I Club.
“Preliminary Guidance on Implementation of a Maritime Services Policy and Related Price Exception for Seaborne Russian Oil,” U.S. Department of the Treasury, September 9, 2022.
For examples of guidelines, see “Preliminary Guidance on Implementation of a Maritime Services Policy and Related Price Exception for Seaborne Russian Oil,” U.S. Department of the Treasury, September 9, 2022 and “OFAC Guidance on Implementation of the Price Cap Policy for Crude Oil of Russian Federation Origin,” U.S. Department of the Treasury, November 22, 2022.
These data were used in two research papers published by an experienced group of economists. See Babina, Tania and Hilgenstock, Benjamin and Itskhoki, Oleg and Mironov, Maxim and Ribakova, Elina, Assessing the Impact of International Sanctions on Russian Oil Exports (February 23, 2023), p. 30. Available at SSRN: https://ssrn.com/abstract=4366337 or https://dx.doi.org/10.2139/ssrn.4366337. See also Hilgenstock, Benjamin and Ribakova, Elina and Shapoval, Nataliia and Babina, Tania and Itskhoki, Oleg and Mironov, Maxim, Russian Oil Exports Under International Sanctions (April 26, 2023). Available at SSRN: https://ssrn.com/abstract=4430053 or http://dx.doi.org/10.2139/ssrn.4430053.
OFAC Alert, “Possible Evasion of the Russian Oil Price Cap,” April 2023. See also, S&P Global Commodity Insights, April 21, 2023.
S&P Global Commodity Insights, 31 January 2023.
For a report on incidents of spoofing in the Russian oil trade, see The New York Times, 30 May 2023. The portion of the Russian oil trade involved in spoofing operations is very small; as a practical method of evading sanctions at scale, it is of very limited use. Over 80% of Russia’s seaborne exports load in the Baltic and the Black Sea. To reach international markets, they transit two of the most heavily monitored chokepoints in the world, the Danish Straits and the Turkish Straits. No amount of electronic wizardry can enable a 275 meter, fully laden Suezmax to pass undetected through those waterways. Once spotted, it will easily be identified as a vessel carrying Russian oil. Spoofing has marginally more likelihood of succeeding out of Russia’s in Pacific ports, but only just. Nonetheless, the mere fact that Russian exporters have sea trialed spoofing can only erode OPEC confidence in the veracity of Russian data. See also the American Club’s response to the New York Times report.
Some shipping brokers state they are already avoiding transactions involving undisclosed buyers while implying that other are not. See Tradewinds, 22 March 2023. Greater scrutiny by enforcement agencies could help constrain sales opportunities for undisclosed buyers. Also see Tradewinds, 9 Mar 2023.
Industry leaders have been calling for government action to address the threat posed by improperly insured vessels. See, for example, comments in Lloyd’s List Daily Briefing, 6 June 2023, pp. 2 – 3.
See Lloyd’s List, 17 April 2023, Lloyd’s List, 29 July 2021, and Tradewinds, 20 June 2023.
Tradewinds, 18 May 2023.
Greece formally claims territorial waters in the Aegean out to 6 nautical miles, but maintains it has a right to claim territorial waters out to 12 nautical miles as permitted under international law. See Jason Theo Halog, “Expansion in the Aegean Sea?” Volkerrechtsblog, 19 February 2021. The 6-mile limit may open a potential passage for shadow tankers shipping out of the Black Sea to avoid Greek territorial waters en route to the Eastern Mediterranean.
See Lloyd’s List, 17 April 2023, Lloyd’s List, 29 July 2021, and Tradewinds, 20 June 2023.
Balancing the jurisdictional rights over shipping between flag states and coastal states is a legal issue dating back centuries. In recent decades, the manifest failure of flag state to reliably enforce international standards has led coastal states to be more assertive in exercising their own rights. For those interested, some relevant discussion can be found in the following papers: James Peachey, Tradewinds, 6 July 2023; Black, James Andrew. "A New Custom Thickens: Increased Coastal State Jurisdiction within Sovereign Waters." BU Int'l LJ 37 (2019): 355; Sage, Benedicte. "Precautionary coastal states’ jurisdiction." Ocean Development & International Law 37.3-4 (2006): 359-387; Bardin, Anne. "Coastal state's jurisdiction over foreign vessels." Pace Int'l L. Rev. 14 (2002): 27, especially pp. 60 – 61; Qi, Jiancuo, and Pengfei Zhang. "Enforcement failures and remedies: Review on state jurisdiction over ships at sea." JE Asia & Int'l L. 14 (2021): 7; Whomersley, Chris. "The Principle of Exclusive Flag State Jurisdiction: Is It Fit for Purpose in the Twenty-First Century?." Asia-Pacific Journal of Ocean Law and Policy 5.2 (2020): 330-347; Yu, Yaodong, Yue Zhao, and Yen-Chiang Chang. "Challenges to the primary jurisdiction of flag states over ships." Ocean Development & International Law 49.1 (2018): 85-102; Molenaar, Erik J. "Multilateral creeping coastal state jurisdiction and the BBNJ negotiations." The International Journal of Marine and Coastal Law 36.1 (2021): 5-58.
See Paris MoU White, Grey and Black List for 2022.
This account is based on open source ship tracking data as well as reporting by the excellent teams at Tradewinds and Lloyd’s List. Figure 28 contains data from Denmark's Depth Model, 50 m resolution, from the Danish Geodata Agency, accessed July 2023.
Hi Craig, wonderfully written piece and very solid, novel recommendations. Thanks for including detailed information on the near disaster in the Danish Straits in the Appendix. I wrote my master's thesis at Copenhagen University (July 2023) on exactly this problem for Denmark and used the Canis Power incident as a case in point. I'm curious to hear if you view it as a one-off or think it could possibly happen again. Is there a role for Danish maritime pilots to verify price attestations or liability insurance before servicing Russian tankers passing through the Danish Straits? Do you have any recommendations for the navigational industry or specific instructions for national agencies that manage these dangerous chokepoints? Thanks.
Superb work, as usual Craig!