The De-Kastri Mystery
Why has half a billion dollars of Sakhalin oil been turned away from India? And what does it portend for Russia’s shadow trade?
Could Moscow’s shadow fleet be running into sanction headwinds? Recent developments suggest so. Consider, for example, the nine tankers transporting Sakhalin oil to India last month that unexpectedly failed to deliver their cargoes—for reasons that remain unclear. Weeks on, they remain adrift at sea, seemingly unable to secure new buyers. Then there are the seven shadow tankers sanctioned by OFAC between October and early December: none appears to have lifted or delivered a single cargo since getting “blocked.” Ships aside, Moscow has also seen a handful of its “under-the-radar” oil traders hit with sanctions by the U.S. and Britain. And then there’s state-owned Sovcomflot’s flag-of-convenience fiasco. During the first half of January, the company has been scrambling to reflag some fifty tankers after they were abruptly dropped by Liberia. But by letting most of its fleet fly Liberia’s U.S.-administered flag throughout 2023 while also sometimes transporting oil priced above the cap, the company likely caused some 75% of its tankers to violate sanctions rules, putting them at risk of OFAC action.
These setbacks—and others—are the direct result of a recent campaign by price-cap coalition countries to step up pressure on intermediaries in the shadow oil trade. The campaign has included a series of public enforcement actions against a small sampling of market players—shipowners, ship brokers and oil traders. It has also, reportedly, involved private overtures to a range of other entities—foreign banks, flag registries, insurers and the like—urging them to show greater diligence in their price-cap compliance. And some, like the Liberian registry, appear to have taken the message to heart.
But while the coalition’s campaign is clearly getting some traction, its scale thus far has been too limited to achieve what really matters: a major reduction in Russian oil export revenues.
Nonetheless, the campaign is surely setting off alarm bells in the Kremlin. And understandably so. The initial phase of the new campaign has the hallmarks of a probing operation. Though limited in scale, it has nevertheless managed to flush out vulnerabilities in Moscow’s circumvention strategy. Once identified, those weaknesses can be more aggressively targetted, causing real damage to Kremlin finances.
For many months, Moscow has been toiling to construct a shadow shipping infrastructure beyond the reach of coalition authorities. At its core is a gradually expanding fleet of shadow tankers. But it also involves networks of critical intermediaries, like traders, banks, ship brokers, flag registries, insurers and others. As usual, Moscow has sought to project an aura of invincibility around its creation—presenting it as a formidable, well-oiled machine hardened against external interference. But as those who built it know, in reality it’s a jerry-rigged contraption, assembled on the fly—less ghost armada, more Potemkin flotilla. And like similar Kremlin improvisations, it’s turning out to be riddled with weaknesses and imperfections.
Two vulnerabilities in particular are likely to concern Moscow. One is the campaign’s ability to erode the cost-effectiveness of the shadow trade by increasing the risk premium associated with it. Each announcement of additional sanctions ratchets up the level of perceived risk in the market. As compensation for this rising risk, intermediaries will seek higher fees while importers will demand deeper discounts. A case in point: it was Indian demands for unacceptably deep discounts that reportedly prevented the nine tankers mentioned above—each with a significant risk profile—from completing their deliveries.
There’s even circumstantial evidence suggesting the Indian buyers may have taken risk management a step further, perhaps demanding price-cap linked pricing. That would be a nightmare scenario for Moscow since it would effectively give coalition policymakers the power to influence prices in Russia’s largest market for seaborne exports.
The second major vulnerability exposed by the new coalition campaign is OFAC’s apparent ability to sideline shadow tankers with blocking orders. As noted above, none of the seven sanctioned shadow tankers has yet to return to service. Were OFAC to block a much larger number of vessels, it could substantially reduce the footprint of the shadow fleet. This, in turn, would force Moscow to rely more heavily on the ample mainstream fleet, where revenues would be more exposed to price-cap restrictions. Moscow is surely pushing hard to return its blocked vessels to service. If they eventually succeed, watch who is willing to receive their cargoes and whether OFAC takes measures to discourage them.
Beyond blocking orders, coalition states have other powers they could use to shrink the footprint of the shadow fleet. EU states, for example, could use their maritime legal rights to prevent improperly insured shadow tankers from lifting cargoes from Russia’s Baltic ports—through which half the country’s seaborne exports flow. And if Moscow finds an increasing number of its costly shadow tankers blocked, excluded or otherwise unusable, it might stop trying to buy more.
Like Prospero, coalition authorities now appear to have the power to conjure up a perfect storm around Russia’s shadow fleet. How hard will they press their advantage? And what countermeasures might Moscow come up with? Only time will tell. But a year into the price cap, the situation remains as dynamic as ever.
Introduction: a half billion dollars of Sakhalin oil stranded at sea
In early November, at Russia’s remote De-Kastri export terminal, a cargo of oil from nearby Sakhalin Island was loaded for what should have been a routine, one-month voyage to India. Four weeks on, however, as the cargo was deep in the Bay of Bengal, less than a day out from its destination port, the tanker transporting it abruptly idled its engines and began to drift. Over the course of December, a similar scenario would play out with seven other tankers transporting Sakhalin crude to India. One by one, at various points along the well-travelled route, they cut their engines and stopped making way. By the end of the month, an estimated half a billion dollars of Sakhalin oil filled the holds of a string of idled tankers stretching from the Korean Strait to the Laccadive Sea (see Figure 1 below).
This was anomalous. For months, a steady stream of Sakhalin crude regularly plied the routes from De-Kastri to Vadinar, Paradip and other Indian ports. Then, over the course of a few weeks, shipments along this lucrative artery gradually seized up. Meanwhile, the heavy flow of India-bound tanker traffic from Russia’s other ports carried on unabated.
Viewed from afar, it looked as though some issue had unexpectedly arisen around these Sakhalin cargoes, a sticky problem buyer and seller were having a hard time resolving. At the end of December, weeks after the first tanker had suspended its voyage, the idled tankers abruptly signalled new destinations outside of India. Those vessels already near India reversed course and began steaming eastward. Negotiations appeared to have hit an impasse, and the seller was doing the maritime equivalent of storming out of the room.
Why did these sales of Sakhalin oil to India fall apart?
What happened? Why did this seemingly routine series of shipments fail to be delivered? In the Russia-India oil trade, which sees over 750 shipments a year totalling some $40 billion in value, this episode is highly unusual. And while Sakhalin deliveries account for only 10% of Russia’s oil sales to India, given India’s central importance to Russia’s war finances, it’s worth examining this unexpected trade rupture more closely and trying to unravel the mystery of the failed De-Kastri cargoes.
Varying explanations for the breakdown have appeared in the press. One maintains there was a problem with payment mechanics. The parties had decided to settle in dirhams, but the Sakhalin exporter was having trouble arranging accounts for settling the trades. Another report claims the standoff was over price. Indian buyers were demanding discounts that the seller wasn’t prepared to pay. Still others imply it all had something to do with sanctions.
Structure of the report and key conclusions
Three different explanations—each plausible. Which is correct? In search of an answer, this report examines the Sakhalin-India trade from several angles.
Part 1: The coalition’s campaign of stepped-up enforcement is causing a sea change in sanction risk around the shadow trade. The report begins a brief overview recent moves by OFAC and other enforcement agencies and how they are reshaping the risk environment around Russia’s shadow trade.
Part 2: The two-stage structure of Sakhalin-to-India shipments. It then describes the two-stage shipping pattern used for delivering Sakhalin cargoes to India. That’s important to understand since it increases the exposure of Sakhalin cargoes to sanctions risk.
Part 3: A risk analysis of tankers involved in the failed De-Kastri deliveries. There follows a forensic analysis of the fifteen tankers involved with the failed De-Kastri deliveries, assessing each vessel for a range of relevant risk markers, such as who flags, insures and manages the ship. It turns out that the tankers involved with the December Sakhalin deliveries have a high concentration of sanction-related risk attributes. This may have caused these Sakhalin cargoes to appear particularly risky to prospective buyers and other transaction counterparties, especially against the backdrop of OFAC’s stepped-up enforcement campaign.
Part 4: Why were the De-Kastri cargoes turned away from India? A speculative fourth explanation. Armed with this knowledge, the report then assesses the plausibility of each of the three explanations behind the failed De-Kastri deliveries—payment mechanics, pricing and general sanctions risk. It finds all three explanations plausible, and mutually compatible, but ultimately insufficient to make sense of the facts at hand. It goes on to speculate that, given the risks involved, the Indian importers might have sought to “de-risk” the trades by requiring they comply with the price cap—a condition the Russian sellers were unwilling to accept, even in the absence of another firm offer for the cargoes.
Conclusion: If enforcement efforts are scaled up they could reduce the footprint of the shadow fleet and inflict real damage on the Kremlin’s oil income. The report concludes by observing that the coalition’s stepped-up enforcement campaign appears to be gaining traction, but will need to be substantially scaled up to have a major impact on Russia’s oil finances. It observes further that the coalition has potent options it could pursue—should it choose—that could substantially reduce Moscow’s ability to use its shadow fleet and compel it to rely more heavily on the mainstream fleet, where price-cap policies have a better chance of constraining Russian oil revenues.
Appendix: Sovcomflot’s flag-of-convenience fiasco—a mass, forced reflagging from Liberia to Gabon is now underway. In the opening days of January, Sovcomflot has been scrambling to reflag some 50 tankers, after they were abruptly dropped from Liberia’s U.S.-administered registry. Nearly all have reflagged to Gabon, which has now become the leading flag in the Russian shadow fleet, and whose tanker registry is not dominated by Russian shadow vessels. Reflagging might reduce the sanctions risk these tankers pose to third parties, but it doesn’t cleanse them of their past offences—they remain “at risk.” Market sentiment towards them may largely hang on whether OFAC moves to sanction more of them.
Part 1: The coalition’s campaign of stepped-up enforcement is causing a sea change in sanction risk around the shadow trade
The end of 2023 saw an unexpected sea change in the sanctions risk around Russia’s shadow trade. What was thought to be a relatively benign environment for shadow shippers and other market participants—like Emirati bankers and Indian importers—has suddenly started looking more fraught with risk.
This perception of rising risk comes in response to a series of enforcement actions that OFAC began imposing on a targeted range of shadow trade intermediaries starting in October. It began with the blocking of a handful of shadow tankers. The specific charge against them: transporting oil priced above the cap while relying on restricted, U.S.-based marine services. Under U.S. rules, that’s a violation of the price cap and puts the offending party “at risk” of enforcement actions. More recently, OFAC has taken action against several “under-the-radar” traders as well as a ship management group. OFSI has also sanctioned a commodities brokerage active in the Russia trade and four UAE-based ship managers.
A major administrative blunder by Moscow in managing the shadow fleet has left half of it “at risk” of OFAC sanctions for price-cap violations.
When OFAC started sanctioning shadow tankers for price-cap violations back in October, it came as something of a surprise. Shadow tankers were supposed to be safe from price-cap sanctions, since their commercial relationships are structured to avoid using restricted marine services—like insurance and broking—based in coalition countries. When tankers are being repurposed for the shadow trade, Kremlin bureaucrats overseeing the process should ensure they are scrubbed of all such service ties. Those ties get replaced with services from non-coalition providers. At least that’s how it’s supposed to work.
But in a major blunder, the Kremlin officials overseeing Russia’s shadow fleet neglected to sever ties to U.S.-based companies providing a critical, restricted marine service: flagging. A large number of Russian shadow ships continued to rely on U.S.-based flagging services—over 100 by my count—long after sanctions were introduced. A similar blunder was made with U.S.-based spill liability insurance, though on a smaller scale.
Because of these missteps, nearly 150 shadow tankers—including three quarters of the Sovcomflot fleet—continued to rely on restricted U.S. marine service providers during part or all of the first year of sanctions (see Dangerous Waters). Many—perhaps all—may have relied on these restricted services while also carrying cargoes priced above the cap. Under U.S. law, that constitutes a sanctions violation. The offending vessels—as many as half Russia’s active shadow fleet—might now be “at risk” of OFAC enforcement action.
An OFAC enforcement action against a tanker is no hollow threat. Of the handful of tankers OFAC has blocked since mid-October, none—as of early January 2024—has lifted or delivered a cargo since being listed. For the moment at least, getting blocked is tantamount to being put out of operation.
Such “at risk” tankers can also present a threat of “contagion” to any other shadow trade participants involved with them.
That alone is bad news for the shadow fleet. What’s worse, however, is that at-risk tankers can become vectors of “contagion” putting other parties at risk. Market actors—say, an Emirati banker or Indian buyer—participating in deals involving above-cap cargoes that are transported by tainted tankers are, themselves, potentially in violation U.S. sanctions rules. They, too, could be subject to an enforcement action.
As if to underscore the “contagion” risk to market intermediaries, on December 20th, OFAC added several “under-the-radar” oil traders to its SDN list. In justifying its enforcement action, OFAC cited—among other misdeeds—the chartering of tankers that “have been identified as having engaged in the transport of Russian crude oil priced above $60 per barrel after the price cap came into effect while using services of a covered U.S.-based provider.”
All these adverse developments—the imposition of price-cap sanctions on a handful of shadow tankers, the realization many more vessels might already be at risk, and the sanctioning of traders for making use of tainted tankers—only serve to increase the perception of risk around the shadow trade.
These elevated risks likely spell higher costs for Moscow.
Markets price risk. When risks around the shadow trade rise, someone has to bear the additional costs. In this case, it looks like that someone is Moscow. These risk-related costs can take different forms. Buyers will demand deeper discounts. Service providers ask higher fees. Some participants might even take things a step further. Instead of demanding increased compensation for sanctions risk, they may seek to mitigate it altogether by refusing to participate in transactions priced above the cap. Indeed, as we shall see below, that may be what was behind the rupture in the Sakhalin-India trade.
This new reality of shadow trade risk would likely have been on the minds of various parties involved with the Sakhalin cargoes. That includes not only the sellers, but the prospective Indian buyers and the Emirati bankers involved with settlement of the transactions.
By December of 2023, one thing they would likely have been doing was scrutinizing more closely the tankers involved with those trades. How much risk did they pose to importers and other transaction participants if their cargoes did not comply with the price cap? Were they already on the sanctions list? Or might they be among those vessels “at risk” and potentially subject to enforcement?
In the next section, we’ll address these questions when we take a closer look at the sanctions risk profile of the tankers carrying the Sakhalin cargoes. First, however, a brief word about the peculiar two-stage shipping process along the De-Kastri-to-India route.
Part 2: The two-stage structure of Sakhalin-to-India shipments
De-Kastri to India: a tanker-intensive route
By Russian standards, De-Kastri is an export terminal of modest proportions. It handles some 200,000 barrels a day of crude, produced on nearby Sakhalin Island. That’s just a quarter of what comes out of Russia’s main Pacific port at Kozmino, located some 1,200 kilometers down the coast from De-Kastri.
Lifting out of De-Kastri poses significant logistical challenges. As Chekhov describes in Sakhalin Island, his unflinching 1895 exposé of the penal colony at Sakhalin, De-Kastri is ice bound for half the year and suffers from treacherously shallow waters. What was true 130 years ago remains so today. Consequently, loadings are done through an off-shore, single-point mooring system. And because of the ice risk, De-Kastri is serviced by a dedicated fleet of seven, double-hulled, ice-class Aframax tankers belonging to Sovcomflot (“SCF”), Russia’s state-owned shipping company.
Prior to December, some 80% of De-Kastri’s exports were routinely sold to India, the remaining 20% going to China. The outbound trip to China can be comfortably done in a week to 10 days and is normally done end-to-end by one of De-Kastri’s dedicated ice-class tankers.
A two-stage process for deliveries to India
The deliveries to India, however, are a more complex affair (see Figure 1 above). A direct round trip from De-Kastri can easily exceed 50 days. Using expensive ice-class tankers for the long-haul voyage to India is an inefficient use of these expensive vessels. With vessels away from their home port for so long, Russia would need a much larger number of dedicated, specialized tankers to keep De-Kastri exports flowing. To avoid this problem, nearly all deliveries to India are conducted in two stages, with the ice-class tankers acting as short-haul shuttles.
In Stage 1, a cargo is loaded at De-Kastri onto an ice-class Aframax, which transports it to Yeosu Anchorage, a lightering area just off the southern tip of Korea. There, the cargo is transferred ship-to-ship (STS) into a standard tanker for the onward journey to India (Stage 2).
This two-stage process also means that India-bound cargoes are normally handled by two different vessels en route. In the case of the 9 aborted Sakhalin-to-India deliveries, some 15 different ships were involved:
Stage 1: six “shuttle” tankers from De-Kastri’s dedicated ice-class fleet, and
Stage 2: nine “delivery” tankers from the broader shadow fleet.1
Given the “contagion” problem noted above, the more shadow tankers involved with a cargo, the greater the chance it could get “tainted” by being handled by an at-risk tanker. Contagion becomes an especially acute risk if the oil being shipped is routinely quoted at price levels well above the cap. And for many months, that has been the case with the Sokol-grade crude shipped from De-Kastri.
Part 3: A risk analysis of tankers involved in the failed De-Kastri deliveries
Risk profiling: tankers transporting crude from De-Kastri to India in late 2023 show a significant number of markers associated with U.S. sanctions risk—especially Liberian flagging.
With De-Kastri logistics mind, we now take a closer look at the risk profile of the 15 vessels involved in the failed deliveries to India (see Figure 2 below). To start with, none of these vessels is from the mainstream fleet. As noted earlier, all the ice-class STS shuttle tankers belong to Sovcomflot. Seven of the nine delivery tankers do as well. The remaining two are shadow tankers with opaque ownership structures.
The matrix in Figure 2 assesses each of these vessels for four significant risk markers:
1) formal sanctions by OFAC;
2) flying a U.S.-administered flag, such as the Liberian flag;
3) management services provided by Sun Ship Management, a Dubai-based subsidiary of Sovcomflot that was sanctioned by OFAC on December 20, 2023; and
4) using American P&I Club insurance after the introduction of the price-cap and, possibly, while transporting oil priced above the cap.
As shown in the matrix, every cargo, bar one, was handled by at least one tanker with a significant risk marker. As for the outlier cargo, number 7, it, too, is associated with certain other attributes that some might consider risky.
Let’s take each risk attribute in turn.
1) Already sanctioned by OFAC: 1 cargo affected
Only one of the cargoes was carried by a tanker formally sanctioned by OFAC. That’s delivery vessel 1 (“D-1”), which is the NS Century. Its parent company, a single-ship special purpose vehicle, was added to OFAC’s SDN list and the vessel “blocked” on November 16th. Like other sanctioned long-haul tankers, it was cited by OFAC for carrying oil priced above the cap while relying on restricted (“covered”) coalition marine services. In the case of the NS Century, it appears that the covered service in question was flagging. Like most SCF vessels, the NS Century was registered with Liberia, which outsources its flagging operations to a private company based in the U.S. state of Virginia.2
2) Flying a U.S.-administered flag: 6 cargoes affected
In addition to the NS Century (D-1), five other delivery tankers were also flying the Liberian flag—an adverse mark on their risk profiles. If OFAC deems their cargoes to be priced above the cap, their reliance on U.S.-based flagging services could constitute a violation of U.S. sanction rules. These five additional vessels would then potentially be at risk of enforcement action in the future. And even if those vessels haven’t been subject yet to actual sanctions, third parties that participate in transactions involving their cargoes could, potentially, be in violation of U.S. sanctions rules according to the price-cap sanctions guidelines.
3) Management services provided by Sun Ship Management, a sanctioned entity: 3 cargoes affected after sanctions on Sun Ship were announced
One of the delivery vessels is, according to IMO data, managed by Sun Ship Management D Ltd (“Sun Ship”), a Dubai-based subsidiary of Sovcomflot. Sun Ship was sanctioned by OFAC on December 20th. Five shuttle tankers are also reported to be managed by Sun Ship. Two of them (S-3 and S-2) handled cargoes (#8 and #9) after Sun Ship’s December 20th sanction date.
Based on IMO data, Sun Ship does not appear to be in the ownership chain of any of the 24 or so SCF tankers it reportedly manages. Consequently, no vessels were explicitly blocked when Sun Ship was sanctioned. Nonetheless, the involvement of a sanctioned entity like Sun Ship in the chartering process might increase the perceived risk around a cargo in the eyes of some market participants.
4) Previously insured by the American Club while carrying an above-cap cargo: possibly 1 cargo affected
Based on International Group insurance records, one vessel appears to have been insured by the American Club earlier in 2023. While insured, it transported a cargo out of the Pacific that OFAC might deem to have been priced above the cap. If so, that would put the vessel at risk of enforcement actions for price-cap violations.
When tallied up, that comes to eleven distinct risk markers affecting eight different cargoes.3 What’s more, all but two of these cargoes may pose a threat of “contagion” to third parties: any traders, banks or importers that participate in transactions involving these cargoes, are potentially violating U.S. sanctions law and could be subject to enforcement actions. That’s a lot of risk for counterparties to manage.4
December shipments to India from Russia’s western ports as well as from Kozmino were likely deemed to pose far less risk compared to those from Sakhalin
But what about the dozens of other Russian cargoes arriving in India during December? What kind of risk profile did they have? These break down into two groups. By far the largest are Urals shipments from Russia’s western ports. They were delivered by a wide variety of vessels—some with risk attributes similar to those noted above, others without. Notably, however, Urals prices in December hovered around or below the price cap. Consequently, even if the transporting tanker is, say, Liberian flagged or American-club insured, if the cargoes are at or below the cap, importers might see them as relatively low risk.
Then there have been the handful of ESPO crude cargoes shipped from to India from Russia’s Pacific port of Kozmino since early December. Like Sokol grade crude from De-Kastri, ESPO is routinely quoted at prices well above the price cap, and has done so for many months. As with the Sakhalin Sokol cargoes, the high price of ESPO represents a significant risk factor. But unlike with the failed Sakhalin deliveries, however, the tankers transporting ESPO cargoes to India during this period have almost none of the risk attributes dogging the Sakhalin deliveries (see Figure 3 below). None was sanctioned by OFAC; none flew problematic, U.S.-administered flags; none was managed by Sun Ship, and just one appears to have been insured by the American P&I Club at the time.
Forensic analysis suggests the Sakhalin cargoes may have looked riskier than other recent India-bound cargoes from Russia—and were therefore singled out for additional risk-management measures.
In summary, what this forensic analysis of sanctions risk suggests is that December’s India-bound cargoes from Sakhalin may have looked much riskier to Indian importers than those arriving from elsewhere. And it stands to reason that their higher risk profile might explain why cargoes from Sakhalin—but not elsewhere—were the ones that ran into trouble
Part 4: Why were the De-Kastri cargoes turned away from India? A speculative explanation
With these forensic observations in mind, let’s return to our initial question: why did the Sakhalin cargoes fail to get delivered? We’ll begin with the three varying explanations reported in the press.
Explanation 1: there was a problem arranging settlement in dirhams
One report suggested there was a problem with payment mechanics. It claims that India and Russia had agreed to settle their trades in UAE dirhams, but that the Sakhalin exporter “has been unable to open an account with a bank in the UAE to accept dirham payments.”
Settlement currency has reportedly been a vexed issue in the Russia-India oil trade for months. Moscow is eager to move away from the dollar, since it reduces sanctions risk and limits Washington’s ability to track trade flows. India has pushed for settlement in rupees, which Moscow roundly rejects, because of convertibility issues. Moscow has pushed for settlement in yuan, which some Indian buyers resist for political reasons.
As a compromise, Russia and India have reportedly been settling in UAE dirhams. The dirham has good liquidity, is supported by a developed banking system, and is stable, thanks to its dollar peg. But here the peg is both blessing and curse. Maintaining it means the UAE must hold large dollar reserves and have ready access to dollar clearance and U.S. correspondent accounts. This, however, may make Emirati banks sensitive to concerns from U.S. officials.5
Plausible? Yes: Emirati banks are reportedly under pressure not to service trades violating the price cap; they might now fear “contagion” risk from involvement in tainted transactions.
We can only speculate on why a Russian oil exporter might have trouble opening up a settlement account in dirhams. The reason could have something to do with reported efforts by U.S. officials to enlist Emirati banks into supporting the price cap. Since October, some UAE banks are said to be taking a tougher line on Russian-oil related business, to assure compliance with the price cap. It’s conceivable that UAE banks were not satisfied that Sakhalin cargoes complied with the cap and refused to provide settlement services for them. If so, it marks a notable win for OFAC.
Explanation 2: Indian buyers were demanding a deeper discount than Russian sellers were prepared to offer.
An alternative explanation for the failed deliveries concerns price. This explanation comes from none other than India’s Oil Minister, Hardeep Singh Puri, who addressed the issue at a briefing on January 3rd. “There is no payment problem,” he averred, “it is a pure function of price at which our refiners will buy.”
Plausible? Yes. But the way in which these trades fell apart—suspended mid-voyage, long delays at sea, failure to secure alternative buyers—is unusual and suggests something more might be going on than just a disagreement over price.
As the largest importer of Russian seaborne crude and Russia’s largest swing importer, Indian buyers have significant pricing power. They’ve used this to great effect in the past to beat down prices. So, it would come as no surprise to learn that Indian traders are driving a hard bargain. And with over 750 oil cargoes a year now arriving in India from Russia, agreeing pricing has become a routinized process.
So, a sudden failure to agree pricing around a cluster of nine cargoes out of Sakhalin is quite unexpected. And the manner in which these price negotiations collapsed is highly unusual. Agreements for delivery appear to have already been made and some tankers were already within a day or two of landing at an Indian port. But instead, the tankers were kept idling for days, even weeks. That’s not at all the normal-course pattern of price discovery for the Russia-India trade. In fact, it’s quite extraordinary. And that suggests something more may have been going on than haggling over price.
We’ll explore what that might be further below.
Explanation 3: it has something to do with sanctions—again, entirely plausible.
A third explanation offered in the press has been that the De-Kastri delivery debacle is somehow related to the step-up in sanctions enforcement.
We know, of course, that Indian authorities have been concerned about sanctions risk presented by the OFAC-blocked NS Century. That’s a matter of public record. And we saw above that other idled tankers with Sakhalin cargoes suffer from a relatively high risk-profile when it comes to sanctions. Those flying Liberian flags appear to have risk profiles similar to the NS Century, prior to its sanctioning. In the new sanctions environment, it’s entirely possible Indian authorities and importers view the Sakhalin tankers as laden with risk. So, it’s entirely plausible that sanction concerns help explain these failed deliveries.
Which explanation is correct? Perhaps they all are, to some degree, but ultimately price likely played a major role.
These three explanations are not mutually exclusive—perhaps they are all true to some degree. At root, the failed deliveries look to be a sanctions problem, arising from cargoes with a bad risk profile at a time of stepped-up sanctions enforcement. That root cause, in turn, could have caused the payment mechanics problem and the dispute over pricing. So, perhaps the answer to the question “which explanation is correct?” is “all of the above.”
But an important question remains unanswered. In the end, the deal probably wasn’t aborted over payment mechanics: alternatives are available to the dirham. The ultimate sticking point would seem, then, to be price. At least, that’s how it looked through the end of December, when the nine tankers carrying Sakhalin all abruptly turned away from India, and five of them signaled new destinations in China. Based on that data, a reasonable conclusion to draw was that the Russian sellers didn’t like the price on offer in India and had secured better bids elsewhere.
Subsequent events, however, call into question the conclusion better bids had been secured elsewhere. More than than weeks on, not a single De-Kastri cargo has reached China. What’s more, three of the five tankers previously signalling for Chinese ports have dropped those designations. And the two still signalling China suspended their voyages over many days ago. They’ve been idling in the Riau Archipelago along with other ships from the troubled group. Three group vessels are now signalling “for orders”—indicating they have no buyers. None appears headed to a destination port to unload its cargo.
But the usual behavior of the Russian sellers suggests the deliveries were aborted over more than just a pricing disagreement
If, then, the Russian sellers had no firm bid from Chinese buyers, why did they break off negotiations with India? Hardball negotiating tactics? Unlikely. Such behavior is highly out of character for the more than 750 shipments of Russian oil now arriving annually in India. Moreover, by walking away from the table without a firm bid in hand, the Russian exporters risked turning into distressed sellers—which is just what appears to have happened. Not an enviable position to be in.
Circumstantial evidence suggests the Indian buyers might, perhaps, have sought to de-risk these problematic cargoes by requiring pricing linked to the price-cap
One possible explanation—purely speculative it must be stressed—is that the disagreement with the Indian buyers wasn’t just over a few dollars of discount. It was more fundamental than that and binary in nature. It’s possible that the buyers—considering the the risk profile of these particular cargoes and the overall worsening risk environment around the shadow trade—may have sought to safeguard themselves by requiring that pricing in these trades comply with the price cap.
For the Russian sellers, any explicit linkage to the price cap would have been a non-starter. Moscow is intent on preventing buyers from linking pricing to the price cap. The Kremlin made that clear in Putin’s December 2022 decree on the price cap. The only substantive action of this otherwise hollow decree was to prohibit sales contracts “that directly or indirectly provide for the use of a mechanism for capping the price.”
For Moscow, such linkage is a non-starter, since it hands pricing power to coalition authorities.
It would be easy to understand Moscow’s neuralgic response to any demand for price-cap linkage—especially with a buyer as important as India. Once that precedent is established, it puts pricing power into the hands of coalition policymakers. If they chose to ratchet down the price cap, Indian traders could claim—with straight faces—that they have no other choice but to reduce their offers.
In a normal market, Russian exporters could just find a better buyer elsewhere. But the market for Russian oil exports is no longer normal, thanks to the coalition ban on imports. It’s highly concentrated. With Russia’s loss of access to Europe—its primary oil export market for over a century—India emerged as the only buyer ready to provide secure, predictable offtake on the scale Russia needs for its dislocated volumes. But that has given India outsized bargaining power relative to Moscow, which it has used to impose deep discounts.
This time, however, when India tried to use its whip hand to impose tough terms, the Russian sellers didn’t cave. They chose to walk away with no other firm bid in hand, perhaps preferring to risk ending up as distressed sellers rather than accept pricing linked to the price cap. Which leads one to suspect that the real stumbling block—the real explanation behind the De-Kastri mystery—might not have been simply a difference in price, but a demand by India that the cargoes comply with the price cap.
Whatever the case, with no apparent buyers, the exporters of these Sakhalin cargoes now appear to be distressed sellers. That can only hurt Russia’s overall bargaining power in the export markets. It sends a signal that something is seriously amiss with Russian exports, further elevating perceptions of risk around the Russian shadow trade. And after months of making incremental progress with thwarting oil sanctions, Moscow suddenly looks on the defensive as coalition authorities seize the initiative.
Conclusion: If enforcement efforts are scaled up they could reduce the footprint of the shadow fleet and inflict real damage on the Kremlin’s oil income
The breakdown in the Sakhalin-India trade appears likely to be the result of an elevated sense of risk around the shadow trade. If so, then chalk it up as a win for the coalition’s new campaign. It’s notable the coalition has achieved this outcome through a very restrained use of its sanctioning powers. The tanker capacity blocked thus far amounts to just 1.5% of the total capacity Russia needs to keep exports whole.
But while recent events may provide proof-of-concept for the coalition’s new campaign, it’s important to keep things in perspective. At its current scale of deployment, this strategy is likely to have only a marginal impact on Russian revenues. Daily exports from Sakhalin to India account for less than 3% of Russia’s total daily seaborne flows. And it likely won’t be long before they resume flowing to the market.
Meanwhile, although transaction costs may be rising across the board and pricing discounts deepening in some markets, it’s far from certain whether recent events will be enough to have a major impact on Russian revenues. Further action on a larger scale will likely be needed.
Coalition members have potent options available for further constraining Russian oil revenues, should they choose to deploy them.
Coalition members have various options for scaling up their campaign—should they chose to. The most potent might be to focus on constraining Russia’s ability to use its shadow fleet—to shrink its footprint, so to speak. This would force Russia to rely more heavily on the mainstream fleet, where price-cap policies have a better chance of constraining revenues.
Options include limiting Russia’s ability to use its shadow fleet, by scaling up blocking orders on shadow tankers…
They could approach this task in two ways. First, OFAC could significantly scale up the list of blocked shadow tankers. This is a powerful tool. The tankers blocked thus far appear to be effectively out of service. In the three months since the SCF Primorye was blocked on October 12, it has yet to lift a single new cargo, despite having reflagged from Liberia to Russia in early December 2023. The same holds for all the other sanctioned shadow tankers.
As discussed in Dangerous Waters, upwards of 150 active shadow tankers are likely to already be in violation of U.S. price-cap rules and subject to enforcement. So, instead of limiting itself to just listing 7 long-haul shadow tankers, OFAC could decide to scale this up assertively, by blocking dozens of vessels at a go. To avoid any material supply disruptions, they could time the blocking orders for when vessels are in ballast.
…perhaps even targeting shadow vessels that haven’t relied on restricted coalition marine services…
OFAC could ratchet up the pressure another notch and begin blocking shadow fleet tankers regardless of whether they have relied on restricted U.S. services. Nothing appears to be stopping this. An executive order is in place that allows OFAC to sanction entities for contributing to Russia’s harmful foreign activities simply for operating in the marine sector of the Russian economy. No price-cap infraction is explicitly required.
That point seems underscored in OFAC’s December 20th press release announcing sanctions on three “under-the-radar” oil traders. In recounting the offending activities of the three traders, OFAC calls out each for having “sharply increased its share of the trade of Russian oil.” But only one of the three is explicitly cited for involvement with price-cap-violating tankers.
Were OFAC to begin blocking the most active shadow fleet tankers simply for their “sharply increased…share” in the Russian oil trade—regardless of whether they relied on coalition marine services—it would have an even greater chilling effect on the shadow trade. Participants would grow more cautious still, and costs rise even higher—all at Moscow’s expense. Moreover, sidelining a large number of shadow tankers and declaring all shadow vessels “fair game” would likely result in a major reallocation of export cargoes back to mainstream shippers. It could also discourage Moscow from further bankrolling the expansion of the shadow fleet. Why spend billions on richly priced vintage vessels only to have them sidelined by OFAC with the stroke of a pen? Or when importers are increasingly reluctant to buy the cargoes they carry if priced above the cap?
…and introducing an spill insurance verification program, starting in the Baltic, that could restrict the shadow fleet’s access to ports handling half Russia’s export volumes.
To further limit Moscow’s ability to rely on its shadow fleet, coalition partners could follow the lead of the Turks and introduce a spill liability insurance verification program for tankers passing through European waters (see Measuring the Shadows). This program aims to assure that tankers operating in European waters are compliant with spill liability insurance requirements mandated under international law.
The initial focus should be on rolling out a verification program at navigational chokepoints in the Baltic, through which half Russia’s seaborne trade flows. Under applicable maritime law, EU member states enjoy adequate powers to make certain that tankers passing through their waters meet insurance standards required under international law. Tankers in violation of statutory insurance requirements would not enjoy rights of innocent passage. Given the shadow fleet’s track record of brazen disregard for spill insurance requirements, a verification program could effectively exclude many if not all shadow tankers from lifting cargoes at Russia’s Baltic ports. This would significantly reduce the risk of an environmental catastrophe. Moreover, by excluding a large number of shadow operators from the Baltic, it could significantly increase Russia’s reliance on legally insured, mainstream vessels.
Coalition authorities appear to have seized the initiative and put Moscow on the back foot—at least for the moment. How hard will they press their advantage? And what countermeasures might Moscow come up with? Only time will tell. But a year into the price cap, the situation remains as dynamic as ever.
Appendix: Sovcomflot’s flag-of-convenience fiasco—a mass, forced reflagging from Liberia to Gabon is now underway.
A massive reflagging of some 50 Sovcomflot tankers is currently underway, after the Liberian administrators reportedly informed the Russian company of its plans to expel a large number of tankers from its registry. Liberia’s decision comes in the wake of OFAC’s strategy of stepped-up pressure on intermediaries.
Liberia’s decision has compelled Moscow to hastily reflag most of its SCF tankers to Gabon in the early days of January. As of the January 11th, some 46 (64%) SCF tankers previously registered in Liberia have been reflagged en masse in Gabon, based on analysis of AIS data (see Figure 4 below). More are likely to follow suit in the coming days. We may also see other non-SCF shadow tankers reflagging away from Liberia and the Marshall Islands in the coming weeks.
This mass reflagging has made Gabon the leading flag of the Russian shadow trade, with over 90 shadow tankers (including the SCF tankers) now flying Gabon’s colors (see Figure 5 below). At the same time, this move gives the Russian shadow fleet a dominant position among oil tankers registered in Gabon, accounting for over 75% of the class.6 SCF is following in the wake of another sizeable group of shadow tankers that reflagged to Gabon earlier in 2023, after being deflagged by the U.K.-administered registry of St. Kitts and Neavis.
It will be interesting to see how this move affects market sentiment around shadow fleet risk. Now that these ships appear to have severed all ties with U.S.-based services, will concerns over “contagion” abate? Only time will tell. Reflagging might, indeed, provide a bit more protection for anyone participating in future deals involving these reflagged tankers. But it doesn’t cleanse the tankers themselves of their past offences. If they carried non-compliant cargoes in the past while flying the Liberian flag, they likely remain “at risk” of enforcement action. Market sentiment, then, may largely hang on what future moves OFAC has in store.
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.
To the 8 tankers that suspended their voyages to India during December, we are adding one additional vessel, the NS Century, which idled its engines en route to India on November 18th, two days after it was formally sanctioned by OFAC. Of the fifteen tankers under analysis, this is the only one to have been formally sanctioned to date.
This report uses the term “shadow tanker” loosely, to refer to vessels that have gained greater flexibility to carrying cargoes priced above the cap by dropping their International Group P&I Insurance. In this looser usage, vessels from Russia’s state-owned Sovcomflot fall under our definition of “shadow tankers.” See Chapter 2 of Measuring the Shadows.
According to AIS vessel tracking data, the NS Century reflagged from Liberia to Russia around December 31, 2023.
As for the ninth cargo, carried by D-7, none of these risk markers are explicitly present. It is, however, worth noting that this vessel is Russian flagged and directly owned by the Sovcomflot group parent company in St. Petersburg, according to the IMO. The SCF group parent company is sanctioned by the EU and the UK. It is also subject to U.S. financing restrictions, but is not on OFAC’s SDN list. The cluster of sanctions on D-7’s parent company could be a source of concern for some market participants.
Beyond posing a risk of contagion, the overhang of sanctions adds a myriad of additional other risks to transactions involving Russian oil. Take, for example, settlement risk. When a vessel gets blocked, parties already active in transactions involving that vessel are given a “wind down” period for completing those transactions. So, if OFAC announces sanctions on a tanker just as it’s unloading its cargo in Morocco and that sale is being settled in dollars, problems can arise. The banks handling settlement are allowed to process the payment during the wind-down period, provided the funds are placed in a blocked account. The result: the seller loses possession of the oil but doesn’t receive payment for it until the account is unblocked. Before the coalition’s new campaign, such a scenario seemed unlikely—not worth losing sleep over. But with so many shadow fleet tankers now at risk, the blocked account scenario has become entirely plausible. It adds yet another layer of risk to Russian cargoes—risk that ultimately translates into additional costs for Moscow.
On December 22, 2023, the Biden administration issued a new executive order targeting foreign financial institutions involved—wittingly or otherwise—in transactions supporting Russia’s military-industrial base. OFAC can impose full blocking sanctions on foreign banks or prohibit the maintenance of U.S. correspondent accounts. This new order will pressure compliance departments at banks in the UAE and elsewhere to scrutinize activity in Russia-related accounts more closely. Providing banking services for Russian oil trades as such does not appear to be prohibited under this new order (though facilitating trades that violate the price cap are generally prohibited under the price-cap guidance). Nonetheless, this new order could lead some banks to conduct a broader review of their exposure to Russia sanctions, including exposure to price-cap related risks. In some cases, that could lead to a more cautious approach to problematic oil trades.