Why the G7’s oil price cap is unlikely to impact Russia

What are the problems with this price cap?

The fact that it took nearly six months for the EU and the US to come to an agreement on the cap reflects the complexity of this proposal and the internal wrangling with the groupings for arriving upon a figure. The problems are on two counts:

As a solution, the price cap seeks to balance two contrasting objectives – how to cut Russia’s oil and gas earnings without simultaneously crimping the global supply of oil, which could stoke runaway inflation further? That’s where the problem lies.

In May, when the EU first proposed the ban, the inference was that this would deal a major blow to Russia’s oil cash flows. And what gave it further teeth is the fact that European shipping liners and insurers have long had a stranglehold on global energy markets.

But the hurdle here is that while a ban is intended to squeeze Russia, it cannot concomitantly be allowed to end up as a chokehold on Russian crude: because if Russian oil does not make its way into the global oil market, then crude prices could potentially spike, impacting consumers in the EU and the US, alongside those in the rest of the world. The concern of an inflationary spike is very real. So, the floor price formula was decided on.

Why at $60, the price cap is unlikely to make any difference?

Robin Brooks, the chief economist at the Washington-based Institute for International Finance had tweeted last week that a $30 cap would “give Russia the financial crisis it deserves.” The finally agreed cap is double that amount, something that countries including Poland and the Baltic nations have cited as being excessively high, given that it is broadly in line with the current market price for the Urals crude – Russia’s main export variant.

So, essentially, the embargo and price cap scheme has little bite, given that it is just marginally below the current market price for Russian crude. Russian oil is already trading at a discount of about $68 per barrel as compared to $85 for Brent crude, according to Vortexa data.

Also, the price cap of $60 is way above Russia’s cost of production of its main crude variants such as the Urals, which is thought to be in the region of $20-$44 a barrel, according to estimates by the Economist. With the price cap of $60 per barrel entailing a significant monetary cushion, Moscow would continue to have a commercial reason to pump crude and offer it to customers that are willing to buy it.

EU leaders have been quoted as saying after the decision that this $60 cap might be lowered over time, but the problem is with the optics: that it took nearly 6 months for the grouping to come up with a price cap of $60, and this figure barely makes a dent in Moscow’s oil profits that President Vladimir Putin is using to sustain the war with Ukraine.

According to analysts, If the price cap had been around $50, it would have started to eat into Russia’s oil margins, but even that figure would have been above Russia’s cost of production. Even at $45, analysts maintain that Moscow would have an incentive to keep selling crude simply to avoid having to cap wells that can be tough to restart from an economic viability point of view.

Also, with regard to the logistical hurdles envisaged in the price cap proposal, a paper by Reed Blakemore, the deputy director of the Atlantic Council’s Global Energy Center; Charles Lichfield, the deputy director of the Council’s GeoEconomics Center; and Brian O’Toole, a nonresident senior fellow at the GeoEconomics Center and a former senior adviser to the director of the Office of Foreign Assets Control at the US Department of the Treasury, “it is possible for the shipping industry to misrepresent or obscure the origin of its cargo” and there are historical precedents to that.

Also, exemptions for certain pieces of the Russian production complex (including the Sakhalin-2 project that was heavily funded by Japan) suggest that there will be “un-capped” Russian barrels still floating into the market, they noted in the paper. The price cap also does not fully address blends that include Russian crudes, suggesting that there may be additional opportunities to divert Russian barrels “through refined or partially refined products”.

In practice, the price cap will work only if the service providers ask their clients for proof that they have bought Russia-linked crude at a cap-compliant price. In end-November, the US Treasury Department’s Office of Foreign Assets Control (OFAC) had published a determination to pursue the cap and said in its guidance that shipping and insurance firms may not have complete information about how much their clients pay for each shipment and called upon the industry to request attestations that the cap has been respected via simple, and already standard, contract provisions.

The main concern for the EU and the US would be the routing of Russian oil, outside of the price cap remit, through non-European shipping channels to countries such as China, Turkey, Indonesia and India. Moscow has already said it will refuse to use tankers that joined the oil cap scheme and could cut its oil exports relying on a smaller group of non western tankers and insurers.

How does this impact Russia?

Russia’s export revenues have dipped since the second quarter of 2022, due to an easing of global oil prices and lower gas sales due to Russia’s decision to cut flows into Europe through the sabotaged Nord Stream 1 pipeline. But despite all this, Moscow’s current account surplus this year is projected to be above $250 billion, second only to China’s. And the price cap at $60 does not really impact its earnings for now, with crude prices hovering where they are currently. If crude falls, and the price cap stays, then it could be a different story altogether.

What is India’s position?

Despite the United States-led sanctions on Russia post its invasion of Ukraine, India has decided to not just continue with, but also double its trade with Moscow in the “near foreseeable future”. New Delhi’s stand, for now, has been to remain non-committal on any such pricing cap arrangement.

On November 9, External Affairs Minister S Jaishankar and Russian Foreign Minister Sergey Lavrov met in Moscow and India made it clear that it will continue to purchase from Moscow. “…But, as the world’s third largest consumer of oil and gas, as a consumer where the levels of income are not very high, it is our fundamental obligation to ensure that the Indian consumer has the best possible access on the most advantageous terms to international markets. And in that respect, quite honestly, we have seen that the India-Russia relationship has worked to our advantage. So, if it works to my advantage, I would like to keep it going,” Jaishankar had said in Moscow.

The increase in trade volumes between the two countries have mainly come on the back of sharply higher import of discounted Russian crude by India. India, which imported less than 1 per cent of its total crude from Russia before the Russia-Ukraine war, now imports over 20 per cent of its total requirement from it. Crude imports from Iraq and Saudi Arabia, which were the top two suppliers of crude to India, constitute around 21 and 16 per cent, respectively, of India’s total import.