by Daniel DePetris
The United States and its allies in Europe have spent the last 10 months turning the screws on the Russian economy in retaliation for Vladimir Putin’s war on Ukraine. The Western coalition blocked Russia from accessing around half of its more than $600 billion in foreign reserves, disconnected multiple Russian banks from the global financial system, diversified away from Russian natural gas and banned the import of Russian coal.
Now, Russian crude oil is being targeted. For the foreseeable future, the European Union, still the biggest buyer of Russian oil, will cease looking to Moscow as a source for the fuel. On Friday, Dec. 2, the G-7 (consisting of the U.S., the U.K., Canada, Japan, the EU, France, Germany and Italy) finalized a novel plan that aims to limit the revenue Russia receives from oil sales around the world to $60 dollars a barrel, essentially stripping Moscow of the power to dictate prices.
Maritime financial services and insurers in the EU and U.K. will no longer provide coverage for vessels carrying Russian oil unless the oil is sold at or below the cap. U.S. Treasury Secretary Janet Yellen is confident the mechanism will work, writing that “the price cap will immediately cut into Putin’s most important source of revenue.”
The idea of the cap is to accomplish two seemingly contradictory goals at once: reduce Russia’s profits and keep enough crude on the market to ensure prices don’t spike. It’s the geopolitical equivalent of having your cake and eating it too, and if Washington and Europe can pull it off, the mechanism will almost certainly be repeated the next time a major oil producer enacts policies the West doesn’t like.
The problem is that while the price cap sounds good in theory (who would cry at the notion of Putin losing tens of billions of dollars in oil revenue?), it’s an untested idea. Nobody knows if it will work. And like most policy decisions, the price cap isn’t a panacea.
The Russians have always known there was a possibility of the EU imposing additional sanctions on its fossil fuel industry, a dangerous prospect since the majority of the Russian government budget is underwritten by the sale of oil, gas and coal.
EU member states have been debating an oil price cap since the spring, so the Kremlin has had the better part of six months to prepare. The Financial Times reported on Dec. 2 that Moscow has quietly assembled more than 100 aging tankers, some of which can carry upward of 2 million barrels per trip, to ensure its oil can ship to buyers in Asia without having to rely on vessels now bound by the G-7′s new rules.
Indeed, Russia has been transitioning away from Europe and toward Asia since the war began in February. The reason the Kremlin is still swimming in oil money is due in no small measure to China and India, the latter of which has increased Russian oil imports between January and October.
Those purchases will continue regardless of the price cap — India in particular has demonstrated that it will scrounge around for the best deal possible. There is no better deal on the table right now than the roughly $25-$30 per barrel discount Russia is offering to buyers.
Even with Russia’s preparations, however, Moscow won’t be able to reroute all of its crude to Asia. China, normally an energy-hungry economic giant in high demand for oil, is still in the middle of strict COVID-19 lockdown procedures (although some localities are beginning to loosen those restrictions due to protests). Less movement means less demand, which translates into Chinese refiners buying less than they otherwise would. The Paris-based International Energy Agency assesses that 1.4 million barrels of Russian oil could be off the market by the beginning of next year, in part a consequence of declining Chinese demand.
We shouldn’t rule out a global price hike either. Since the summer, Americans have been the fortunate benefactors of lower prices at the pump. But depending on how much Russian oil is taken off the market and whether other producers make up the difference, the costs could rise yet again.
If one were a gambler, it wouldn’t be a bad bet to place your money on exactly that outcome. The Russians have threatened to cut production in retaliation for the G-7′s price cap, a threat that should be taken seriously given Moscow’s previous interruption of natural gas supplies to Europe. While it would cost a considerable amount of money for Russia to stop production over the long term, Putin has shown over the last 10 months that he’s willing to use all of the leverage Russia possesses to cause economic pain in the West.
The war in Ukraine has changed the way many around the world think about international politics. Energy markets aren’t immune to change either.
