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Can the New Oil Price Cap Starve Russia’s War Effort?

Lights illuminate the low-temperature isomerization unit at the Novokuibyshevsk oil refinery plant, operated by Rosneft PJSC, in Novokuibyshevsk, Samara region, Russia, on Wednesday, Dec. 21, 2016. Oil trimmed a second weekly gain as investors weighed rising U.S. inventories against coming coordinated output cuts by OPEC and other producing nations. (Photographer: Andrey Rudakov/Bloomberg)

Sanctions imposed on Russia by the US and its allies failed to starve President Vladimir Putin of funding for his war in Ukraine because there were still plenty of ready buyers of Russian oil. So Putin’s adversaries spent months devising a Plan B: force Moscow to sell the oil so cheaply that its profits collapse. What isn’t clear is whether the price cap eventually agreed to in early December is low enough to really hurt Putin and whether his biggest customers, including China and India, will play along. 

1. How does the cap work?

The Group of Seven wealthy nations, the European Union and Australia agreed to a maximum limit of $60 per barrel on seaborne Russian oil. Those countries still buying it must pay that price or less, or will be deprived of access to key services supplied by firms in those countries. Those include the best insurance against risks such as collisions and spills, and the European-based tanker fleet including ships owned in Greece and Cyprus. Around 95% of the world’s oil tankers are covered through the International Group of Protection & Indemnity Clubs in London, backed up by Europe-based reinsurance services.  

2. What’s the thinking behind the cap?

An EU ban on seaborne Russian crude that kicked in on Dec. 5 deprived Moscow of its last big western buyer. However, an increase in prices through much of 2022 has brought Russia excess revenue that helped to cushion its economy from the sanctions. Western governments know there’s little prospect of China and India joining their oil embargo. They’re hoping the price cap will bring prices on the sale of Russian oil closer to the cost of production, limiting Moscow’s income. What they don’t want to do is stop Russian oil flowing entirely, which could disrupt their fragile economies. The cap provides an offramp, allowing buyers adhering to it to access the insurance and shipping services that the new EU sanctions would otherwise prohibit. This may prevent global crude prices from surging as those sanctions take effect. 

3. Is it likely to succeed?

The challenge was to find a price level that would inflict some damage on Moscow but wasn’t so low that it refused to sell at all. Some in Europe saw the plan, which was initiated by the US, as a way to water down sanctions and pushed for a lower cap. The $60 figure that finally emerged was still about $10 above the key Urals grade shipped from Russia’s western ports but below ESPO, which is loaded onto tankers at Kozmino in Asia, according to data provided by Argus Media. It’s not clear whether a country like China will accept to be told what price to pay for a key commodity, even if it’s attractively low. And there are wider considerations for Beijing and New Delhi, such as their long-term relationship with Moscow. 

4. Are there ways to ignore the cap?

Buyers willing to defy the cap can call upon a growing shadow fleet of tankers that’s emerged to ship Russian crude, with many of those vessels registered to unknown owners. Whether there will be enough of them to maintain a full rate of exports in the long term is not yet certain. And Russia’s key remaining customers will have to weigh the appeal of discounted prices against the risk of taking inferior Russian insurance. 

5. How is Russia responding? 

Russia has consistently said it won’t sell oil to countries that participate in the price cap, and the countries that Russia currently sells to have not signed up to it. But the US and allies hope they will use it as leverage to extract discounts. Russian Foreign Minister Sergei Lavrov said his government will continue to negotiate with its partners “directly” over the pricing of crude sales, noting that “there is always an element of balance of interests,” including on prices. This leaves Russia room to make sales below the cap while claiming it is irrelevant. 

6. Who else could benefit from the cap?

Since the war broke out, several new traders have been marketing Russian oil to buyers in Asia, as traditional entities stepped away. Those include companies like Coral Energy, Wellbred and Montfort. Businesses trading out of Dubai without links to the EU aren’t subject to the bloc’s sanctions, but would still need key services like insurance and finance. The growing risk of carrying Russian oil has seen tanker earnings spike for cargoes loading after Dec. 5 when the cap came into force. 

--With assistance from Olga Tanas and Ewa Krukowska.

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