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The G-7 Just Agreed to Cap Russian Oil Price. What Does That Mean?

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)

Since the US and its allies began to shun Russia’s oil, there’s been little sign that the measures are inflicting the kind of pain that might force President Vladimir Putin to rethink his war in Ukraine. Other countries including China and India are still buying Russian energy, and a surge in prices has softened the blow from the sanctions. So Putin’s adversaries have hit upon a new idea: make Russia sell its oil so cheaply that it can no longer afford to wage war. The move, while hard to execute, would also help a global economy struggling with higher energy prices that have fueled inflation. 

1. What’s being proposed?

The US, the UK and Canada have announced bans on Russian oil, while the European Union plans to ban seaborne imports of Russian crude and refined fuels. In a further step, the Group of Seven most industrialized countries agreed in September to implement a price cap for global purchases of Russian oil. Buyers in third countries would only be able to access European insurance and financial services to facilitate oil purchases if they adhere to a price cap that would slash Moscow’s profits on those sales. 

2. How might an oil price cap work?

Under a mechanism outlined by the G-7 nations in June, a maximum price would be “agreed in consultation with international partners” and applied to seaborne deliveries of crude oil and petroleum products. Their main lever is their ability to block insurance coverage for those deliveries. Around 95% of the world’s oil tanker fleet is covered by the International Group of Protection & Indemnity Clubs in London and some firms based in continental Europe. Governments could let buyers negotiate for Russian crude, and then qualify for an exception to insurance bans if they secure a price at or below the agreed cap, senior US Treasury officials say. 

3. What could be the impact?

Putin says Western nations are suffering more than Russia from the economic penalties they imposed over his invasion of Ukraine. Surging prices of Russian commodity exports have brought excess revenue that’s helped his government to weather the sanctions. Backers of a price cap hope that pinning prices at a level closer to the cost of production would deal a blow to Moscow’s finances, while still ensuring that energy flows to where it’s needed. As Russia is one of the world’s biggest oil suppliers, a price cap could also relieve inflationary pressure that’s causing economic hardship across the world. 

4. What are the obstacles? 

The plan came closer to reality on Oct. 5, when the EU agreed on a new package of sanctions that would prohibit the shipping of Russian oil to third countries above a capped price. However, all 27 EU member states will need to give unanimous approval to the exact level of the cap that’s still to be decided by the G-7. If it does come into force but fails to hold, it would hand a symbolic victory to Putin. There are plenty of ways that might happen: There’s no guarantee that Russia would agree to ship oil at capped prices, particularly if the cap is close to production cost. The Kremlin may believe that holding its oil off the market for a while would do more damage to the economies of Europe and North America than to its own. 

5. Would big buyers of Russian oil fall into line? 

A price cap may be incredibly profitable for Chinese and Indian businesses, and good for combating inflation. But there are wider considerations for Beijing and New Delhi, such as their long-term relationship with Moscow. They may accept to take inferior Russian insurance rather than be told what to pay for a key commodity, even if it’s at an attractively low price. On a visit to India in August, US Deputy Treasury Secretary Wally Adeyemo said the coalition for implementing a price cap on Russian oil has broadened and a number of countries have joined, while declining to name them. US officials have made the case that, even if countries like India don’t formally join the coalition, they can use the transparency of a low price cap to negotiate a better deal on their own with Russia. 

6. How is Russia responding?

Russia has said it won’t supply crude oil, refined products or gas to any nations that introduce price caps on Russian commodities, and that Russian oil will find alternative markets. It’s already setting up an alternative to the P&I clubs, offering insurance through the Russian National Reinsurance Company. By late September, there were reports of some Russian oil shipments to India being insured through Russian companies. However, it’s not clear that most buyers are ready to accept Russian liability cover. Moscow also plans to launch a national oil trading platform that’s independent of western energy markets. Foreign buyers of Russian oil will be encouraged to trade there with the aim of establishing a local benchmark price.  

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