The bid to cap Russian oil prices

The U.S. and its allies want to limit the price of Russian oil to hinder Moscow's ability to fund the war. Would that work?

Story by Ekaterina Mereminskaya. Abridged translation by Sam Breazeale.

For months now, Western countries have been talking about implementing a price cap for Russian oil. According to proponents of the idea, forcing Russia to sell its oil for cheap would hamper its ability to finance the war in Ukraine — and would have the added benefit of not causing a global energy crisis. The problem, according to some analysts, is that the U.S. and its allies likely don’t have the tools to build a cartel that includes major buyers like China and India — and Russia’s retaliatory restrictions could send prices as high as $380 dollars a barrel (up from the current price of $95). Meduza explains how the proposed oil price cap mechanism would work — and why it’s not likely to become a reality.

What's going on?

The West is embroiled in a sanctions war with Russia. Ukrainian President Volodymyr Zelensky called the EU’s most recent sanctions package “insufficient,” and countries appear to be easing anti-war restrictions left and right; Canada, for example, recently issued itself a permit that allowed it circumvent its own sanctions and return a repaired turbine to Russia so that the Nord Stream pipeline could continue working at full capacity, while the EU adjusted sanctions to allow some Russian companies to export gas to third countries.

Still, though, the sanctions war goes on. Since December, the EU has prohibited seaborne imports of Russian crude oil, while Poland and Germany are preparing to stop buying Russian oil from pipelines. Altogether, 90 percent of Russian oil shipments are under threat.

Unfortunately for Ukraine, inhibiting Russia’s ability to finance the war is not the West’s only consideration; the U.S. and its allies also need to soften the blows to their own economies and keep negative effects on the global economy to a minimum. One wrong move could cause power shortages in Europe and send global oil prices soaring.

There’s one measure that could theoretically satisfy all of these requirements: a price cap on Russian oil. Western countries have been discussing the idea at least since the start of the summer: at their summit in June, G7 members, led by the U.S., agreed to explore the idea. The proposal didn’t go anywhere, though, and in August, alliance members reaffirmed their intention to consider the measure.

What’s a price cap and how would it work?

Put simply, a price cap is an agreement among a group of buyers not to pay more than a certain price for a product — in this case, Russian oil. According to proponents, the measure could serve as a temporary way to put pressure on the Russian economy while also guarding the world from the massive oil crisis that would likely result from a complete boycott of one of the world’s largest oil exporters. The main party advocating for a price cap is the U.S.; according to Bloomberg, Biden administration members have been meeting to discuss the proposal multiple times a week.

In order for the mechanism to work, the world’s largest Russian oil importers would have to agree to it, creating a cartel large enough to dictate its own terms of purchase. The West could “convince” countries to join the cartel by threatening, for instance, to restrict their access to insurance. Over 95 percent of oil tankers are insured through the International Group of Protection and Indemnity Clubs, an association of insurers that’s based in London. Its participants could theoretically be prohibited from insuring ships containing Russian oil bought above the agreed-upon ceiling price. The international banks that facilitate petroleum sales from Russia could do the same thing.

But many analysts — and even some G7 members — are skeptical of the idea; in their opinion, the tools at the West’s disposal aren’t strong enough to convince large importers like China and India to join the cartel, nor are they capable of monitoring compliance everywhere in the world.

How low would the cap be?

Despite the lack of consensus around the plan, key details have come into focus in the last month. Sources “familiar with the matter” told Bloomberg that the cap on the price of Russian oil would fall somewhere between $40 and $60 per barrel — about half the current market price. G7’s challenge would be to find a price that would keep Russia from making excess profits but that would still cover extraction and delivery costs so that Moscow wouldn’t refuse to sell its oil altogether.

According to the economists drafting the initiative, a cap in the $40-$60 range would keep oil production profitable for Russia. The Biden administration is reportedly leaning towards the higher end of that spectrum.

Since Russia launched its full-scale war in Ukraine, its oil revenues have greatly exceeded expectations, even despite the decline in exports to Europe. When the country made its budget for 2022, the price of Urals oil was forecast at $62.20 per barrel; the actual average price of a barrel this year is now projected to come out at $80. In addition, China and India have begun purchasing more oil than in previous years.

Despite the decline in oil purchases from the West, Russia’s oil and gas budget revenues for the first six months of this year amounted to 6.4 trillion rubles ($106 billion). The country’s budget planned for 9.5 trillion rubles ($157 billion) in oil revenue this year. Every day, Russia makes about $600 million from oil exports; by the end of the year, it’s slated to make another 8.5 trillion rubles ($140 billion), leaving it with a third more oil revenue than it made last year, according to the forecasting consultancy TS Lombard.

Would a price cap significantly reduce Russia’s oil revenue?

Russia’s 2022 budget was made assuming an oil price of $62 a barrel. $60, the likely price cap if one is implemented, is also the price at which the Russian Finance Ministry has suggested establishing its cut-off oil price if the budget rule that diverts excess oil revenues to the country’s National Welfare Fund is reinstated. That means the government would leave most of its planned expenditures in place, even if the West agrees on a $60 price ceiling.

Budget revenues are also highly dependent on the value of the ruble. If oil prices are artificially set from outside of Russia, the Russian authorities can take steps to weaken the national currency to prevent high oil revenue losses, according to Alexandra Osmolovskaya-Suslina, head of the Economic Expert Group’s fiscal policy division.

Osmolovskaya-Suslina told Meduza that the bigger threat to Russia’s budget right now is a loss of non-oil revenues; after all, the economy is shrinking and imports are restricted, which will eventually lead to an additional slump in domestic economic activity overall. “VAT revenues, the country’s second largest source of budget revenue after taxes on the oil and gas sector, will soon start to decline,” she said.

Though the Russian budget may suffer as a result of other sanctions, the West appears to be far from implementing its price ceiling idea. The G7 countries may have come to a preliminary agreement, but the G20 countries have not. For example:

• In July, Indian Prime Minister Narendra Modi and Vladimir Putin discussed prospects for growing the economic ties between their countries.
• Brazilian presidential frontrunner Luiz Inácio Lula da Silva has vowed not to implement sanctions against Russia.
• South African President Cyril Ramaphosa has criticized U.S. sanctions against Russia.
• Turkey reported that higher energy prices and tourism restrictions resulting from the sanctions against Russia have cost its own economy $35 billion.

Meanwhile, China and India have ramped up their Russian oil purchases. In June of this year, China spent 72 percent more on Russian energy than in the same month in 2021, and in the first three months of the war, it spent twice as much as it did in those months the previous year. In May and in June, Russia replaced Saudi Arabia as China’s top oil supplier. In the first three months of the war, India purchased $5 billion of energy resources — four times more than in the same month a year earlier.

Both countries have been getting Russian oil at a discount: in June, they were buying Urals oil at a price about $25 lower per barrel than that of Brent oil, and in April, the difference was more than $33. While it could be more profitable for China and India to join the American-led buyers’ cartel and fix an even lower oil price for themselves, they will likely be unwilling to spoil their relationships with Moscow.

Finally, the cartel idea might not have the support of the OPEC countries, whose supplies would have to replace Russian oil if Russia refused to sell oil at the price the new cartel demands. OPEC suppliers won’t want to do anything that could shock global oil markets, especially as the price capping plan would set a precedent that could threaten them further down the road.

What happens if Russia refuses to sell oil at the price the cartel demands?

Most analysts expect that Russia would refuse to sell oil under any conditions dictated from the outside — even if the sales would still technically be profitable. “As far as I understand, we won’t provide oil to any countries that impose a price limit,” Russian Central Bank head Elvira Nabiullina said at a recent press conference. And in any case, Russia would still be able to supply oil to Asian countries “against the backdrop of rising global oil prices,” which would compensate for its losses, Nabiullina said.

It’s difficult to predict exactly what effect the plan would have on global oil prices. A month ago, American analysts speculated that a price cap would cause them to rise to $185 dollars a barrel, which could cause a global recession. Earlier, JP Morgan rattled global markets by warning of a “stratospheric” price spike to $380 a barrel if the market suddenly lost Russia’s contribution of five million barrels a day. If Russian supplies don’t stop completely and instead decline by three million barrels per day, the price would rise to $190 a barrel, according to analysts from the bank.

Moscow appears not to have decided what it will do if the price ceiling becomes a reality. The country has “repeatedly demonstrated its affinity for playing the long game, its unusual utility function, and its readiness to play negative sum games in which everybody loses,” independent oil industry analyst Sergey Vakulenko said. In his view, the Kremlin might, for example, “set a price floor rather than a ceiling.” That, he said, would “reduce supply in the markets, driving prices up, and then it would only be a matter of time before countries would start withdrawing from the buyers’ cartel and agreeing to buy oil under Russia’s conditions.”

Another possibility would be for Russia to inflate the cost of associated services such as documentation translation rather than the price of oil itself. In that case, the service price difference might make up for the externally-imposed discount and effectively bring the price of oil back to market level, Vakulenko said.

Bloomberg economist Alexander Isakov agreed that the price ceiling proposal has some unresolved issues. The first, he said, is that the plan has never been tested on such a large scale. The second is that it would be too difficult to monitor compliance: the oil market is fairly decentralized, and exporters could refine their oil in third countries, he warned.

Two other experts Meduza spoke to Meduza on the condition of anonymity said they saw a lot of technical flaws in the proposal: for example, it’s not clear who would be in charge of implementing it, or who would be responsible for ensuring compliance and preventing abuse. Leaving these concerns unaddressed would “create a gray area with unclear rules,” one of the experts said. The result, he concluded, would be not a blow to Russia’s budget but a global spike in oil prices.