EU Settled on Oil Price Cap to Limit Russian Revenue without Global Energy Shock
The view of a Gazprom refinery from a local residence in Omsk, Russia. Photo: Alexey Malgavko/Reuters
On Friday, Dec. 2nd, several officials and diplomats from the European Union agreed on an oil price cap of $60 per barrel for Russian cargoes, which aims to limit oil revenue that Putin has used to continue the Russo-Ukraine War while preventing a global energy shock.
The Group of seven industrialized nations and their allies drew up the price cap as one of the responses to Russia's invasion of Ukraine. The G7 will make an official announcement this weekend, according to EU officials. Prior to this Friday, talks regarding a Russian oil price cap had been ongoing in Brussels for over a week. The upcoming EU embargo on Russian energy imports will go into effect on Dec. 5th, allowing the price cap previously devised by G7 to limit Russian revenue effectively. Led by Poland, several pro-Ukraine European countries are also going to announce additional details, including new sanctions and active price monitoring on top of the price cap. Russia previously stated that it would not sell the oil under the price cap system. In the meantime, the US also argued that it would be better to set a price high enough that Russia would comply during the negotiation last week.
Despite concern over its effectiveness, the price cap is the latest coordinated effort that includes multiple mechanisms by Western allies to deter Moscow's financial power. At its core, the price cap intends to allow Russia to continue selling oil but lower the revenue per barrel. The domestic energy crisis in Germany and Eastern Europe has proven to Western allies that stopping Russia from selling oil risks global economic instability by putting pressure on the global supply chain and driving up prices. Moreover, support from Russian oil's primary buyers, such as India and Turkey, is key to creating diplomatic pressure on Moscow. Thus, the US and its allies proposed a price cap to lower the revenue per barrel from Russia. It demonstrates the sanction policy's failure from the western allies– Russia, in fact, is on track to earn more in 2022 from energy exports.
However, the actual mechanism of the price cap is a restriction on shipping and insurance firms. The G7 described the plan as a straight-forward "price cap," which is essentially impossible for a global commodity such as oil. Instead, the plan seeks to utilize G7's dominance over the shipping and insurance industries, which are almost entirely based in G7 countries. The plan will prohibit these industries from providing shipping and insurance services for Russian crude unless the shipment is sold for lower than the "price cap." Russia heavily relies on European tankers and insurers and will risk security and higher expenses if it insists on switching services. The plan aims to leverage this dominance to reduce Russia's oil income.
Even though Russia's heavy reliance on European shipping and insurance companies creates a pathway to success for the plan, the price cap still draws many concerns from allies and experts on both sides. Pro-price cap diplomats believe the price cap is a disappointment by setting a higher-than-expected price. Harder-line pro-Ukraine countries such as Poland believe that the $60 price cap still allows substantial profit for Putin to continue the warfare. Experts skeptical of the plan argue that there are several ways for Russia to circumvent the cap. Industrial officials pointed out the need for more feasibility because it relies on all parties in the supply chain to comply. If Russia insists on refusing to sell oil, the trader partner's intent to keep the commodity flowing will instead put side payment on other commodities that are not oil–overpaying Russia for export that isn't subject to the sanctions. The same happened during the 1990s when the UN imposed a price cap on Iraq. Furthermore, China, India, and other buyers might buy Russian oil by letting the acquisition be handled by non-European companies or import Russian energy from other countries that do not comply with the sanction.
There is no lack of responses to these concerns from the pro-Ukraine allies to improve the plan. The plan would not apply if the buyers ship and insure the cargoes outside the G7, and in response, an EU embargo forces the price cap to apply to buyers outside the region. The activation of the embargo is, in fact, one of the reasons EU diplomats agreed on the current price cap plan. Moreover, as part of the agreement, the EU will launch another round of sanctions this weekend. Poland also negotiated a regular review of the price cap to ensure it closely follows the market price. Starting on Jan. 15, a committee will meet to review the price cap goal. The Western allies' economic war on Russia will surely be a continuing debate from both sides and will include efforts from experts and diplomats to prevent circumvention. We might not know who is on the right yet, but history will reveal the answer for us at the end of the day.
Oil refineries in Omsk, Russia, in November. Photo: Alexey Malgavko/Reuters