Why the G7 price cap on Russian oil has limits

It’s a bold plan, one that wasn’t even attempted at the height of the 1973-4 oil embargo. On Friday, after months of discussions, the G7 countries agreed to introduce a price cap on Russian oil. Moscow, a member of OPEC+, could now find itself facing a cartel of buyers.

US Deputy Treasury Secretary Ben Harris explained the goals as follows: G7 countries will use their dominance over shipping and insurance to block Russian oil sales that do not meet the price cap. Oil will sink, keeping world prices subdued, but the limit, set a little above Russia’s estimated production costs, will prevent it from earning substantial revenues. Or, more accurately, we should say “ceilings”, since there will be three: for crude oil, and low and high value refined products.

The G7 has not yet decided on the level of the price caps – average production costs for Russian crude are around $35 a barrel. It will also encourage non-G7 states to join, with the carrot of lower oil supply costs and the stick of measures against oil trade and transportation.

What shall we do now? If Russia categorically refuses to sell to the countries applying the price cap, as it has threatened, the price cap simply reduces to the ban on Russian oil already introduced by the United States and the United Kingdom and which to be implemented by the EU in December.

Then the effect depends on the appetite and logistical capacity of India, China and other Asian consumers to buy Russian oil, probably at a substantial discount. Refiners in the Middle East and Asia can use Russian crude and resell the products in Europe, mitigating the impact of the cap while reaping attractive profits.

Or, Russia reluctantly continues to sell, on the basis that, say, $35 a barrel is worse than the current world market level of $93 but better than $0, and India, though probably not China , joins the price cap system to ensure cheaper oil supply.

Either way, the problem with the system is that it makes buying Russian oil extremely profitable. The lucky refiner who secures the supply pays $35 a barrel and can sell the products to a European or any other consumer at $93 a barrel plus the refining margin.

Overzealous enforcement of shipping, insurance and finance sanctions would create tension between the West and Asian countries. As with Iranian and Venezuelan crude, traders will step in to conceal the origin of shipments, by swapping tankers on the high seas or mixing them with other crudes. Or, some countries and ship operators will choose to risk inadequate insurance or find a way to provide their own. The potential profits are colossal: on the order of $130 million for a single tanker load, more than the cost of purchasing the ship itself.

So who benefits from buying this very cheap Russian oil? The Kremlin can allocate it tactically, as Saddam Hussein did under the oil-for-food program, to geopolitical allies, or as a bribe. The pro-Russian corruption that plagues Europe and the United States is increasing tenfold. Or, companies can pay the difference under the table, or through side deals – agreeing, for example, to take overpriced Russian metals or old tires in exchange for an oil allowance.

The goal is also strange – and surely dictated by political imperatives in the United States. The energy crisis in Europe is centered on gas and electricity rather than oil. Brent crude oil prices, around $93 a barrel on Friday, are not particularly high by historical levels and have fallen significantly since their March high of $139 a barrel.

Moderately high oil prices are expected to be thwarted over the next two years by a rise in US production and the growth of non-oil technologies, notably electric vehicles, which are at the heart of environmental policies in both Brussels and Washington.

Oil is a financial necessity for Mr. Putin; gas is strategic. From the start of the war until June 3, the Finnish Center for Energy and Clean Air Research estimated that Russia had earned 59 billion euros ($58.7 billion) by exporting oil , against only 29 billion euros for gas. Despite very high prices, gas revenues will have fallen further since then, as export volumes to Europe have fallen and Russia has no other accessible markets.

Coinciding with the news of the price cap, Gazprom announced that it had shut down the Nord Stream I gas pipeline to Germany due to an oil leak on the last working compressor, and hinted that sanctions prevent it from being repaired currently. This underscores that the real pressure on Europe ahead of a worrying winter is on gas supplies, not oil.

These factors make it all the more difficult to explain why the price cap policy has come this far. There is a much better option: allow the rent from overvalued Russian oil to be captured by governments rather than shady intermediaries.

A rigid mandatory tariff on Russian imports – say $60 a barrel – would achieve the same goal as the gap and create a strong incentive for India and others to participate.

The same could be applied to Russian gas by Europe, since it has nowhere to go, and would call Gazprom into a bluff.

US Treasury Secretary Janet Yellen backed a tariff in May, but apparently dropped the idea in favor of price caps after European opposition. The EU’s problem is that pro-Kremlin Hungary would likely veto such trade measures, which require unanimous approval under the bloc’s rules. But it reinforces the impression, as with so much else about this conflict, that European power brokers haven’t tried hard enough.

Market structures can be changed. Market forces, on the other hand, cannot be ignored. The US and EU have already wasted six months blundering around the idea of ​​price caps and still haven’t nailed it down. They now have one last chance to come up with a real, workable program that exploits the market instead of trying to hinder it.

Robin M. Mills is CEO of Qamar Energy and author of The myth of the oil crisis

Updated: September 05, 2022, 03:30

Richard L. Militello