For months, energy analysts have been fretting about what might happen on Dec. 5, when two things were due to occur. First, a European ban on seaborne imports of Russian oil would go into effect. Second, the world’s advanced economies would impose a price cap on Russian oil.
December 5 has arrived, and … nothing much has changed. That’s good news for oil purchasers, since markets are not registering any unusual concern about supply disruptions. But business-as-usual in energy markets also suggests the West’s latest effort to curtail Russia’s war-making ability is a dud. Russia seems likely to continue earning billions from oil sales, providing crucial funding for Russian President Vladimir Putin’s illegal war in Ukraine.
Europe agreed back in June to ban Russian oil imports, starting in December, with the lag providing a window to secure oil from other sources. The boycott is meant to make it harder for Russia to sell its most valuable export and dent the oil revenue that accounts for 30% of Russia’s federal budget.
But Russia can sell that oil elsewhere, and it has been finding new buyers while Europe has been finding new sellers. The United States developed the concept of a price cap on Russian oil, or a maximum amount participating nations would pay, as a way to depress Russia’s oil revenue no matter who’s buying it. If enough big nations abide by the cap, in theory, it will force down the price every buyer pays for Russian oil, and reduce Russia’s oil revenue. Even nations not participating in the price cap, such as China and India, will demand lower prices for Russian crude if the price cap lowers the benchmark price.
Making this work depends on getting the price ceiling right—and that’s where the scheme appears to be faltering. On Dec. 2, the Group of Seven nations—Canada, France, Germany, Italy, Japan, the UK and the United States—plus Australia set the cap at $60 per barrel. Ukraine and some of its allies wanted a cap as low as $30. Russian oil already sells at a discount to market prices because of existing sanctions that make those purchases more complicated. Buyers demand compensation for the added risk in the form of a lower price.
The discount on Russian oil is about $25 relative to the price of Brent crude (BZ=F) the European benchmark. The current price of Brent is around $83 per barrel. So the G-7 price cap of $60 equates with the price buyers are already paying for Russian oil, and that is plenty high for Russia to turn a profit.
“We’ve been reluctant to hit Russia where it hurts,” Robin Brooks, chief economist at the Institute of International Finance, wrote on Twitter on Dec. 3. “That’s why we … set the G-7 price cap at $60. This is the path of least resistance in the short term, but we are giving Putin the means to fight a ‘forever war’ in Ukraine.”
Poland and other Eastern European nations that border Russia initially lobbied for a $30 price cap, as did Ukraine itself. Brooks speculates that Greek shipping tycoons whose ships carry more than half of Russia’s oil exports pressed for a higher cap, and won out, for now. Ukrainian President Volodymyr Zelensky criticized the $60 cap and basically said it won’t accomplish anything.
Before the war, it cost Russia about $40 to produce a barrel of oil, on average, according to research firm Energy Intelligence. So Russia makes money at any price above $40. That explains why hawks wanted a price cap of $30, which would force losses on Russia, depending on how widely the price cap were imposed.
There are several wild cards with the price-cap regime, and it’s possible the G-7 coalition prefers to wade in gently rather than risk a reckless plunge. Russia has said it won’t comply with any price cap, which raises the question of how Russia might respond if the cap really does start to hurt. The most destabilizing thing Russia could do is stop exporting oil altogether, which would send global prices soaring, given that Russia provides 10% of the world’s supply. That would cause Russia itself a lot of damage, beyond just lost revenue. Russia doesn’t have the storage facilities to bank an indefinite amount of oil, and shutting down rigs and other oil infrastructure can wreck equipment. But Putin is increasingly desperate as his disastrous war in Ukraine drags on and Russia’s military suffers devastating losses.
The G-7 group can also lower the price cap whenever it wants, and it may do so on a gradual basis that squeezes Russia slowly. “There is an inherent tension between (1) meaningfully curtailing Russia’s export revenue and (2) avoiding physical shortages in the global oil market,” analysts at investing firm Raymond James wrote in a Dec. 5 report. “Policymakers are mindful of the current inflationary pressures and political complications arising from that.”
Western sanctions on Russia following its Feb. 24 invasion are straining the economy there, which could shrink by 5% or 6% this year. But it could be a lot worse for Russia. “They have managed the impact of sanctions much more effectively than most international observers anticipated,” Mark Galeotti of Mayak Consulting, said recently on the Geopolitics Decanted podcast. “We can’t write the Russian system off by any means.”
Ukraine’s economy, by contrast, could shrink by 30% this year, as Russia repeatedly attacks the energy infrastructure and levels entire cities. Reconstructing Ukraine once the war ends could cost $750 billion, which is three times as much as all the energy revenue Russia normally earns in a year. Ukraine clearly feels more urgency than some of its allies to bring Russia to its heels, while leaders in the United States and other places, barely affected by the way, want to help Ukraine as long as it doesn’t cause political disturbances at home. The shooting war, meanwhile, goes on, as incrementalism fails to turn the tide one way or the other.