Despite Russia’s war with Ukraine, Russian oil exports have remained largely stable. However, an embargo could lead to drastic price increases – and would only have a certain range.
Editor’s note: After months of negotiations, the G7, the European Union and Australia agreed on December 2 on a price cap for Russian oil of $60 a barrel.
Nine months after the invasion of Ukraine, Vladimir Putin’s war chest continues to be fueled by oil revenues. Even after Western sanctions, Russian crude oil exports remain stable. The price of Ural oil has stayed close to its 2014-20 average. Russia is expected to post a current account surplus of EUR 252 billion this year, second only to China.
However, the last word has not yet been spoken. On December 5th, the European Union finally started to implement measures that had already been defined in May. According to this, Russian oil imports by sea are to be prevented. At the same time, European companies will no longer be allowed to insure, ship or trade Russian crude oil unless the oil is sold below a price cap set by the West.
Since the war began in February, the West has faced a dilemma of how to curb Russia’s fossil fuel revenues without reducing global oil supplies and fueling inflation that weighs on consumers around the world. With the embargo, Europe had threatened a severe blow to Russia’s oil revenues. European insurers and shipping companies have long had a firm grip on the energy markets. Around 95 per cent of property and liability insurance for all oil tankers comes from UK and EU companies. It appeared to be an effective means of controlling the sale of Russian oil.
And yet the first weaknesses became apparent when the embargo was announced. A lack of Russian oil on the world market would result in a sharp increase in oil prices and thus a burden on consumers in the West. The US Treasury Department has now presented a sophisticated plan to cushion the embargo: European companies should continue to be able to offer their services as long as the oil is purchased under a price cap set by the West.
In theory, this sounds reasonable. An amount below current market prices would reduce Russia’s revenues. And as long as the price exceeds the production costs (an estimated range of between 19 and 42 euros per barrel) there would be reason for Putin to continue to extract oil. Price reductions would then be possible on the consumer side and inflation would be kept in check. Even non-aligned countries like China and India certainly couldn’t resist this bargain.
Oil industry realists, on the other hand, know that life is rarely that simple. Two factors are uncertain. On the one hand, there is the question of how Putin will react if his marketability actually gets caught in a headlock by European companies. Russia has already announced that it will no longer use tankers operating under the oil price cap. This could limit its oil exports and rely on a smaller group of non-Western tankers and insurers, causing world prices to rise sharply.
This fear may explain why the West has cautiously priced oil at levels that are still attractive to Russia. At the time of reporting, the expected level was around 57 euros per barrel – the current market price of Ural oil. The embargo and the upper price limit would therefore hardly be effective.
The other uncertainty is how much power the West will eventually wield over global oil markets. A shortage of non-Western tankers could limit Russian supplies in the coming months. Certain types of insurance, such as against major leaks, are rare outside of the West. Still, countries like China, India and Indonesia want to avoid getting involved in Western sanctions and embargoes. They’re looking for alternative sources of everyday insurance coverage – and since the embargo was announced six months ago, they’ve had plenty of time to prepare.
The real balance of power in the oil markets will be revealed after December 5th. A sharp rise in prices cannot be ruled out. However, the lesson to be learned from this year is that the long-term global oil system is more adaptable than one would like to think. Much like the financial sanctions have encouraged attempts to bypass the western banking system, the war will prompt China, India and others to bypass the west’s energy infrastructure. Like weapons, sanctions and embargoes have a limited range – and a limited durability.
The article first appeared in The Economist under the title “The West’s proposed price cap on Russian oil is no magic weapon” and was translated by Cornelia Zink.
*The post “Oil Price Cap Against Putin Sounds Good, But Reveals Massive Gaps” is published by The Economist. Contact the person responsible here.