Why is the New Oil Price Cap Destined to Have a Minor Impact on Russia’s War Effort and What Should the EU Do Next?
Since the outbreak of the war in Ukraine, natural resources have been used by the Kremlin as a pawn to economically destabilize the EU and finance its military operations. Stuck between a rock and a hard place, European leaders in the past months have scrambled to find effective measures that can stabilize the price of key energy resources and curtail Russia’s profits over its oil sales. To address these concerns, on December 5th, the EU and the G7 introduced a $60 price cap on seaborne Russian oil. On top of this, the EU on the same day also finally joined the US and Canada in banning all Russian seaborne oil imports. It is the former measure that has caught the headlines though, given the unprecedented nature of this action. As political commentators have put it, it is “one of the most forceful interventions in the global oil market ever”.
So how does the price cap actually work? The price cap prohibits EU and G7 nations from insuring, financing and servicing any vessels that transport Russian oil acquired at a price of over $60 per barrel. This measure mainly relies upon the EU and G7’s influence in the global maritime transport market, since these two international organizations provide insurance to 90% of the world’s cargo ships. As a result of this, the EU is hoping that the price cap will have an impact globally by forcing Russian oil customers worldwide to opt in to this new policy. To ensure its effectiveness in the long-term, the price cap has also been made revisable, as the EU has pledged to ensure that the cap will remain at least 5% below the average market price of oil.
In reaction to the price cap, Russia has firmly stated its intention to not sell oil to countries that abide by this policy. An action of this type would almost certainly cause a significant spike in the price of oil due to the restriction of supply, which would spell bad news for the West. Currently, Russia has not acted on its threats as for the time being Ural oil prices have actually dropped to around $54 per barrel. OPEC has also not well received the news of this new price cap that gives oil consumers greater leverage over producers. In retaliation to the price cap, OPEC is likely to cut oil production, which could also cause a spike in prices and ultimately damage the overall efficacy of this ambitious new policy. The dependence of the effectiveness of the cap on the actions of OPEC, which will most likely act in its own interests, highlights the susceptibility of this measure to a myriad of factors that are beyond the EU’s control.
When we consider the aim to restrict Russian oil revenues the EU also faces an uphill battle, given the various mechanisms that Russia has in place to evade the punitive measures enacted under the price cap. The main factors that currently undermine the potential success of this policy revolve around India and China’s role as sanction busters and Russia’s creation of a shadow tanker fleet. Since the start of the conflict non-aligned nations such as India and China have avoided participating in sanction packages introduced by the West. Recent developments indicate that this policy is not going to change anytime soon, as non-aligned states are currently seeking alternative sources of naval insurance to snap up discounted Russian energy. These third parties are enabling Russia to maintain steady revenue streams from its oil products, as Putin’s regime is set to boast a $265 billion current account surplus this year, only second to China.
Knowing that the imposition of a price cap was imminent by the West, Russia has also bought over the past year roughly 100 oil tankers that enable Putin’s regime to supply its global customer base. Experts have estimated that at current prices, the “shadow fleet” assembled by Russia which mainly serves oil demand from India and China is helping Putin rake in anywhere between $10 to $15 billion a month in revenues. Undoubtedly, these numbers are a significant decrease from Russia’s reported revenue of $21 billion this past June when Brent oil prices reached a record breaking $120 per barrel. Oil prices since then have somewhat stabilized partially thanks to the markets recognising that it was only a matter of time before the West implemented an oil price cap. Because of this, it may be argued that the main impact of the current price cap has actually occurred before its actual implementation. Russian revenues in this instance have already been hurt and are unlikely to fall significantly further unless the price cap is tightened.
Overall, the price cap seems to be a punt in the dark more than anything else, as the EU has entered uncharted territory. Instead of rushing to lower the price cap to $50, if prices continue to drop further, which would probably cause a strong retaliatory reaction from Russia and OPEC, the EU must stay put and make sure it vigorously enforces the current cap. Crackdowns on oil tanker infractions of the cap must be carried out through the close monitoring of tanker documentation and routes of suspected vessels, which have been involved in the past ofspoofing their locations to avoid EU sanctions. A pragmatic approach in this instance is crucial, as Russia’s tanker fleet is still about60 to 70 tankers away from matching its current oil transportation needs. The EU has time on its side and it should not push recklessly its price cap policy to a point of no return. Any changes to the price cap must be approached with utmost caution, as another oil price spike could prove fatal for the West’s unwavering support of Ukraine.