A price cap on Russian oil has been proposed by the world’s seven-largest industrialized economies in an effort to further limit the Kremlin’s capacity to finance its onslaught in Ukraine and to safeguard consumers amid rising energy costs.
The G-7’s efforts to set a price cap on Russian oil are not without its challenges, however, as energy pundits have serious doubts about the validity of the idea.
The Kremlin, for its part, has cautioned that any attempt to put a price restriction on Russian oil will cause more negative impacts than positive ones.
Idea of price cap on Russian oil
The US seems to have played a major role in the price cap on Russian oil. When explaining the concept to her European counterparts in May, US Treasury Secretary Janet Yellen asserted that it would act as a tariff or cap on Russian oil and benefit Europe while waiting for a complete ban to be imposed.
Later in the same month, the EU decided to impose a gradual embargo on Russian oil till 2022 end. This was only possible after several weeks of hard negotiations among the 27 nations.
One of the most significant customers for the Russian government, the bloc used to import around 25% of its oil needs from that country. This move of stopping oil purchases is an attempt to harm Russia’s economy, for its unprovoked invasion of Ukraine. But here’s the catch: some European Union countries are heavily dependent on Russian fossil fuels.
U.S. President Joe Biden presented the idea of an oil price cap to the rest of the G-7 leaders over the weekend of June 25 and 26 and his counterparts agreed to look at how to do it. The G-7 comprises the U.S., Canada, France, Germany, Italy, the U.K. and Japan.
Over the weekend of June 25 and 26, US President Joe Biden brought up the idea of an oil price cap to the other G-7 leaders, and they all agreed to look into how to execute it. The United States, Canada, France, Germany, Italy, the United Kingdom, and Japan make up the G-7.
Olaf Scholz, the chancellor of Germany, said the plan required “a lot of work” to materialise since it was an ambitious one.
In an email to CNBC, a spokesperson for the European Commission, the executive arm of the EU, said, “We share the G7 countries’ concerns about the burden of energy price increases and market instability, and how these aggravate inequalities nationally and internationally.”
“In this context, as tasked by the European Leaders, the Commission will continue our work on ways to curb rising energy prices, including assessing the feasibility of introducing temporary import price caps where appropriate,” the spokesperson added.
He further stated that the discussions are considered “a matter of urgency.”
How does the price cap work?
Energy analysts have questioned exactly how the G-7 can impose a price ceiling for Russian oil, warning that the plan could backfire if key consumers are not involved, and time may be running out to make it workable.
Neil Atkinson, an independent oil analyst, said, “I’m one of those scratching my head.”
“Something like this could only work if you get all of the key producers and crucially all of the key consumers working together and then finding some way of enforcing whatever plan you come up with. And the reality is that the biggest consumers of Russian oil, or amongst the biggest consumers of Russian oil, are China and India,” he added.
Discounted Russian crude has benefitted China and India, according to Atkinson. When compared to the global benchmark Brent crude futures price of $110 per barrel, Russian oil has been selling at a significant discount of $30 or more, and China and India have been purchasing it.
Atkinson also emphasised a lack of consensus about Russia’s invasion of Ukraine given that China and India have not denounced the Kremlin directly.
Atkinson said, “In any event, the Russians won’t just sit there and do nothing. They can play games with supplies of oil and indeed gas…they can mess with the G-7′s head in some respect so I think this plan is really a non-starter.”
In an interview with CNBC, Energy Aspects co-founder and director of research Amrita Sen said, “For me, honestly the mechanism doesn’t work. They haven’t thought it through, they haven’t spoken to India and China…Do we really think they are going to agree to this? And do we really think that Russia will actually accept this and not retaliate? I think this sounds like a very, very good theoretical concept but it is just not going to work in practice.”
Amrita pointed out that the countries around the globe are on the same wavelength with Western policymakers, especially when it comes to energy security, which is “the biggest misconception right now.”
“I think that really needs to go away,” she added.
Energy research firm Rystad’s senior vice president Claudio Galimberti stated that insurance is the most direct means to impose a price cap on Russian oil.
Claudio said, “The International Group of Protection & Indemnity Clubs in London covers around 95% of the global oil shipping fleet. Western countries could try to impose a price cap by letting buyers keep that insurance, as long as they agree to pay no more than a certain price cap for the Russian oil on board. However, there are many obstacles that could derail such a plan.”
The fact that Russia might decide not to sell at the prices set by the cap, especially if the benchmark is excessively low and near to the cost of production, was one of the most evident examples, according to Galimberti.
Russian President Vladimir Putin has previously demonstrated his willingness to stop supplying so-called “unfriendly countries” with natural gas if they don’t agree to his gas-for-ruble payment conditions.
Galimberti said that China is the “next most likely obstacle.” He felt that since Beijing may decide for geopolitical reasons “to lend support to Russia by accepting inferior Russian insurance and therefore facilitate a loophole for the price cap.”
“Still, a price cap is surely a measure worth considering at this stage, albeit time is running out, as the EU is determined to ban imports of Russian oil by the end of the year,” Galimberti affirmed.
Even prominent personalities from the oil industry themselves have questioned the idea.
During an interaction with the press in Singapore last week, Shell CEO Ben van Beurden, said, “I am not entirely sure how that would work or who gets punished most, insurance companies or somebody else. I am not saying that it definitely can’t work, it’s premature to draw conclusions like this. They can definitely look at it if only we know what to comply with if that would come into effect, it’s not as easy or as trivial as it sounds.”
Russia’s response
Russia has cautioned that any effort to control the price of Russian oil might sabotage the energy system and drive up commodity prices.
The effort by Western leaders to explore setting a price ceiling was characterised by Russian Deputy Prime Minister Alexander Novak as “another attempt to intrude into the market mechanisms which may only lead to market’s disequilibrium…which would lead to [a] price increase.”
Alexander was sure that Russia would restart oil production at pre-sanction levels in the coming months because a substantial percentage of Russian crude had been transferred to Asian markets.
Russia plays hardball
Germany Economy Minister Robert Habeck has asked the utility firms to increase the gas prices for the customers, which in turn will help in lowering the demand for natural gas.
This development comes after the head of the International Energy Agency warned Europe that Russia is planning to cut off gas exports to the region starting this winter.
The governments have been asked to work on reducing the demand for fuels and keeping the nuclear power plants open.
Fatih Birol, the Executive Director of the International Energy Agency has mentioned that there will be a reduction in supplies in the coming weeks as Gazprom announced that they will be cutting the deliveries via the pipeline by around 40%, stating the reason behind this as “maintenance work”.
This in turn could be the beginning of a huge shortage by preventing the filing of the storage facilities in order to prepare for the upcoming winter season.
Commenting on this, Robert Habeck has stated that the Russian energy plant Gazprom’s decision to cut supplies of natural gas to the European countries was a “political” move.
When asked if gas rationing would be needed, Habeck said, “Hopefully never” but added, “Of course, I cannot rule it out.”
With this news, the EU countries are rushing to refill the storage sites. Germany plans to reach 90% of its capacity by November.
In response to their decision to put sanctions on the Kremlin over its invasion of Ukraine, numerous EU members have seen Moscow limit or even stop their gas deliveries in recent weeks.
G7 bans Russian gold
Meanwhile, in a series of latest repercussions against Russia, US President Joe Biden announced that the US and other Group of Seven (G7) leading nations (France, Italy, Canada, Germany, US, UK, Japan) will ban imports.
To prevent the impact of Russia’s invasion of Ukraine from fracturing the international coalition, Biden and his counterparts will meet supplies and combat the inflation of gold from Russia.
The principal new economic restriction against Russia that emerged from the summit appears to be the prohibition on gold imports, which may result in a fine of tens of billions of dollars.
Officials from the administration chose not to reply when asked if additional sanctions will be applied.
It would be more difficult for Russia to compete in international markets if imports of gold were prohibited as they are Moscow’s second-largest export after energy.
The US Treasury will release a decision to forbid the entry of new gold into the country, further isolating Russia from the rest of the world’s economies by barring its participation in the gold market, according to a senior administration official.
According to British Prime Minister Boris Johnson, the ban stated that it will directly hit Russian oligarchs and strike at the heart of Vladimir Putin’s war machine.
Boris Johnson further added that Putin is unnecessarily spending his resources on this pointless war.
According to the White House, gold accounted for almost USD 19 billion, or approximately 5% of global gold exports, in 2020.