Since the Russian military invaded Ukraine in February 2022, the world has responded with sanctions, diplomatic restrictions and condemnation – but a question remains about how markets function without the decades-long reliance on Russian oil exports.
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From December 5, the G7 governments will ban imports of Russian crude oil by sea. Transporting refined oil products, such as diesel and gas, by sea will be prohibited from 5 February 2022.
However, imports will be permitted provided they comply with a price cap agreed upon by the G7 coalition.
Analysts are torn between forecasts of surges in market rates and shocks to the supply sector. Still, the intention is to prevent the Russian government from benefiting from increasingly higher profit margins on every barrel of oil sold while protecting economic stability.
Potential Outcomes Of The G7 Oil Price Cap
Reuters reported that The Kremlin announced it will not sell oil to countries with a price cap, although this may not be reflected in reality.
There is the possibility of pushback to restrict exports to the G7 countries, which include the United States, Japan, Germany, France, Britain, Italy and Canada.
The G7 is also attempting to enlist countries benefiting from discounted oil rates, such as China and India. Although this might not happen, they may yet take the opportunity to negotiate discounts.
For example, if the Chinese government insists on a discount, even outside of the G7 price cap, it will support the intention to exert financial pressure.
Considering the partial restrictions already imposed by the European Union, which it says will remove up to 90 per cent of Russian exports to the EU 27 member nations, Russia may not be keen to limit its supplies further.
Oil price caps would not affect existing sanctions or replace other embargoes but would be introduced simultaneously.
Current Russian Oil Export Volumes
US Treasury Officials have stated that Russian is bargaining aggressively to try and secure long-term pricing contracts at lower than current rates ahead of these changes.
Following the Ukraine invasion in February, oil exports dropped by roughly one million barrels per day, primarily because European buyers decided to limit or cease purchases in response to public dismay at the unfolding events.
The International Energy Agency originally reported that Russian exports, usually at over 10 million barrels per day, were predicted to decline to 3 million a day within months. These forecasts were not borne out, demonstrating a more resilient market than thought.
India is a driving force importing around a million barrels a day at discounted crude oil prices by July 2022, around one per cent of the world supply.
These export levels meant worldwide oil prices dropped from £106 to £84 a barrel in June, but there is little realistic opportunity for Russia to replace exports to G7 countries and the EU to retain the same pace.
The G7 will restrict related services such as shipping, insuring, and financing Russian oil, and China has a well-established diversification policy relating to energy supplies. Therefore, available profits will significantly reduce, possibly by enormous amounts, if Russia refuses to supply governments adhering to the price cap.
While Russia exported 1.6 million barrels per day to China in 2021, it exported 2.4 million to European buyers. The combined effect of these sanctions, price caps and restrictions will certainly make an economic impact.
The Impact Of Oil Price Caps
Russia supplies around 10 per cent of worldwide oil, and officials have been concerned about sanctions causing oil prices to spike.
One of the possible outcomes is that Russia opts to reduce exports, limiting access by G7 and EU countries. Moscow has already dropped exports but has maintained profit levels because of growth in international oil prices.
Following the fall of the Soviet Union, outputs fell to around six million barrels a day from 10 million. They took over two decades to recover, so it seems unlikely that Putin won’t be considering options to avoid this level of disaster.
It isn’t solely the oil that is affected since the G7 nations manage around 90 per cent of shipping insurance services. Although the EU has backtracked slightly on the original idea of banning insurance for Russian vessels, the price caps will apply.
Insurers may respond by pulling cover against oil shipments that have breached the price cap or refusing to offer any insurance on oil exports to avoid being held responsible for assessing oil trade values.
Economists do not predict that the oil price cap will cause inflation to climb higher or force countries into recession – quite the opposite.
The oil futures market is pricing future orders much lower than today’s market prices, adopting steep backwardation. That indicates that financial markets are not in free fall and may view the price cap as beneficial to stabilise the sector, offering lower prices in the months ahead.
If the EU had enforced the originally planned blanket ban on Russian oil transport via sea, this could indeed have caused prices to skyrocket, so a price cap appears to be influencing investor confidence.
Enforcing Price Caps On Russian Exported Oil
A big consideration is enforcement, and how governments will ensure sanctions and price caps are applied across the board.
Essentially, it is the businesses, oil companies and buyers who bear responsibility for compliance, with several considerations:
- Breaching an international sanction could result in severe legal repercussions, which no global business will entertain in return for a higher profit.
- Previous bans on a similar scale linked to anti-terrorism financing and money laundering attracted comparable scepticism but have been successfully implemented.
- Business ecosystems now have the infrastructure and skills to ensure compliance with sanctions, and the private sector has supported the price cap as a more digestible alternative to an outright ban.
There may be some private firms involved in commodities trading, with bases in Russia, or that provide shipping or financing services that decide to resume business as usual. Still, the reality is that they will likely charge much higher rates due to the lack of competition.
The anticipated outcome is that Russian profits will be affected from all sides. Even where refineries in neutral jurisdictions continue processing and selling Russian oil, multinationals will be unwilling to trade, ship or purchase it.
For now, we wait to see whether these sweeping reforms have called Putin’s bluff or if he really will carry out the threat to stop selling oil altogether.
Considering that energy exports have formed over half of the Russian government budget in recent years, it seems unviable to turn off oil supplies and further diminish the country’s economic health, which has already been depleted from financing the war in Ukraine.
G7 Oil Price Cap Explained FAQ
What will the G7 oil price cap be fixed at?
The exact price cap has not been confirmed, but insiders expect a price per barrel to be around $40 to $60 (£35 to £53) for crude oil. A lower cap would be close to the product cost, with the higher limit matching historical crude oil averages.
What does the Russian oil price cap hope to achieve?
G7 leaders have agreed on a price cap, rather than a ban, to prevent Russia from profiting from higher energy market prices and funding the war in Ukraine. The idea is that countries can still legitimately buy Russian crude or refined oil but the cap weakens the Russian economy and reduces the profit margins available.
At what price does Russian oil production break even?
Production and logistics costs vary, but the general breakeven is approximately $30 to $40 (£26 to £35) per barrel. Even though price caps would limit Russia’s ability to finance the war effort, they would allow for revenues slightly over the cost of production.
How will Putin respond to G7 price caps on Russian oil exports?
A Kremlin spokesperson announced in a conference call that Russia would refuse to supply oil to any country where a price cap is in place or enforced – but the jury is out on whether that transpires. The Western nations collectively consume around 70 per cent of all oil exported from Russia, and there is the possibility that Putin will attempt to cut off supplies and redirect them to buyers from China and India. However, if those countries cannot purchase oil at such volumes or adhere to their own energy diversification policies, Russia may not have any buyers left to sell to.
Why is marine insurance so important in enforcing oil price caps?
Insurance is a fundamental aspect of global sea freight because every cargo must hold specialist insurance, of which at least 90 per cent is provided through the International Group of Protection and Indemnity Clubs, based in London. Because G7 countries control such a high volume of the maritime insurance market, even those nations that choose not to participate may be unable to organise the logistics required to transport oil from Russia.
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