Why the Russian oil price cap won’t work

First floated by U.S. Treasury Secretary Janet Yellen, the idea of capping Russian crude oil exports had a dual aim: keeping Russian oil flowing abroad, which would set a ceiling on prices, and at the same time reducing Russia’s oil revenues, which make up a sizeable portion of GDP, Oil Price writes.

The price cap idea was taken up by the G7 leaders at their meeting in June where the seven vowed to find a way to enforce it. From the beginning, the most plausible way to apply price pressure on Russia was by reducing the availability of insurance for its oil tankers unless it agreed to sell its oil at a certain price. In addition to the fact that 90% of the insurance market is in the hands of Western companies, the fact that Western companies are also some of the biggest players in the maritime shipping business was also going to be crucial for the price cap if the G7 wanted it to have any chance of success.

"Today we confirm our joint political intention to finalise and implement a comprehensive prohibition of services which enable maritime transportation of Russian-origin crude oil and petroleum products globally," the G7 finance ministers said in a statement. These services will be made available to Russian oil companies only if they agree to sell their oil at a price "determined by the broad coalition of countries adhering to and implementing the price cap." And this is where the problems begin. The first problem is that Russia, contrary to what the G7 were apparently expecting, did not take this latest attempt to “defund” it . Russia said plainly—twice last week—that it would not sell oil to countries with a price cap in place.

"In my opinion, this is utterly absurd. And this is an interference in the market mechanisms of such an important industry as oil," said Deputy PM Alexander Novak, who represented Russia at OPEC+. "Companies that impose a price cap will not be among the recipients of Russian oil," a Kremlin spokesman Dmitry Peskov said on Friday, adding "We simply will not cooperate with them on non-market principles." 

The proponents of the price cap argue that Russia will have no choice but to comply with the price caps because of that 90% of the insurance market and because of the “broad coalition”. The truth is that the coalition is simply not broad enough to make the cap work. The coalition, despite the G7’s best efforts, does not include either China or India—Russia’s two biggest oil clients. The coalition itself is not a big importer, and two of its members—the United States and the UK—banned oil imports from Russia early on.

A third one, Japan, would be quite hard pressed to enforce the price cap, too, given its dependence on any and all sorts of energy imports. It was not a surprise, therefore, that while Japan’s finance minister Shinuchi Suzuki spoke about the G7 decision, media noted, citing a Finance Ministry official, that oil from Sakhalin-2, the Russian project, which is exported to Japan, will be excluded from the price cap.

The proponents’ argument is that Russia cannot afford to stop selling oil to the G7 price cap enforcers. Russia has already raked in much higher than normal revenues from its oil and gas exports because of the havoc wreaked on markets by Western sanctions. It could then afford to sit back and watch prices top $100 and more once again. Especially, with OPEC+ today deciding to cut production by 100,000 bpd for October in response to the price slide.

The G7 price cap is entering into effect on December 5 for crude oil and for oil products on February 5.