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The uncertainty unleashed by the war in Ukraine has driven up energy prices and allowed Russia to rake in record revenue from its imports. Despite large discounts compared to Western benchmarks, export income has allowed the ruble to appreciate and may help Moscow mitigate against some of the medium- to long-term effects of Western sanctions, including export bans of key technologies.
The West has tried to accelerate its diversification away from Russian energy but can’t stop new, non-aligned buyers from stepping in. Even if this were possible, cutting off Russian supply would send energy prices higher still.
Today, at the Group of Seven (G7) nations meeting in Bavaria, Germany, leaders are weighing the pros and cons of capping the price of Russian oil exports, even for buyers in markets that aren’t wielding sanctions against Russia. In theory, this could be done unilaterally, via US secondary sanctions, or by imposing specific constraints on the insurance market—an approach which would need to include the United Kingdom and the European Union (EU).
While the United States is pushing for a price cap, consensus is further off than it may seem. Germany wants to maintain US-EU alignment but doubts it can get the measure past all member states. France wants a global cap, applying to all countries’ exports, which would require implausible coordination with the Organization of the Petroleum Exporting Countries (OPEC).
To assist the discussion, the GeoEconomics Center called on three experts (two policymakers and one markets analyst) for their takes on the pros and cons of the cap.
Neutralizing Kremlin profits: The case for price caps
In the first one hundred days of Russia’s war against Ukraine, the Kremlin collected nearly one hundred billion dollars by selling energy on global markets. Of this, more than 60 percent was from the sale of crude oil and petroleum products.
This windfall has been Russian President Vladimir Putin’s financial lifeline, helping Russia’s economy stabilize amid a torrent of international sanctions. With tight global oil markets, crude oil trading at well more than one hundred dollars per barrel, and Western countries grappling with inflation, cutting this lifeline has proven a tough problem to solve—and one that demands creative approaches.
The objective of G7 policy is to cut revenues flowing into Russia, not oil flowing out. If Russian oil supplies can address global demand without benefiting the Kremlin, the West will have crafted a successful policy.
One tried-and-true method of doing this is the approach that’s currently being used against Iran: requiring payments for oil sales to flow into escrow accounts outside of the country. This could be viable and deserves careful consideration by the G7. The one potential problem is that it requires compliance by neutral and pro-Russian countries, such as India and China, without giving them a strong positive incentive.
Another approach is to impose a global cap on the price of Russian oil. Such a price could be set at, or close to, Russia’s marginal cost of production, ensuring the Kremlin is not profiting from its oil sales. At the same time, Russia would have an incentive to keep exporting oil, since the alternative would be a costly shut-in of production at home and the permanent loss of strategic markets abroad.
The G7 could enforce this price cap with both negative and positive incentives. The negative incentive would be the threat of sanctions: For starters, G7 countries can make it illegal for any bank or company in their jurisdictions to provide material support to shipments of Russian oil that exceed the price cap. This would give Russia’s oil exporters a clear choice: Sell oil at or below the cap—with verifiable proof—or lose access to shipping, insurance, ports, and financial services from G7 member states. They can also threaten secondary sanctions against foreign financial institutions that participate in transactions that violate the price cap. For instance, if a Turkish bank were to make a payment for Russian oil in excess of the cap, it could face sanctions.
The positive incentive would be even more important: the opportunity to buy cheap Russian oil. Buyers in India and elsewhere are already driving hard bargains for Russian oil, which is being sold at a discount to compensate for the risk of sanctions. The price cap and the attendant risk of secondary sanctions would give them substantially more leverage, driving down the price of Russian oil even further and accomplishing the policy goal of curbing Russia’s revenues. Unlike most secondary sanctions strategies, in which third countries are compelled to comply with US objectives because of downside risk, the price cap would also give compliance a major upside. It is thus far more likely to work in practice—even if countries like China, India, and Turkey remain neutral (or even friendly to Putin).
While ideally the price cap would be endorsed by the G7, thereby adding legitimacy to the measure, G7 support is not strictly necessary for the policy to work. In practice, all that’s required is a US commitment to implement the policy and enforce secondary sanctions when needed. The aforementioned sanctions on Iran’s oil exports—one of the most remarkable successes of modern economic statecraft—were implemented by the United States alone, yet they still had global impact.
The Biden administration should advance a price cap without delay. In parallel, Congress should advance legislation that codifies a process for the cap to be set and enforced. While congressional backing isn’t necessary, it would be helpful to provide clarity to energy-market participants and demonstrate US resolve to stick to the policy for as long as it’s needed.
—Edward Fishman is a nonresident senior fellow at the Atlantic Council’s Eurasia Center and served at the US Department of State as a member of the secretary’s Policy Planning Staff.
Messy in practice: The case against price caps
The goal of depressing Russian oil profits while allowing oil supply to reach the world market is admirable—but failure to establish a clear enforcement mechanism would lead to confusion among brokers and cheating. Instead of preserving Russian supply and stabilizing global markets, uneven enforcement would spook an oil market already struggling to adjust to existing sanctions and supply rerouting, pushing prices even higher. Previous enforcement failures on complex measures prove that point: the United Nations’ Oil-for-Food Program in Iraq in the 1990s and the 2011 sanctions exception regime in Libya both faced rampant cheating and were used illicitly by the targeted regimes to move money out.
The other popular idea—levying massive import tariffs on Russian energy—faces enormous challenges of its own. Tariffs would require that purchasers have the option to buy from alternative sources to force Russia to eat the tariff costs, but sky-high energy costs have already proven that there aren’t sufficient alternative oil and gas supplies (for now at least). Tariffs would leave European consumers, not Moscow, to bear the cost burden.
Two alternatives exist, but each features its own drawbacks.
The West could expand its sanctions regime and use primary and secondary sanctions to target Russian energy supplies. This would limit Russian revenues by pushing supply off the market, especially if the market has already “priced in” the possibility of Russian supply disruptions and non-Russian supply increases due to higher global prices. But this would cause further energy price increases in an already high-inflation environment and could increase global recession fears from downward economic growth pressure. And in the worst-case scenario, if the market hasn’t accounted for the possibility of disruption, there could be a one-to-one price increase that would make the remaining Russian exports on the market even more profitable.
My preference is to reduce Russia’s ability to benefit from energy exports. Whether or not it’s charging importers in rubles, Russia is receiving large amounts of Western currency in exchange for its exports and uses those revenues to prop up the ruble. Therefore, eliminating the convertibility of Russian energy exports would inflict enormous damage on the ruble and create a chilling effect on almost all trade with Russia. The West can use sanctions on Russian banks to eliminate carve-outs for energy-sales payments, preventing conversions to the US dollar, British pound, euro, and Japanese yen. Moscow could opt to run even larger trade surpluses with China, Turkey, and India to rack up yuan, lira, and rupees—but they would not be able to freely exchange those currencies on the open market to prop up the ruble. This option accomplishes the dual goals of keeping Russian energy on markets and restricting Moscow’s ability to benefit from sales, while also making enforcement far easier, since Western banks already know how to restrict currency convertibility. To maximize pressure on Russia, convertibility—not prices—should be the West’s primary target.
—Brian O’Toole is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center and worked at the US Department of the Treasury as senior adviser to the director of the Office of Foreign Assets Control.
The market-friendly solution: Seeking alternative sources
The price cap policy would not put Russia under the immediate fiscal stress many expect, nor can markets be expected to interpret a potential cap the way the Biden administration might want them to. Without the coordinated rationing of Russian oil imports by everyone, including buyers such as India and China, the cap could be a signal for demand to increase outside of markets engaged in sanctioning Russia and for non-Russian supply to decrease (as those suppliers couldn’t compete).
Clearly, the measure of this policy’s success must be its fiscal impact on Russia. But that battle has already been lost, for this year at least. The Russian Ministry of Finance has already cleared expected oil and gas revenues for this year based on last year’s budget projections. To date, it’s reporting gross revenues of $190 billion, of which $153 billion is attributable to oil and gas. That’s even with an appreciated ruble (which means export income converts less favorably). Russia’s brazen behavior in reducing gas flows to Europe should be seen in this context: It can do just fine without the additional income.
Russia is already selling oil at a discount. In combination with surging demand, which is three to four times higher than pre-COVID-19 trends would have suggested, the uncertainty around the supply of Russian oil has driven prices up across all benchmarks. Yet Russia’s Urals blend is around $80 per barrel, while the more widely traded Brent is currently assessed at over $119. The effects of some traders shunning Russian oil, and the EU’s progressive ban on seaborne exports, are already at work. A cap would have to push this price further down, to the marginal cost of production at $45, precisely as global prices rise.
Implementing a cap via insurance markets, which appears to be under discussion, could also distort these markets to the extent that the policy becomes ineffective. If the price of non-Russian crude skyrockets due to some perception of a future shortage, then risking the penalty for violating sanctions may still make economic sense for some insurers (otherwise, they would be issuing enormous liability coverage on oil that is priced well above the current $119 per barrel). The liability for Russian oil priced above the cap but below market prices would be much lower. Such distortions are not necessarily rare; policymakers simply need to bear in mind that putting the burden of implementation on the insurance market creates a new opening for sanctions evasion.
These daunting knock-on effects should give us pause and make us consider approaches that work with markets, rather than against them. S&P Global data on Russian exports for the month of June now show around 3.9 million barrels per day of seaborne exports, whereas European pipeline imports are around 1.3 million barrels per day. This puts volumes in net crude trade above pre-war levels. A sustainable strategy would require a combination of new sources of supply (which US President Joe Biden’s July trip to the Middle East may be aimed at) and market-led demand reduction.
—Mark Mozur is a market analyst for S&P Global Commodity Insights. The views expressed are strictly his own.
Image: Ukrainian President Volodymyr Zelensky addresses G7 leaders via video link during a working session at Elmau Palace, Germany, on Monday. Photo by Reuters.
