The Group of Seven economic powers (G7) recently proposed a cap on the price of Russian oil and pipeline gas supplies to international markets in a bid to curb Russian energy exports and force it to stop its war in Ukraine. The potential mechanism would only allow the transportation and insurance of Russian oil and gas products sold below an agreed threshold of a fixed international price. The West is trying to avoid mistakes made in previous economic sanctions imposed on Russia as Moscow managed, despite Western pressure, to support Russia’s economy and currency by growing government revenue from oil and gas exports thanks to rising international prices.
The success of the proposed plan will hinge on several determinants, including a unified European stance, as well as the positions to be taken by China and India. Russia’s reaction cannot be ignored as Moscow is likely to take the risk of further reducing oil and gas supplies to Europe if the cap is put on its energy exports.
At a meeting in June, 2022, the G7 leaders discussed a proposed new mechanism to put the squeeze on Russia’s energy exports, which rose after the prices of oil and natural gas surged when the war in Ukraine broke out. The plan is in contrast with the ambitions of the United States, which actually aims to undermine Russia’s economy. The proposed mechanism is likely to be based on certain assumptions, outlined here as follows:
1. A ceiling on Russia’s revenue from energy exports:
Consumers around the world are likely to be allowed access to Russian oil and gas supplies as long as products sold are below an agreed threshold of a fixed international price pre-determined by the West, which means a ceiling will be put on Russia’s revenue from energy exports.
The prices of Russian energy exports are of course higher than production cost, but should not enable Moscow to generate huge revenue. It should be noted that the breakeven point (BEP), i.e. the production level at which total revenues equal total expenses, for Russian oil companies range from US$10 to US$15 per barrel, according to the International Monetary Fund. This means that Russian companies will still have good financial standing despite a steep fall in oil prices, while Russia’s budget can achieve its breakeven point at a price ranging from US$60 to US$70 a barrel.
3. Involving insurance services:
The proposed mechanism will allow Western companies to provide shipping and insurance services for transporting Russian oil and gas as long as shipments are compliant with a determined price ceiling. Accordingly, no cargo companies or importers are allowed to get Russian shipments unless they stick to the price cap set for oil and natural gas.
The motives behind the US and European countries’ proposal for putting a cap on Russian energy exports can be outlined as follows:
1. The current ineffective ban on Russia’s energy exports:
When the war broke out in Ukraine, the United States and Canada imposed a ban on oil imports from Russia. The move was followed by a decision by the European Union banning seaborne imports of Russian crude oil as of December 5, 2022, and ban petroleum product imports as of February 5, 2023. But these measures proved to be ineffective in curbing Russian exports. Russian oil and gas continued to flow into international markets and then get redirected to Asia and some European countries, and Germany in particular.
2. Russia’s quest for alternative markets:
Moscow responded to some European buyers’ shunning Russian crude by sending more shipments to China and India, while also incentivizing refineries there by discounts of $30 per barrel. This pushed China’s and India’s imports of Russian oil by 55 percent over the past three months. Russia’s oil exports to China jumped to 1.9 million barrels per day in May 2022, a year-over-year increase of 55 percent.
3. Growth of Russian energy revenues:
There are no signs that Western sanctions aimed at phasing out Russian energy imports and deprive the Kremlin of revenues to finance its war in Ukraine. Despite a fall in Russia’s energy supplies to consumers, in Europe in particular, Russia's export revenues remained stable on the back of soaring global prices. Data published by the Finland-based Center for Research on Energy and Clean Air (CREA) show that Russia still made an estimated 880 million euros (US$917.5 million) per day from energy exports, including oil, gas and coal, in March-May 2022 compared to 1.1 billion euro per day in January-February 2022, a decrease of less than 20 percent.
4. Challenges to imposing tariff on Russia’s energy imports:
When the war in Ukraine broke out, European officials proposed imposing a tariff on energy imports from Russia, a measure that would increase the cost of energy imports if European buyers are unable to find alternative suppliers. This is the case in global oil and gas markets suffering a deficit in supply. No doubt, tariffs would mean that European consumers, and not Moscow, have to bear the burdens of the new policy.
The success of imposing a ceiling on Russia’s energy exports hinges upon several dynamics, outlined here as follows:
The mechanism for putting a cap on the price of Russian oil and pipeline gas cannot be put in place unless it is unanimously passed by European states. This would also require a re-drafting of the economic sanctions imposed on Russia, including a ban on oil shipments, insurance services and marine shipping. Some observers doubt that European leaders would unanimously agree on putting this mechanism in place. The task is not easy and it might take a long time.
Since the war in Ukraine broke out, positions taken by European countries on banning Russian oil varied. In addition to the flow of natural gas supplies, some countries agreed to pay for Russian gas in rubles while others refused. Moreover, some European countries are not willing to escalate politically and economically against Moscow for fear it would cut gas supplies to the whole continent.
A cap on the prices of Russian energy exports would offer an opportunity to consumers in Asia, and China and India in particular, to secure cheap energy supplies to offset the economic damage they sustained because of the continuous soaring prices over the past period. Even if Beijing and New Delhi are importing Russian oil at lower prices (between US$70-80 a barrel), the implementation of the new mechanism will cause a significant fall in the prices of Russian crudes, which would be a major gain for the two Asian powers.
3. Imposing sanctions on violators:
Some assessments have it that the implementation of the proposed mechanism may require the G7 to threaten to impose financial fines on international maritime shipping and insurance companies and even on states that do not observe the price ceiling set for Russian energy supplies. This means that violators of the new mechanism will be exposed to serious financial risks. One of the proposed measures for implementing the mechanism involves depositing Russia’s revenue from oil and gas exports in foreign bank accounts and trading them for essential commodities needed by Russia. Moscow might view this measure as serious escalation by the West and even respond by political and military counter-escalation.
4. Precautions for cutting Russia’s energy supplies:
The greatest danger resulting from the implementation of the proposed price cap on Russian oil and gas would come from Russia’s counter-measures, such as cutting more oil and gas supplies to consumers in Europe. In response to the G7’s proposed mechanism, Russia’s energy company Gazprom said it might have to review delivery contracts if Western countries impose the cap on the price of Russian gas.
As a result, there is no guarantee that Russia would agree to shipping oil and gas at determined prices, especially if the ceiling price is close to the breakeven point of Russia’s budget. Rather, Moscow might reduce gas shipments to European markets causing further damage to economies. Russia’s retaliatory measures can push European industries of high energy consumption rates to the brink of collapse, prompting European officials to issue warnings recently.
In conclusion, Moscow is well aware that its energy exports are a highly effective weapon. Any attempts by the West to undermine Russia’s revenue from oil and gas by imposing a cap on the prices will prompt Russia to respond by reducing oil and gas supplies to Europe, a measure that will play into the hands of Russia itself because energy prices are likely to jump enabling the Russian government to make record financial revenue.
