After several months of debate and preparations, the United States and other G7 nations introduced a price cap on Russian crude oil on December 5. In the ten months since Russia invaded Ukraine, this is the first serious attempt by the West to slash Russia’s oil revenues, which remain Russia’s biggest cash cow.
Until now, most sanctions have targeted the financial sector and technology. The United States, United Kingdom, Australia, and Canada banned imports of Russian oil and petrochemicals back in March, but they had in any case imported insignificant volumes. The EU, meanwhile, postponed the introduction of an oil embargo passed in June until December, and an embargo on petrochemicals until February.
The price cap is aimed at solving the difficult task of preventing the Kremlin from replenishing its war chest while avoiding sparking a surge in global oil prices by removing one of the biggest exporters from the market, since such a surge could cancel out any losses felt by Russia in terms of export volumes. But will it work?
Following the introduction of sanctions this spring, Russia mostly redirected its oil exports to China, India, and Turkey. It will likely do the same with the remaining 1.2 million barrels a day that had until recently been sent to Europe. The first question, therefore, is how Asian importers will react to the price cap: will they risk using non-Western transporters and insurers (since Western ones are forbidden from transporting and insuring cargos of Russian oil being sold at prices higher than the cap), and setting up alternative logistics chains with Russia?
India has already said it will continue to buy Russian oil, using non-Western companies to obtain those supplies, but the country’s capacity to refine deliveries from Russia is not unlimited. China and Turkey have not yet made their positions clear, but Turkish imports from Russia have grown significantly this year, and Turkey is likely to remain a hub for Russian oil.
Further growth in Chinese demand, however, is hampered by both the fallout from the COVID pandemic and Beijing’s focus on energy security and determination to diversify its suppliers. For this reason, it won’t be particularly fast or easy to divert Russian oil supplies from Europe to Asia.
Even the act of diverting supplies to Asia entails a significant reduction in Russian companies’ profit margins. It costs a lot more to transport oil to Asian markets than to Europe, and there is not much spare transport capacity, which pushes up the cost of freight, reducing the profit made by Russian companies, whatever the amount at which the price is capped.
The price cap also enables Asian buyers to obtain big discounts on Russian oil. China and India may not officially be enforcing the cap, but it’s hard to imagine that companies from those countries will not use it to barter the price down. Indeed, this is already happening: some shipments to China due to be loaded onto tankers in January were sold at $5–6 cheaper per barrel than usual.
The second question is how fiercely Russia will fight the price cap. Russian officials have repeatedly said they will not accept a price cap, and have threatened to stop working with anyone who abides by it, even if that means Russia having to reduce its oil production, thereby taking an economic hit.
Russia has also been making practical preparations in recent months, expanding its own fleet of tankers to meet its transport needs and establishing contact with the “shadow fleet” assembled many years ago to transport Iranian oil following the Western embargo on it. Russia is also creating its own insurance company and cultivating connections with insurers in developing countries.
So how much will the price cap initially be felt in Russia? In the second week of December, market prices for Russian Urals crude were in any case below the $60 cap, falling to $43.73 on December 7. At the same time, the introduction of the price cap prompted a spike in freight prices due to a lack of tankers prepared to take on the new risks of transporting Russian oil. If transport prices remain where they are, the revenue from selling Urals crude could drop to $40–45 a barrel.
In all likelihood, an informed assessment of the impact of the oil cap will not be possible for the next six months. There’s too much uncertainty on the market and over the workings of the price cap itself. In the first week following its introduction, shipments of Russian crude fell drastically: by 16 percent on December 6, or about half a million barrels a day, according to analysis by Kpler.
The situation will likely unfold in a similar way to that seen in March and April: with an initial shock and slump in export volumes—caused by the disappearance of some previous supply chains, a high degree of uncertainty, and glitches in how the oil cap mechanism functions—followed by a period of stabilization and even minor growth. At the beginning of 2023, therefore, we can expect to see a fall in both export volumes and production, but with the prospect for a bounce-back in both areas.
Ultimately, however, a fall in revenue for Russia appears inevitable. Following the introduction of the price cap, Russia’s Finance Ministry more than doubled its forecasted budget deficit from 0.9 percent to 2 percent of GDP. Next year, the ministry expects oil and gas revenues to fall by 23 percent, but that might be an optimistic forecast, since the Russian budget is based on oil prices of $62–70 per barrel.
Still, the Russian economy is hardly likely to collapse as a result of the decline in oil revenues. Most likely, the slump in 2023 will be comparable to that seen during the pandemic in 2020, and won’t be enough to force Russia to end its war against Ukraine.
Even if oil revenues decline drastically, the National Wealth Fund is big enough to finance Russia’s war for another year or eighteen months. What the decline certainly will impact is Russia’s development and long-term investment in new projects, both fossil fuels and green technology. In a decade, the energy superpower status Russia had claimed will be firmly in the past.
