Key Flaws Hamstring Russia Oil Price Cap

John Hardie

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The G7, European Union (EU), and Australia formally adopted a mechanism to “cap” the price of Russian oil exports earlier this month, aimed at squeezing the Kremlin’s coffers while avoiding a spike in oil prices. However, the mechanism’s high price ceiling and its inability to compel Russia’s top customers to respect the cap undermine its ability to deprive Moscow of substantial revenue to fund its aggression against Ukraine.

In June, the EU decided to ban both seaborne imports of Russian oil and the provision of services facilitating Russian oil shipments, most notably insurance and reinsurance, industries which EU and British companies dominate. The Biden administration, which had already banned direct imports of Russian oil, feared the EU ban would cause oil prices to skyrocket by shutting in large volumes of Russian exports.

Instead, Washington proposed a ban on the provision of services facilitating seaborne exports of Russian crude oil and petroleum products — unless the purchasers paid a price below a predetermined ceiling. As originally devised, the idea was to set the cap high enough to incentivize continued Russian oil exports while minimizing Moscow’s oil revenue, the backbone of Russia’s federal budget. Although Moscow threatened to cut supplies to participating countries, the cap’s proponents argued Russia was bluffing, pointing to its dependence on oil revenue.

In the weeks and months before the cap came into effect, the U.S. and UK governments released guidance on how to comply, and the EU followed suit on December 2. The mechanism’s prohibitions took force with respect to crude oil shipments on December 5 and will extend to petroleum products beginning on February 5.

While even a well-constructed price cap would be challenging to execute, the Western coalition has hamstrung its plan’s chances of success. First, the scheme lacks a mechanism to compel participation by China, India, and Turkey, Russia’s top three oil customers, which are not part of the price-cap coalition.

Seeking to solve that problem, Senators Chris Van Hollen (D-MD) and Pat Toomey (R-PA) proposed legislation in September authorizing sanctions against foreign individuals or entities that knowingly facilitate shipments of Russian oil sold above the price ceiling. But the Biden administration ruled out use of such secondary sanctions. Meanwhile, Moscow and its customers have pursued alternatives to Western insurance, reinsurance, shipping, and other services.

Another key flaw is the price itself. Some countries, including Ukraine, pushed for a ceiling of $30 to $40 per barrel. That would be well below the price Moscow needs to balance its budget but above Russia’s estimated average cost of production (excluding taxes). But the EU, with the Biden administration’s blessing, ultimately settled on $60 per barrel. That was just below the then market price of approximately $62 per barrel for Urals crude, which has been selling at a significant discount since early in the war and is now going for around $58.50 per barrel — meaning the cap is above the actual price.

The Biden administration and EU have pledged to review the price ceiling regularly to ensure it actually reduces Russia’s revenue. Market conditions permitting, Washington should encourage the EU to substantially lower the ceiling during its next review, set for mid-January.

At the same time, the administration, in coordination with Congress, should revisit its stance on applying sanctions or other restrictive measures to oil cap violators. Washington could also take a page from its Iran sanctions playbook and develop a mechanism to restrict Russia’s access to hard currency earnings from oil exports. For example, it could require Russia’s oil customers to deposit Russia’s proceeds, in whole or in part, into special accounts denominated in local currency that Moscow could use only to purchase trade goods.

Making Russia oil sanctions work will no doubt be difficult, but defeating Putin’s aggression is worth it. The Ukrainians are fighting for their lives and their freedom. The West should provide all the help it can.