A European ban and price cap on Russian oil went live this week, as the United States and its allies go after Russia’s all-important oil revenues.
These are some of the biggest sanctions to date, as Europe — once the destination for about half of Russia’s oil exports — further weens itself off Russian energy. And Europe, along with the United States and other major economies, like the United Kingdom, Japan, Canada, Australia, have agreed to a maximum of $60 per barrel on Russian seaborne oil, which means anyone who still wants to buy Russian oil has to pay that price or less if it wants to ship cargo through operators or insurers based in the EU or other countries who signed on to this price cap.
The big question, of course, is how this all might work — and whether it will achieve what the United States and its allies want it to, which is to reduce Russia’s profits and restrict its ability to fund its war in Ukraine, while trying to protect the rest of the global economy from dramatic price shocks.
There are a lot of unknowns, but this is a dramatic and unprecedented move by the US and its partners — especially given how dependent Europe was on Russian energy. “If anyone told you a year ago that the EU is going to effectively eliminate its dependence on fossil fuel imports from Russia, over a period of a year, you would have thought they’re a complete lunatic,” said Lauri Myllyvirta, lead analyst at the Centre for Research on Energy and Clean Air.
It’s true that Europe continued to buy a lot of Russian oil and gas in the first half of the year, even after Russia invaded Ukraine. It’s also true that Moscow itself cut off supplies of natural gas, giving Europe little choice but to find alternatives. But even so, it’s a real and rapid scrambling of a relationship, and the EU has largely (if not perfectly) been decreasing its Russian fossil fuel imports with the expectation of the ban and other measures. Starting in February, the EU will also ban oil product imports from Russia.
“Energy has historically — for good reason — been the third rail with respect to engagement from Russia and sanctions,” said Adam M. Smith, an international trade partner at Gibson Dunn and former senior adviser to the US Treasury.
As a result, Smith added, it is “an important watershed moment — no matter what happens with respect to effectiveness and implementation [and] enforcement.”
The effectiveness and implementation of a price cap like this are untested. The EU ban will cover all seaborne oil — about 90 percent of EU Russian oil imports, although an exemption remains for pipeline gas. The United States and other countries already banned the import of Russian oil, but that didn’t have as much impact because they didn’t buy as much as Europe. But the EU embargo would have also prevented operators from insuring ships carrying Russian crude. That could throw the global oil market out of whack by taking a lot of Russian oil off the market and spiking prices. This would put a lot of pressure on poorer countries that just couldn’t compete, exacerbating global food and fuel crises. It would also likely increase profits for the Kremlin since they’d make more money on the oil they could still sell to willing buyers.
Enter the price cap. With this, European firms and any of those within the price cap coalition — the Group of Seven, plus Australia — can continue to finance, insure, transport, and broker ships that carry Russian oil — as long as it’s happening at that agreed-upon $60 price cap. Any country that wants to pay more for Russian oil can’t use operators or insurers from this coalition, which is a big share of the market.
Right now, Russia has said that it will not abide by the price cap, even if it means cutting production. But if the price cap works as it should, the increased costs and inefficiencies of trying to work around it will dissuade buyers from doing so. And for Russia’s most important clients — like China, Turkey, and India — the price cap could serve as a negotiating tool so they continue to buy Russian oil on the cheap.
Of course, this is if it all goes according to plan. There are already caveats. Though Russia isn’t exactly going to be transparent about this, the $60 price cap appears to be about what Russia is already selling its oil for, which means Russia’s oil revenues are unlikely to nosedive immediately. Some countries, like Poland, pushed for a much lower cap, and Ukraine has also said this doesn’t go far enough. There are also some questions around enforcement, as shippers have to attest they are abiding by the price cap, and negotiators ended up weakening some of the penalties for violators.
But the US and its allies were trying to strike a balance through a mechanism that hasn’t been attempted before. They wanted to avoid completely disrupting global oil markets while applying more pressure to Russia’s oil profits. The cap is not firmly set, and is subject to a review every two months. That means it — and its enforcement mechanisms — are likely to be tinkered with depending on how this all plays out.
“This is about balance. It was never about not having any Russian oil on the market. It was about balancing supply and demand but also balancing the need to limit Mr. Putins’s ability to profit. And again, we think that $60 per barrel will do that,” National Security Council coordinator for strategic communications John Kirby said on a press call Monday.
“It doesn’t mean that that cap can’t be adjusted going forward as we see the way it’s being implemented, and as we see how the Russians might react to it,” Kirby added.
How the $60 price cap on Russian oil is supposed to work
After a lot of wrangling, the European Union agreed to put a $60 price cap on Russian oil, which was adopted by this Group of Seven coalition. The United States and Secretary of the Treasury Janet Yellen had championed the price cap as a way to stanch a sharp rise in energy prices as a result of Europe’s embargo. Some European countries, like Poland and the Baltic states, wanted to really go after Russian income and set a much lower price cap. (Ukraine had pushed for about $30.) But the US and other countries — especially those, like Greece, with big maritime interests — were wary that setting the price cap too low could force Russia to cut production a lot and broadly unsettle the global economy.
Basically, the coalition doesn’t want to stop the purchase of Russian oil altogether, they just want the international equivalent of a permanent Black Friday sale.
And so they landed on this $60 price cap. Here’s how it’s supposed to work in practice: Any actor in a jurisdiction of the price cap coalition that transports, insures, or finances the shipment of Russian oil by sea, can only do so if the price per barrel is $60 or less.
The reason the coalition thinks it could work is because a lot of maritime operators and insurers and reinsurers are based in Europe and the United Kingdom — or as Myllyvirta put it: “The two big things are Greek ships and UK insurers.” That market domination would make it costly and cumbersome to insure your ship against an oil spill, say, or find an available tanker that doesn’t fall under a jurisdiction that’s adopted the price cap.
Previous sanctions and the EU’s overall reduction of consumption of Russian oil — even before the latest ban — were already driving a discount in the price of Russian oil. A full-on EU embargo would drive that discount even more, since Russia now badly needs to unload its oil elsewhere. But the EU embargo, as initially proposed, would have also prevented EU entities from insuring ships carrying Russian crude, which could create a major jam in the global markets because there simply wouldn’t be enough insured ships to carry that oil to where it needed to go. But with a price cap, there’s only a scarcity of ships that can transport Russian oil above that $60 price gap. So if you’re trying to get around the price cap, those shippers are likely going to charge higher rates — which also means you probably don’t want to pay very much more for Russian oil, too. “If you achieve significant enough coverage of the price cap, that is going to drive the prices down for the transactions that aren’t covered by the cap,” Myllyvirta said.
Russia has said it will not sell oil subject to the price cap, even if it has to scale back production. But this is easier said than done because Russia still needs oil buyers, like China and India, who now have a lot of leverage. “Am I going to buy [oil] at anything above 60 bucks, knowing that’s the only option Russia has? Are you going to do Putin a solid and say, ‘no, I’ll pay you $65, I’ll pay you $70.’ I’m not sure why they would, especially because they have all the cards,” Smith said.
As Christopher Miller, an associate professor of international history at the Fletcher School at Tufts University, pointed out, discretion is also a bargaining chip. Beijing doesn’t have to say its following the price cap publicly, but it can milk Russia for as much of a discount as possible behind the scenes. That lets Russia save face, and everyone else saves money. “We shouldn’t be surprised to see a situation in which everyone is denying the price cap having an impact, even as there’s some quantitative evidence from price dynamics, that actually, it might be impacting the discount,” Miller said.
That doesn’t mean this plan is foolproof. Russia is amassing a “shadow fleet” of tankers to try to blunt these measures. Enforcement is also a question. Right now, relevant transporters and insurers have to disclose and attest to their compliance with the price cap.
And, right now, the EU penalties for carrying oil above the price cap are somewhat light; EU operators are prohibited from insuring, financing, and servicing a vessel for the transport of Russian oil or petroleum products for 90 days. This was scaled back from a lifetime prohibition. Still, evading sanctions is subject to other legal penalties.
Other factors could test the staying power of the price cap. Russia could get really good at getting around it; it could cut its energy exports, hurting global supply. Oil prices might rise again for other reasons.
“The logic of the price gap was to shift the burden of the cost onto Russia rather than onto the rest of the world,” Miller said. “We haven’t seen a really tough test of the price cap mechanism yet because of where global oil prices are and where Russian discounts have been thus far. If oil were to spike upward again, then we’d face a real test of whether the price gap is going to hold out.”
These sanctions are a big deal, but what’s left?
However this price cap functions, the symbolism of a coalition going after Russia’s energy is still remarkable, and very difficult to imagine before Russia’s invasion. It is a tremendous step, especially for Europe, and shows how much Russia’s invasion, and the cruelty and violence of it, has shaken the West.
Russia is under unprecedented financial and energy sanctions, especially for an economy of its size. Russia has weathered a lot of that pressure so far, and its energy and resource exports are a huge reason why. Still, sanctions are undoubtedly having an effect. Russia’s economy has shrunk. Import bans on advanced technology are forcing Russian manufacturers to scale back features — no airbags in cars, for example — because they can’t get parts. That is also affecting Russia’s ability to make advanced weapons. And even if Russia was buoyed by its oil and gas sales, those are declining, and Russia has been heavily taxing some of its oil and gas industries to try to raise more revenues. That can’t work forever, either.
As experts said, there are still more sanctions to impose on Russia — we’re not at the level of an Iran or a North Korea yet — but all of that would come with repercussions for the United States, Europe, and the rest of the world, all of which is struggling with inflation and rising food and fuel prices.
And almost a year into the war, the United States and its European allies have evolved and adapted how it thinks about punishing Russia and supporting Ukraine. Specifically, the West has invested a lot into providing more advanced military equipment to Ukraine, to aid in their counteroffensive and reclaim territory. Giving Ukraine HIMARS and high-tech tanks also seemed as unlikely at the start of the war as the West targeting Russia’s energy sector.
And this price cap may do what it’s intended: target Russia’s oil revenue, intensify pressure on the Kremlin, gum up Moscow’s war machine, all while insulating some of the world from the fallout. As Myllyvirta said, maybe the first question isn’t what else the West can do to punish Russia, but do we need more? “I will say that if we pull this off — if we make the price cap work, the oil ban work — then we are going to have Russia on the ropes.”
Jen Kirby
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