EU agrees to cap price on Russian oil

On December 3, European Union countries, G7 members and Australia reached an agreement on the imposition of a price cap on Russian oil. After months of intense and difficult negotiations, the price cap has been set at $60 per barrel. Russia, on the other hand, has stated that it will not conform to the imposed limit and has heralded countermeasures for adhering countries, such as halting oil sales. The purpose of this measure is to hit Moscow’s revenue volume so as to curtail its resources available for military spending in Ukraine. Yet, the decision comes rather late stage in the development of the conflict. Fear of upside inflationary risks has certainly affected the timeliness of the price cap approval. In fact, European governments feared that a price cap on oil could send the price per barrel and inflationary momentum soaring. The new measure envisaged several elements of flexibility of a quantitative and temporal nature. On the quantitative side, the ceiling threshold will be subject to bimonthly revisions to respond to changing economic, political and military conflict-related trends, so as to maintain a ceiling at least 5 percent below the market price. Regarding the time dimension, a gradual transition has been envisioned. Therefore, the cap will not apply to oil purchased and loaded onto ships prior to December 5 and discharged by January 19, 2023. The deterrent effect of the price cap does not apply exclusively to purchase volumes. In fact, the Russian oil consumption of the signatory countries to the agreement has already declined significantly since the beginning of the invasion and, in addition, since December 5 (the same day the price cap came into effect), the EU has introduced an embargo on Russian oil imports by sea. Nevertheless, the new measure is relevant insofar as it prevents shipping companies, insurance companies and credit institutions based in the signatory countries from participating in the transportation of Russian oil if sold at a higher price even to third countries. As the world’s major shipping and insurance companies are based in G7 and EU countries (G7 countries alone provide approximately 90 percent of insurance services for global cargoes), the measure could make it difficult for Moscow to sell oil at a higher price. What’s more, it is estimated that Russia depends on the shipping and insurance services of G7 countries to transport 1 million barrels per day (10% of its total production, about 20% of its exports) In its practical application, however, the measure may have some critical issues. In particular, its operation depends largely on the ability of shipping and insurance companies in member countries to verify that their customers have purchased Russian crude oil at a price in accordance with the cap. However, companies not infrequently lack adequate information on the prices their customers pay for shipments. There are several factors that could hinder the effectiveness of this measure. First, the group of countries participating in it is limited and does not include the largest importers of Russian crude oil, such as China and India, which have decided not to adopt any cap on oil prices. This decision is motivated by their fears that such a measure would make their exports less competitive, as well as the fact that at the moment both New Delhi and Beijing already buy Russian oil at favorable prices. In addition, OPEC+, the organization of oil producers (of which Russia is a member), has decided not to curtail production and not to adhere to the measure adopted by Brussels. Secondly, the ceiling set is only marginally below the current market price of crude oil, which hovers, at the moment, around $74 per barrel. Thirdly, even with a ceiling set at $60 per barrel, the profit margin for the Kremlin is still considerable, since Moscow’s fiscal oil breakeven point is between $30 and $40 per barrel, with variations depending on the area of extraction. At the moment, the impact of the new measure is uncertain and would seem to have more political value than actual practical value, albeit in the general context of the long-term effectiveness of sanctions and the suffering of the Russian economy.