The G7 group, together with Australia, are due to decide about setting a price cap on exported Russian oil by December 5, 2022. If the decision is to be adopted, the group will agree to set a fixed price rather than a floating rate. This unprecedented proposition by Canada, France, Germany, Italy, Japan, the UK and the U.S. aims to prevent Russia, which is currently the second largest oil producer in the world, to profit from high oil prices following its invasion of Ukraine. At the same time, the G7 wants to ensure that most of Russia’s oil continues to flow to global energy markets. This situation has sparked much debate within the international community. DevelopmentAid asked several experts and learned of various pros and cons.
What are some of the pros and cons of this decision in your opinion?
“The pros of such a measure are to create stress for Russian public finances by reducing revenues and depreciating the main resource that supports the war in Ukraine while maintaining global demand. A fixed cap would create stability and simplify compliance while maintaining the export of oil from Russia to the market, avoiding disruption. For this measure to be effective, it requires the support of the main Russian oil importers such as the EU 27 Member States and countries that have benefited from western sanctions such as India, China and Turkey, as well as the involvement of other oil producers. The cons of such a measure involve certification that the price cap is applied in all transactions and the threat that some trading partners may circumvent the cap through illicit trade. Another issue is how to set the cap as the market can fluctuate. To be effective, the capped price should be substantially lower than the global average and seasonally adjusted to market fluctuations. As a response to the measure, the Russian threat to reduce supply to highly dependent countries might escalate inflation and consequently increase global recession fears due to a downward economic growth forecast.”
“The objective of the G7 policy is to cut revenues flowing into Russia, not oil flowing out. The price cap aims to block Russia from profiting from high oil prices and limiting Moscow’s ability to fund its invasion of Ukraine. The bloc of countries receives about 25% of its oil imports from Russia and represents one of the most important buyers for the Kremlin. The cap will help to negotiate lower prices with Moscow and increase market stability. Russia is the world’s second-largest crude exporter and they could stop exporting oil to countries that enforce the cap. Moscow could also end up cutting production and again, as a result, this would apply upward pressure on global oil prices. Any attempt to limit the price of Russian oil could wreak havoc in the energy market and push commodity prices even higher. The plan could backfire if key consumers are not involved or if it lacks a centralized enforcement mechanism. The reality is that amongst the biggest consumers of Russian oil are China and India. Those countries have already benefited from discounted Russian crude. They may decide for geopolitical reasons to lend support to Russia and facilitate a loophole for the price cap.”
“The idea of adopting an energy price cap or a floating rate was initially conceived to highlight the importance of Israeli and Egyptian gas as an alternative energy source but this supply can only reach 20 bcm which is significantly lower than the Russian annual supply of 140 bcm. Based on CEIC data, we can easily calculate that an amount of $0.5 billion reaches Moscow daily in revenue from oil and gas. This exceeds the average per-day cost of $0.3 billion of military expenditure. Thus, the idea of limiting Moscow’s energy exports revenue is attractive. Gas/electricity prices are more of a problem since we have never seen this upward price movement before. But the debate on energy price caps focuses on oil because gas is not a problem for the US or Canada and because gas issues are very complicated for Europe. Since the price cap on Russian oil was conceived to fight inflation (mainly in low and middle-income countries), there was no way a floating rate could be considered (a floating rate is also not appropriate in a market that is already distorted). The price cited by the U.S. Treasury is $60 per barrel which states that ‘this is an important tool to put downward pressure on global energy prices by allowing Russian oil to continue flowing to the global markets, which will help to mitigate price spikes and put downward pressure on oil prices…countries can choose not to formally join the price cap but they can use their newfound leverage to drive a better bargain when they buy Russian oil’. But as we have already seen, the price cap deals only with oil. Also, this price is relatively close to the market price in a global economy under recession. In addition, countries already use the Russian offer of $35 per barrel discount which has significantly offset the increased oil prices since the war began. Even if the insurance hurdle can be bypassed, G7 seems to think that other shipping industry services such as financing, servicing, and bunkering cannot be bypassed. But the system of attestation ‘where the purchaser of the Russian oil, will need to furnish the service providers it uses’ is not in place. Besides any benefits of limiting Russian oil revenues, the shipping market may be damaged by this measure. Also, there is a risk that it will exacerbate oil prices since it seems that OPEC+ is not willing to fill the void, but will allow prices to increase and also because Russia has announced that it will decrease production by up to 70% of current levels.”
“In response to Moscow’s invasion of Ukraine, the EU plans to enforce a price cap on Russian oil exports. Russian oil products being sold above the cap would be prohibited, without any time limit, from obtaining any shipping industry services, such as insurance and financing from European providers. Faced with a shortage of transportation and therefore a need to curtail production and lose revenue, it is hoped that Russia will soften its hold on Ukraine. This plan seems at first to be effective, however, it might create long-term turmoil for service providers and the shipping market which would be obliged to check a ship’s history after the introduction of sanctions. Moreover, if the global economy goes into recession, market prices might come close to this benchmark, or even fall below it. Given that the declared cap is not lower than what Russian crude has been fetching recently, at this price Russia will be able to preserve its cash flow.”
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