Curtailing Russia’s energy revenue has been a tough nut to crack for Western governments so far.
After President Vladimir Putin launched a large-scale invasion of Ukraine on February 24, the United States and the European Union imposed sanctions on Russian energy imports in an attempt to undermine the Kremlin’s ability to fund the war.
While the volume of Russian oil and gas output has declined on the back of those sanctions, that has been offset by surging energy prices -- driven higher in large part by fear of further supply disruptions from Russia in an already tight market.
Even with Russian oil selling at a steep $30 discount to global market prices of between $100 and $120 due to the sanctions, Putin’s government is still earning more per barrel today than in the months prior to the invasion.
Now, Western nations are working on a new strategy to target the price Russia receives for its oil to curtail revenue while at the same time hoping to avoid deepening the supply crunch, U.S. Treasury Secretary Janet Yellen said on June 20.
The goal is to “push down the price of Russian oil and depress Putin's revenues, while allowing more oil supply to reach the global market," she said.
Oil accounts for about one-third of Russia’s federal budget revenues and a sharp drop in its price -- by market forces or a price cap -- could seriously crimp the government’s ability to finance its war in Ukraine.
U.S. President Joe Biden may discuss the issue with his counterparts at a summit of the Group of Seven leading industrial nations in Germany on June 26-28.
However, some analysts have thrown cold water on the prospects of imposing a price cap, saying it would be difficult to implement and monitor.
“I think they are grasping at straws right now,” said Ed Chow, an energy analyst at the Center for Strategic and International Studies in Washington.
It may “sound good” on paper, “but in practice [it] won't work,” Chow said.
Yellen seemed to suggest that one way the West could impose the cap is to ban insurance for ships delivering Russian oil above a certain price per barrel.
Europe And Asia
The European Union, the largest consumer of Russian energy, earlier this month formally approved a plan to phase out seaborne imports of Russian oil by December and Russian oil products by February 2023, a move that will force Moscow to look for other markets.
China and India have been snapping up most of the Russian oil that the EU has forgone.
The EU and Britain also agreed to bar their companies from insuring tankers carrying Russian oil, which could potentially limit the amount delivered to Asia, thus worsening the global oil supply crunch and driving prices even higher. The International Group of Protection & Indemnity Clubs in London insures about 95 percent of the global oil shipping fleet, according to Rystad Energy, an Oslo-based research firm.
The new policy under consideration by the G7 would apparently create a carve-out to allow those shipments of Russian oil to continue if below a certain price.
But a price cap on Russian oil might not mean a discount for its buyers. Why not? Because the West is looking for ways not just to deprive Moscow of money it can use to fund the war but to put that money to work for Ukraine.
Amos Hochstein, a senior adviser for global energy security at the U.S. State Department, told a Senate hearing earlier this month that the Biden administration and European allies are looking at a “variety of options” to rebuild Ukraine with Russian energy revenue.
He said the administration wants to make sure that “nobody’s profiteering” from the Western sanctions imposed on Russian energy, a reference to the $30-a-barrel discount India and China are currently receiving.
However, China could help Russia get around the price cap, and presumably any revenue diversion, “by accepting inferior Russian insurance,” Rystad said in a June 23 note.
'No Return To Profit'
Craig Kennedy, a fellow at Harvard University’s Davis Center for Russian and Eurasian Studies, earlier this year proposed an alternative policy to reduce the Kremlin’s energy revenue while setting aside money for Ukraine’s reconstruction.
Kennedy suggested that Western nations bar all Russian oil imports except those purchased through a specialized body, which would receive the market price from the buyer but pass on only the cost of production to the Russian company, or about $20-$25 a barrel, setting aside the remaining cash into a fund for rebuilding Ukraine.
Kennedy contends that the Kremlin is in a weak bargaining position vis-a-vis Brussels because Russia energy infrastructure -- including rails, pipelines, and ports -- is largely geared toward exporting oil to Europe.
Russia exported about 4.5 million barrels a day of oil and oil products -- or nearly half its production -- to Europe prior to the February invasion of Ukraine.
The Kremlin would be hard-pressed to sell much of that oil to China and India due to those nations’ commitment to energy diversification, Kennedy said.
Russia would account for more than 40 percent of oil imports to China and India in such a case, he said.
Thus, Russia would face a dilemma: sell to Europe under a price cap regime or cut production, hoping a price spike would break Brussels’ resolve.
However, cutting production for an extended period of time could cause irreparable damage to oil fields, Kennedy and Chow said.
“Most Russian oil wells have meager flow rates and poor economics,” Kennedy said. “A prolonged, large-scale shut-in would mean laboriously closing tens of thousands of these marginal wells, many of which could never return to profit. It could also compromise complex pressure maintenance programs [that are] critical to field profitability.”
However, Rystad said that Putin “has already shown his willingness” to withhold energy supplies by cutting natural gas exports to several European countries this year.
Would A Tariff Be Better?
Brian O'Toole, a former senior adviser at the U.S. Treasury Department, said that in general a price-cap policy without clear implementation and enforcement could throw markets a curve and lead to further price increases.
Interference in markets can “gum things up in a way that people haven't anticipated and it's going to have negative collateral consequences as a result,” said O’Toole, who is now an analyst at the Washington-based Atlantic Council.
Chow suggested that the West instead impose a tariff, with those proceeds set aside for rebuilding Ukraine, saying it’s an easier concept to implement
For instance, a $50 tariff on Russian oil imports could reduce the price the Kremlin receives to $50-$70 a barrel, compared with the current market price range of $100-$120.
“We know how to impose and enforce tariffs because we do that with thousands of goods,” he said.
