Russian Oil Price Caps Are Failing a Key Test
Oil prices have risen since July, exposing fatal flaws in the price caps on Russian oil exports. Russia has found alternatives to G7 and EU support services, and refiners, shippers, and others have gamed the system by obscuring the real price of oil trades and filing dodgy paperwork. Since mid-July, Urals crude from Russia has consistently traded above the price cap of $60 per barrel. The U.S. Department of the Treasury has now sanctioned several companies for transporting oil sold above the price caps and signaled that tougher enforcement is imminent. But with rising oil prices, there is limited appetite for moves that could reduce supply and increase costs for consumers.
After Russia invaded Ukraine, European buyers aimed to sever their energy relationship with Russia. In their efforts to inflict costs on the Russian economy, the Treasury Department and its EU counterparts had two key goals: keep the oil market well supplied but reduce Russia’s revenue per barrel. They designed a clever instrument to accomplish these twin goals. The price caps on Russian seaborne crude oil and petroleum products depend on closing off access to G7 and EU-domiciled support services for transactions above certain price levels. The thinking was that Russian dependence on shipping, insurance, brokering, trade finance, and other support services from G7 and EU economies would force it to comply. As a result, Russia would have to accept the price caps of $60 per barrel for Russian seaborne crude exports, $45 per barrel for lower value petroleum products like fuel oil, and $100 per barrel for higher value products like gasoline and diesel.
These assumptions were flawed. Russia had months to prepare, and it bought hundreds of crude and product tankers to increase its independent export capacity, including many aging vessels that would otherwise have been scrapped. It sought alternative insurance including property and indemnity coverage. And around the world—especially in the United Arab Emirates (UAE) and Hong Kong—new entities cropped up to facilitate exports of Russian crude and products, sometimes closing deals in UAE dirhams or Chinese renminbi rather than dollars.
The “attestation” process that requires various actors to verify that transactions are compliant with the price cap is toothless. Nearly all of global oil trade is negotiated on floating prices based on benchmarks such as Dated Brent, while the price cap is fixed. Also, oil is normally traded weeks in advance of delivery. For such a transaction, it is impossible to tell whether it is above or below a fixed cap of $60 per barrel, especially for those who provide support services but typically lack access to contract and pricing details. To obtain services such as shipping, insurance, inspection, and brokerage, the industry simply had to provide a document stating “compliance” with the G7 price caps. Sellers of Russian oil also adjusted their pricing by inflating their shipping and other costs to keep headline free on board (FOB) prices below the $60 per barrel cap. This has not been very hard, given the growth of Russia’s independent shipping capacity.
Russia has been forced to discount its oil, but mainly because of embargoes rather than price caps. Embargoes by the European Union and other countries left Russia with fewer, second-tier customers who are unaccustomed and not well configured to refining large quantities of Russian oil. The main importers of its crude oil have been India and China, who now have more leverage in transactions and have forced Russia to cut prices. Shipping over longer distances to India and China, however, increases Russia’s ability to obscure the real paid by customers and to lower FOB prices subject to the price cap.
Rising oil prices exposed the shortcomings of the price caps. As Saudi Arabia’s voluntary production cuts kicked in over the summer, oil prices increased. With Brent trading well over $90 per barrel, any pretense of transacting for Russian oil below the price cap has disappeared. The price cap “worked” only because it was deliberately set well above the prevailing market. As soon as the market price exceeded the cap, it “stopped working.” It is notable that Russian ESPO crude oil—loading in the eastern Port of Kozmino and generally sold into China—has traded well above the oil price cap throughout the period.
The reality is that the original EU sanctions would have had a significant impact on Russian oil exports, at least initially. A primary goal of the price cap was to blunt those sanctions and prevent a large drop in Russian exports, and these goals have taken precedence over efforts to reduce Russia’s oil revenue.
Last month, Russian oil and gas revenues exceeded $7 billion, the second-highest monthly revenue this year, making a mockery of claims that the price caps are working. The recently announced Treasury sanctions on Turkish and UAE shipping companies are a drop in the ocean of crude currently moving above the cap. With hundreds of tankers now owned by Russian companies and insured and serviced by non-Western companies and banks, even much stricter sanctioning of such trades is unlikely to work.
At the heart of the problem is the economic reality that markets work. When the price of a commodity is capped, demand increases and supply falls. But, with the Organization of the Petroleum Exporting Countries keeping oil prices well above the marginal cost of production, and the Russian war in Ukraine requiring the highest possible flow of revenue, the supply is unlikely to fall voluntarily. There is a huge economic rent to be earned by gaming the system.
To reduce Vladimir Putin’s oil revenue, the G7 should remove the price cap and let the embargoes work, supported by the introduction of secondary sanctions to punish companies and countries that violate the rules. This is unfortunately very unlikely to happen.
There are ways to tighten sanctions enforcement. Sanctions watchdogs can work backwards from transactions involving dodgy traders of Russian crude and products, tracing the ownership structure and financial flows of their counterparties. This kind of forensic analysis will no doubt be challenging but could help follow the money trail back to Russian entities. Policymakers can also lean on the Marshall Islands, Panama, Liberia, and other countries that allow “flag hopping” and tanker registration by shell companies, to send a clear message that this notoriously opaque market will have to open its books.
But in a tight market, tougher sanctions enforcement has consequences. With a wider conflict potentially looming in the Middle East and the U.S. presidential election approaching, the Biden administration has to walk a fine line and will be reluctant to take actions that could increase U.S. gasoline prices.
Adi Imsirovic is a senior associate (non-resident) with the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Ben Cahill is a senior fellow with the CSIS Energy Security and Climate Change Program.