Oil prices have been creeping up, which means Russia is earning more energy revenue it can use to prolong its barbaric invasion of Ukraine. It’s a confounding problem with no easy solution.
Last December, the Biden administration led a coalition of advanced nations known as the G-7 in imposing a price cap on Russian oil. The $60-per-barrel cap was meant to pinch Russia’s oil revenue and its wartime financing, while keeping Russian supply on the market to prevent a global price hike that might occur if Russia curtailed exports.
The price cap held for most of the year, but Russia is now selling oil at about $68 per barrel, the highest price for Russian crude since last fall. That could go higher if market prices for oil keep rising, which many analysts expect. Global demand is strong, and production cuts by the OPEC+ cartel, which Russia belongs to, are keeping supply tight, causing price pressure.
This could provide Russian President Vladimir Putin badly needed cash to keep his war going, including the production of artillery shells and other types of ammunition Russian troops are burning through on the battlefield. Sanctions are supposed to choke off Putin’s war-making capability, but Russia’s economy seems a lot more durable than many analysts hoped after 18 months of sanctions.
Some critics say the US-led coalition should cut the cap on Russian oil to $50 or less. But that seems unlikely. Russia, the world’s third-largest oil producer, has cut its own exports recently, contributing to the rise in the Brent benchmark from $74 at the end of June to more than $85 now. US gasoline prices are once again approaching $4 per gallon, a symbolic but important pain threshold for consumers. President Biden’s approval rating dropped sharply during last year’s run-up in gas prices and overall inflation, and he certainly doesn’t want a repeat of that as the 2024 election cycle gets underway.
“The G7 price cap on Russian exports will be increasingly tested,” Eurasia group analysts wrote in a July 31 report. “But substantial changes to the cap level are unlikely given economic and political concerns, especially in the US.”
A senior Biden administration official told Yahoo Finance that an overlooked goal of the price cap regime is to relieve the kind of supply panic that sent oil prices soaring after Russia invaded Ukraine in February 2022, causing hardship for energy consumers worldwide.
“We have two goals,” the official said, “Lowering Putin’s revenue and keeping supply on the market. A lower price cap does raise the risk the Kremlin could refuse to sell oil at all. We think we’re in a much better place keeping oil prices stable, while creating this economic lever that puts downward pressure on Russian prices.”
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Oil is Russia’s largest source of revenue, and the price cap was a novel yet unproven way of constricting that funding without further disrupting global energy markets. G-7 nations provide insurance and maritime services for many of the world’s oil tankers, and those services are now only available for Russian crude sold below the price cap. Buyers don’t have to abide by the price cap, but there’s incentive for them to do so, because oil prices have been above $60 the whole time it’s been in effect. So buying Russian oil at $60 or less is a bargain.
Russia’s cost of production is as low as $15 per barrel, so it’s still making money on oil sales — but not the windfall it raked in last year, when global prices went as high as $133 per barrel. In June, Russia’s energy revenue hit the lowest level since the war began in February 2022, according to Finland’s Centre for Research on Energy and Clean Air. But that’s mainly because market prices for energy have fallen, not because of the oil price cap. Russia's energy revenue should pop back up now that oil prices are rising again.
Russian oil trades at a discount to market prices because of the whole range of sanctions that make it harder to finance and process transactions involving Russian exports. Before the price cap went into effect last December, Russian crude traded at a $15 to $20 discount to the Brent crude. The spread is still about the same.
In a recent analysis, the Peterson Institute for International Economics noted that sanctions as a whole “have successfully reduced Russia’s export earnings and budget revenues.” But Peterson researchers found the oil price cap to be one of the least effective sanctions. More important, they say, is the European Union’s embargo on nearly all Russian oil purchases, which had forced Russia to reorient its entire export structure away from Europe, with India and China now its largest energy customers.
Peterson found many violations of the oil price cap, and others have documented the use of a “ghost fleet” to flout the price cap and other sanctions. “The [EU] embargo has had more of an effect than the price cap, in part because the cap’s level is too high and enforcement is lacking,” Peterson concluded. It called the $60 price cap "irrelevant."
The G-7 coalition could lower the price cap. When the strategy went into effect, Ukraine and some other Eastern European nations argued for a $30 price cap. Robin Brooks, chief economist at the Institute of International Finance, says it’s now time to lower the price cap from $60 to $50.
But Ukraine's allies are reluctant. If oil supplies stayed the same, lowering the price cap would dent Russia’s war financing with no harm to anybody else. But in a tight market, Russia easily has the heft to send prices soaring by cutting off some supply. Russia could suffer costly infrastructure damage if it “shut in” oil and significantly cut back on exports. But Putin’s dodgy handling of the whole Ukrainian war effort shows a willingness to suffer self-inflicted wounds.
“All else equal, lowering the price cap would reduce Russia’s revenue if the same number of barrels were sold,” the senior administration official said. “But we also want to keep supply on the market. We don’t want to set a scenario where Russia would take oil off the market.” Government modeling does suggest that a lower price cap could, in fact, lead Russia to pull supply and jack up prices.
Ukraine’s allies continue to discuss further sanctions that could tighten the screws on Russia. But the toughest measures were largely in place by February, when the European Union imposed price caps on Russian petroleum products, such as diesel fuel. Since then, the economic battle with Russia has come to parallel the military one, a war of attrition in which neither side gains a decisive advantage. Russia is hurting, just not nearly enough.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman.
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