Price Cap On Russian Oil Risks Crisis It’s Meant To Prevent

Make no mistake, the Biden administration isn’t concerned about inflicting too much pain on the Kremlin. It is, however, worried the European penalties could backfire, with devastating consequences for consumers and businesses in the US, Europe, and other countries already feeling the squeeze of high energy prices. In response, the US Treasury cooked up what appears to be a clever solution—though one that could lead to a dangerous showdown with Moscow.

The sanctions in question target Russian oil. In addition to prohibiting almost all seaborne imports of Russian crude, European Union nations agreed in June to ban companies in the 27-country bloc from providing maritime services for tankers transporting the controversial cargo anywhere in the world, effective Dec. 5. The UK and Switzerland have said they would follow suit.

Given that European and UK companies dominate the business of insuring and financing oil tanker cargo, US Treasury staff estimated Brussels’ ban could keep a significant portion of Russia’s ocean-bound oil exports off the global market. Benchmark oil prices could surge north of $140 a barrel as a result.

That would spell economic and political trouble across much of the inflation-wracked world. Recall that when the average price of gasoline ticked above $5 a gallon in the US this June, President Joe Biden’s approval rating and Democrats’ prospects for retaining Congress this November both took a hit. And at that point oil was trading at $120 a barrel.

“If this sixth package goes into force, it’s going to be very disruptive,” says Helima Croft, an oil market analyst at RBC Capital Markets.

Here’s how the Treasury’s plan would work around that: A coalition of governments, while continuing to forswear Russian oil, would endorse an exception to the European shipping services ban for buyers who negotiated a price below an agreed cap. The ceiling would be set above Russia’s cost of production, just high enough to provide Moscow with the incentive to keep exporting oil. That would prevent the dreaded price spike while sharply reducing Russia’s revenues, thereby crimping the Kremlin’s ability to prop up the economy and fund the war in Ukraine.

The concept went public in May after finance ministers from the Group of Seven countries discussed the idea at a meeting in Bonn. Yet for weeks proponents made little real progress, even as US Treasury Secretary Janet Yellen and her staff doggedly lobbied for it around the world. A major breakthrough came at the next G-7 finance ministers’ meeting, held via video conference on Sept. 2, when the group formally endorsed the plan.

Yet plenty of hurdles—plus enormous skepticism—remain. The EU nations must unanimously agree to add the price-cap exception to its sanctions, and some member governments, notably Hungary, seem unconvinced it’s necessary or appropriate. On top of that, many analysts, traders, and energy executives clearly expect the plan to fail. Gal Luft, co-director of the Institute for the Analysis of Global Security, a Washington think tank, dismissed it in a July interview on CNBC as “a ridiculous idea.”

For starters, Western companies have been barred from insuring or financing Iranian oil shipments on and off since 2012, but that hasn’t stopped the sanctioned crude from reaching willing Chinese buyers. So if China and India, the two biggest remaining consumers of Russian oil, won’t get on board with the price cap, the plan is bound to fail, say critics.

That view fails to understand that Treasury wants Russian crude reaching buyers, even if it goes entirely around the ban on services and the price cap. “The whole goal is to prevent a major market disruption,” says Croft, who has attended briefings on the price cap with Treasury officials. “The measure of success is whether Russian barrels continue to flow to Asia.”

This might not rob the Kremlin of as much revenue as Washington would like, but it would avert a price surge. Moreover, with the EU and most of the G-7 buying very little seaborne Russian oil, meaningful demand can come only from China, India, and Turkey—hardly an ideal situation for President Vladimir Putin.

“If there are just three big buyers left for Russian crude, that gives them huge bargaining power over prices,” wrote Julian Lee, an oil strategist for Bloomberg. “They’re unlikely to squander that advantage.” (There are hints that Russia already is offering discounted deals to Asian buyers.)

Treasury officials have been touting this very scenario as one they’d welcome. “Whether that happens by selling under the price cap at a prescribed level, or whether that happens through increased leverage by consumers of oil, really is fine either way,” Assistant Secretary Ben Harris said in a panel hosted by the Brookings Institution on Sept. 9.

But some seasoned Kremlin-watchers believe that another, far more dangerous scenario lies ahead. Craig Kennedy, an associate at Harvard’s Davis Center for Russian and Eurasian Studies, estimates that “at least half’’ of Russia’s exports, currently totaling 7.5 million barrels a day, could be trapped in Russia by the European penalties, because prospective buyers who’ve opted out of the price cap will not be able to procure shipping services from other sources.

“If Russian officials think they can do a few fly-ins and persuade dozens of Asian shippers, insurers, and governments to shift hundreds of billions of dollars of liability coverage to some new Russian-led international insurance club—just so they can pay higher oil prices to Russia—then I think they’ll be disappointed,” says Kennedy, a former vice chairman at Bank of America Merrill Lynch in London.

Should Kennedy prove correct, Russia would face a difficult choice: Sell oil into the price-cap system—which Putin has scoffed at—or significantly throttle back oil production, sending global prices skyrocketing. That’s not an easy choice for Putin. Not only would he lose more oil revenue, but it may also cause significant, long-term damage to Russian wells.

Kennedy says he wouldn’t be surprised if Putin threatens to dial back on oil and gas exports before December, when the price cap would take effect, in an attempt to weaken Western resolve. “The best way to achieve that," he says, “is to precipitate an energy crisis.” Putin wants to send the message, says Kennedy, that “these actions will hurt you, the West, more than Russia. We have greater will, we will win.”

Europe and the US will then have their own difficult choice to make: Either back down from the sanctions and price cap in humiliating fashion or risk the very crisis the US plan sought to avoid in the first place.

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