Implementation Challenges Await G7 Price Cap

Leaders of G7 nations agreed on Tuesday to study a potential price cap on Russian oil to curb Moscow’s ability to fund its war in Ukraine. But the practicalities of implementing such a scheme must still be addressed, and critics are already questioning its likely effectiveness.

The intent of the price cap is to reduce the amount of money going to Moscow without materially cutting Russian crude flows at a time when tight global oil supplies have kept prices running hot.

Russia’s current account over the first five months of 2022 showed a $110.3 billion surplus, compared to $32.1 billion over the same period last year. This rise partly reflects the country’s lower imports since international sanctions were levied on Moscow, but also mirrors the higher prices that Russia has enjoyed for its crude and refined products this year.

In essence, G7 countries are hoping to harness the existing market trend — fed by sanctions and so-called “self-sanctioning” — that has already forced Russian crude to trade at $30-$40 per barrel discounts to places like China, India and Turkey by making the discounts as deep and as universal as possible.

Joint Coordination

A fully effective price cap would of course require everyone to comply, including India and China, which have both increased their intake of Russian oil in recent months. The difficulty orchestrating such a joint approach is why this price cap has faced strong resistance from Germany so far.

But the G7 countries are hoping that they can incent buyers in other countries to only buy within the price cap. Enforcement could come via mechanisms like secondary sanctions on buyers and facilitators, or on service providers such as shipping insurance providers within their jurisdictions, in the event that Russian oil is traded at a higher price than the price cap is set.

Closing Loopholes

The creation of a price cap will likely move even more Russian crude trade to the darker corners of the global oil market, if not all parties seek to join Western efforts to squeeze Moscow.

China, for instance, could decide to trade more with Russia via overland transport by building new pipelines quickly and railroad connections to keep trade out of the easier-to-track international shipping market.

That said, seaborne trade also presents significant enforcement challenges.

Knowing the price at which a specific buyer has purchased a Russian oil cargo would imply a broader and mandatory disclosure of deals — something the industry is always reluctant to do.

And not all trade is within reach of the G7. Seeking to circumvent the recent EU shipping insurance ban, India is now offering safety certification to sanctioned Russian vessels. China is likely to emulate that. And Russia offers re-insurance for ships carrying its oil in place of the EU.

Russia will naturally look for every possible loophole.

Moscow Could Cut Prices

If Moscow does not get the price it wants for its oil, it may be tempted to pre-empt the G7 initiative and find a way to raise prices. At this point, the only way to do so would be to cut crude exports to a bare minimum for a few months.

Regardless of who is still buying Russian oil, this would deliver a huge psychological blow to the market and send prices to new stratospheric highs, and in turn make it harder to tackle inflation, another G7 priority.

Shrinking Global Refinery Capacity

Most importantly, a price cap would not help fix the oil market’s main problem: buyers are not scrambling for crude but for refined products, and global refining capacity has shrunk too much to offset the Russian supply shortfall.

A price cap would make crude cheaper, but those savings can’t carry through fully to diesel, gasoline or jet fuel if refiners are unable to push runs materially higher — limiting the potential impacts the cap can have on battling inflation.