G7 Advances Plan to Cap Price of Russian Oil

Finance ministers from the G7 group of nations agreed on Friday to proceed with a controversial plan to put a price cap on Russian oil, but said they still need to finalize details of how it would work in practice.

The cap is meant to reduce Moscow's oil revenues without limiting the flow of Russian oil to the market — a goal that has been met with considerable skepticism in the market.

EU countries plan to block tankers that carry Russian crude and products from obtaining maritime insurance and financial services — unless their cargoes are priced in accordance with the cap.

More granular details still need to be worked out. That includes the level at which the price cap will be set, products that would be exempted and the precise mechanics of the cap in each country that implements it.

Price Point Pending

A senior US Treasury Department official said on Friday that the plan calls for three price caps: one for Urals crude, and two for products. The price caps will be reviewed periodically and widely publicized.

The prices are yet to be finalized, but another senior Treasury Department official gave some hints for crude.

"You don't want to set it at such a level that they are taking advantage of the price premium introduced in the market," the official said, referring to the increase in oil prices of nearly 40% since the start of this year.

"Russia was selling oil years ago at $60 a barrel and making plenty of money," the official added.

The countries backing the plan want the price cap to be set above the cost of producing Urals crude but below its free market value.

The price of Urals has been quite opaque in recent months, but on Friday it was assessed at about $74/bbl, or roughly $20/bbl below dated Brent.

Russian production costs are unclear but officials have said the country is a "low-cost" producer, which perhaps points to costs as low as $15/bbl.

Russian companies have reportedly started negotiations with Asian refiners to buy Urals under term contracts at considerable discounts — perhaps as much as 30% — below dated Brent.

Western officials suggest this points to the early success of the price cap system, arguing that buyers who operate outside it will be free to negotiate an even lower price as a result of the cap, further lowering Moscow's oil income.

Russia has already been offering large discounts to Asian buyers of Urals since the early days of the war in Ukraine, but its oil revenues have proved resilient because of the overall strength of global oil prices.

Traders say the potential challenges to the policy's success include a lack of cooperation from big buyers of Russian oil — notably India, China and Turkey.

The price cap scheme could also be undermined by the development of alternative sources for tanker insurance, and arrangements which allow prices to work around the cap through side payments, for example.

Following Steps

The specifics of how the cap will work are clearest in Europe, which plans to block its companies from providing maritime and financial services to tankers carrying Russian crude and products from Dec. 5.

However, exemptions will be granted for tankers that carry cargoes priced in accordance with the caps.

An EU ban on purchases of Russian crude also takes effect on Dec. 5 and a ban on purchases of Russian products on Feb. 5.

The price cap system will require changes to EU sanctions in place since June and will require unanimity among the bloc's 27 members.

The Treasury Department said it will release specific guidance this month on how existing US sanctions targeting Russia's energy industry will change.

The G7's other non-EU countries — Canada, Japan and the UK — will have to take similar steps.

Officials said other countries plan to join the G7-led coalition of countries implementing the price cap, but declined to name them.

Western Gamble

The success of the price cap plan also represents a bet that Russia won't retaliate by slashing its oil supplies and driving prices to ruinous levels

Deputy Prime Minister Alexander Novak said on Thursday that Russia would indeed halt supplies to countries that support the initiative.

Shipments of oil are largely processed and financed through the Western system.

Ship brokers say the world does not have enough tankers outside the Western system to keep all of Russia's oil flowing. They say there might be enough to support much of its crude oil exports, but not its refined products.

Asked if Russia is bluffing by issuing threats to cut off oil supplies, a US official said on Friday that there was "some merit" to that notion.

"Russia needs revenues from oil in order to support the economy and support their unjustified war in Ukraine. They need those things even more today than they did before the war," the official said.

However, Russia has already slashed its gas exports to Europe, forcing countries in the region to scramble to stockpile enough gas for winter heating.

Asked whether Russia would sell its crude at a theoretical $55/bbl price cap, one trading analyst simply said: "No."

"Russia has essentially declared war on Europe and will turn off the flow of energy," the analyst said, adding that what has already been happening in the natural gas market will likely play out in the oil market too.

For more coverage of the Ukraine crisis, visit Ukraine Crisis: Energy Impact >