Cap on Russian oil: what happens next?

A price cap on Russian oil agreed by the European Union, G7 and Australia has come into effect starting from Monday. 

It is aimed at restricting Moscow’s revenues, while ensuring that Russia keeps supplying oil to the global market.

An embargo on purchasing Russian seaborne crude is coming into effect alongside the price cap, which EU countries adopted as part of the sixth package of sanctions on June 3. The United States and Canada introduced a similar ban earlier this year.

The move, combined with the Covid-19 restrictions in China, immediately pushed the oil prices up on Monday morning, while supply concerns loomed large. 

How does the cap work?

The price cap on Russian oil exports is set at $60 per barrel. Companies based in the countries that apply the ban will not be able to provide services that enable the sale of (Russian) oil priced above the cap, such as insurance enabling maritime transport.

G7 countries – France, Italy, Germany, Canada, Japan, the United Kingdom and the United States – provide insurance services for 90 percent of the world’s cargo. The EU is a key player in sea freight. 

As the world’s second largest crude oil exporter, Russia could easily find new buyers without the cap, which will apply to cargoes loaded after December 5. A further cap on oil products comes into effect on February 5.

Though Moscow is seeking to make a foray into alternative oil markets, the Russian rouble has weakened to a seven-week low against the dollar.

The cap is to be reviewed every two months, with the option to modify it according to price changes. It should be at least 5 percent below the average market price. Revisions would have to be agreed upon by the EU, the G7 and Australia.

What criticism has it drawn?

The Ukrainian president has criticised the price cap for being too low. 

The $60 cap is well above the current cost of producing oil in Russia, which means the Kremlin will continue to earn income, even if that revenue is reduced.

European Commission President Ursula von der Leyen has insisted that the cap will help “stabilise global energy prices, benefitting emerging economies around the world,” because they will be able to get hold of Russian crude at a lower cost.

All countries are invited to apply the cap, and those that do not adopt it can choose to continue buying Russian oil above the cap – but without using Western companies to acquire, insure or transport it.

Western leaders are walking a fine line between trying to cut Russia’s oil income and preventing an oil shortage that would cause a price spike and worsen inflation around the world.  

What was Russia’s response?

Kremlin spokesman Dmitry Peskov said at a press briefing on Monday that Russia will not recognise “any ceilings,” and called the West’s decision to impose the cap “a step towards destabilising the world energy market.”

On Sunday, Russia said it was considering a ban on oil supplies subject to the price cap, and that it will not operate under it, even if it comes at the cost of cutting production. 

"We are working on mechanisms to prohibit the use of a price cap instrument, regardless of what level is set, because such interference could further destabilise the market," said Russian Deputy Prime Minister Alexander Novak.

A refusal by Russia to sell oil to countries that observe the measures could cause a further spike in global energy costs. 

How have other oil producers reacted?

The Organization of Petroleum Exporting Countries (OPEC) and some other countries agreed on Sunday to maintain their target of cutting oil output by 2 million barrels per day (bpd) until the end of next year. That cut had been agreed in October, triggering a clash with the US administration ahead of last November’s midterm elections.

Some analysts had expected OPEC, which is led by Russia and Saudi Arabia, to impose deeper production cuts this week in order to support prices, which it aims to keep at around $90 a barrel.

Main contracts Brent North Sea crude was up 2.6 percent at $87.83 per barrel on Monday, while West Texas Intermediate advanced 2.8 percent at $82.22 per barrel.

What will China and India do?

Asian oil buyers, including India and China, hold the future of Russia’s oil exports in their hands. 

The Chinese foreign ministry released a statement on Monday, stating that Beijing will continue its energy cooperation with Russia on the basis of “respect and mutual benefit,” according to Russia’s RIA news agency.

China has upped its purchases of Russia's Urals oil blends this year, which now trades at a steep discount to Brent, the global benchmark. 

India has also shown its willingness to keep purchasing Russian oil and gas, according to Reuters quoting a petroleum ministry official as saying.