The global effects of capping Russian oil

The decision by the Group of Seven (G7), which constitutes the world’s most powerful economies to cap the price of Russian oil has finally settled in. The costs of the measure are immeasurable while the dynamics which would allow the global oil market to navigate the shocks of this ceiling also warrant attention. The truth is that this measure may be geared towards stopping Russian funding of the war in Ukraine, but in reality, it allows Moscow plenty of leverage to call out discriminatory policies against it and pursue alternate paths to fill up its dwindling coffers.

The price cap is on seaborne Russian oil and has a major impact on naval trade. It is also $60 per barrel which means that any country which purchases Russian oil at a price equal or less to the price cap will benefit from coverage from Western insurance companies, transport from G7 and Western tankers and credit institutions. Countries which do not adopt such measures can purchase oil above the price cap, but would be deprived of the aforementioned facilities. Here lies the central question – would countries which believe in neutrality as bedrocks of their foreign policy chose to purchase Russian oil above the price cap?

The answer is unclear. While European officials claim that a number of countries in Asia would adhere to the principles of the cap, reactions from countries such as Pakistan are still awaited. What complicates the issue is that Russia has retorted at the entire concept of a price cap and called out Western economic coercion aimed at strangulating the national economy and in turn, the world economy. As a result, the Kremlin as the second largest oil exporter has decided to not sell oil that is subject to it yet open up similar channels to other countries. For most states which do not subscribe to camp politics, this is not necessarily a disadvantage.

Countries such as India which are aligned with the West and partake in numerous provocative platforms such as the Quad have chosen to purchase Russian oil with disregard for any reprisals. Similarly, other countries in Asia, Africa and South America would be tempted to bandwagon with the Russian strategy to fuel their economies particularly as the US Federal Reserve hikes interest rates and consumer demand in the world’s largest economy, China dwindles.

The biggest obstacle however, would be the inability to access the western mechanisms which are needed to transport oil to their respective economies and that too at a lower cost. This trade off will be an area that countries would need to take into consideration while negotiating with Russian in the post price cap scenario. Given that most trading corporations and insurance companies are based in the West, developing the necessary infrastructure to transport Russian sea crude oil will prove to be a tedious and cumbersome task. The positive side is that Russia has indicated that oil will be sold to countries which are willing to work with Moscow under market conditions, regardless of whether oil supplies will be cut short.

Hence, the entire situation is complicated and is dependent on a number of different variables that would define the future of the world oil market. Russia too is constrained by a number of different factors. Firstly, selling oil and gas to Europe has been one of the main sources of revenue for the Russian Federation in the form of foreign currency earnings since the oil and gas reserves were discovered in the swamps of Siberia. To divert historical earnings since the end of World War II will be a major challenge for the Russian President Vladimir Putin. Primary buyers of Russian oil and gas are China, Turkey and India and with the Chinese economy slowing down due to unrest, riots, COVID-19 lockdowns and decline in consumer demand, the only option for Moscow beyond diversifying its consumer base is to continue selling oil at the price cap. It is noteworthy that the ceiling agreed upon by the G7 is not much below the market price of $67 per barrel that Russian oil has closed on recently.

The other scenario that could unfold for developing nations is that Russian chooses to build its own infrastructure, fleet of tankers with operations and insurance at its disposal. Given the current state of the Russian economy, which is heavily relying on oil revenue to fuel its war in Ukraine and sustain a financial breakdown amid tough economic sanctions, this still looks like a distant reality. According to officials in Brussels, Belgium, building a maritime ecosystem overnight will be difficult. Such measures can also dissuade existing customers who are already under pressure to change course on economic cooperation with Russia. This is despite the fact that the G7 is scheduled to review the price cap every two months with the next moot scheduled for mid-January 2023.

The effectiveness of the measures, international adherence, projected alignment and its potential impact on coalition members and partners will have a bearing on the international oil market in the post price cap era. The Russian economy would still be able to weather the pernicious effects of sanctions and declining profits as a result of the ceiling yet the ability of developing countries to maximise their dividends could be compromised. It all boils down to pragmatism and prudence to navigate one of the most volatile periods in world history.

The writer is an Assistant Research Associate at IPRI