On September 9, at a special briefing on ‘G7 Price Cap on Russian Oil’, Elizabeth Rosenberg, Assistant Secretary for Terrorist Financing and Financial Crimes, US Department of the Treasury, said: “The price cap policy is an important tool to put downward pressure on global energy prices by allowing Russian oil to continue flowing to the global markets, which will help to mitigate price spikes and put downward pressure on oil prices. That’s good for countering inflation...”

The price cap policy is also expected to deny Russian President Vladimir Putin revenues to fund his war in Ukraine.

This is not the first time that a “price cap” is being discussed. The Organization of Petroleum Exporting Countries (OPEC) had a concept of price band, which was subsequently suspended. While the idea of a price cap by G7+EU is to reduce Russia’s oil revenue and deter it financially from prolonging the Ukraine war, the ground reality could be different. Here is why.

Due to higher international crude prices, even with a discount, Russia has been earning healthy oil revenues. And suppose the cap does come into effect, given the sheer volume that Russia produces, and if China and India remain the main buyers, it can still make money.

But first let us understand the cap that G7 is talking about.

According to Rosenberg, “The price cap policy itself builds on the European Union’s sixth sanctions package that enters into force on December 5. Specifically, the EU has announced prohibition of services like insurance, banking or brokering for the seaborne shipment of Russian oil and products globally. So, the new announcement from the G7 confirms that all its members will bring into force similar prohibitions.

“Critically, the provision of these services will have an exception, which is to say that oil, Russian oil, sold under the price cap or product sold under the price cap will be expressly permitted. Given that the EU and the UK provide 90 per cent of global shipping insurance and G7 countries provide an overwhelming majority of payment and financing services for the global oil trade, there will be great effectiveness and the policy will be quite far-reaching.”

According to Rosenberg, “the US and allies and partners and many broadly in the G7 have announced plans to wind down their own imports of Russian oil, so the price cap won’t change that commitment, whether this has to do with the services that they provide or purchases of Russian oil by others. Importantly, and I want to stress this, if the G7 did not put in place this price cap policy, we anticipate that it could have led to significant global price spikes, which would harm consumers and businesses around the world... That would let the Kremlin take advantage of this price spike to further pad its own pockets and sell oil at a significantly higher price.”

Not an effective way

While it is a fact that the price cap will allow flow of Russian oil into global markets, it may not be the most effective way to keep oil market well supplied and keep energy prices low. On the other hand, it will distort the market, given the various markers like Brent, WTI, Bonny Light, Opec Basket and Murban all sell at different prices.

A debate is still on regarding the basis of determining the cap price — will it be on cost of production basis or some historical average price and will it be linked to a benchmark, say, Brent with deep discounts?

Says Rosenberg: “There are several key data points we are considering in how the price should ultimately be set, and that includes the marginal cost of production for Russian oil — that is to say, the price cap price should be over the marginal cost of production for Russian oil — as well as it should be in line or consistent with historical prices accepted by Russian in the global market.”

“Over the coming weeks, we in the G7 and this price cap coalition will work together to determine the price cap and to bring forward the legal regimes in our own jurisdictions that will be of more specificity and clarity to exactly how this will work operationally,” Rosenberg added.

The main premise of G7 is that it can enforce a price cap by asking insurance companies (Western insurance companies + Japan control 90 per cent of the business) not to extend cover and, thereby, restrict tankers from transporting Russian crude.

However, given that crude is more fungible compared to gas in international trade, Russia can still create havoc by reducing supplies, which may lead to a crude price spiral. On the ground, the enforcement of a price cap will be a big challenge. Russia can calibrate its position with time to hit back at Western countries, and the ripple effects may be felt by other importing countries. Remember, this is a sector where a million barrels a day cut in supply can lead to a price surge.

Artificial price

As Probal Sen, Analyst, ICICI Securities, puts it: “The move will result in artificial price of fungible commodities in the world. While details are yet to be disclosed on what will be the mechanism adopted for deciding the cap, there is also a challenge as to how much Russian crude can consumers like India absorb.”

Another question is: Will major importers like China and India support such a move? Some experts feel that as countries are looking to control inflation, they may avoid taking the risk of supporting the price cap. But there is also another side to it. If there is a cap, it could be an advantage to consumers like India as they can easily increase the volumes from Russia and buy crude oil at a discounted price.

Of course, Russia will seek to sell its oil to countries outside the price cap, but doing so will come at a cost to Russia and the buyers, who will face higher prices for the services necessary to ship oil without access to G7 services, believe the Americans.

On what it means for consumers like India, the US feels India will have access to lower price, to more affordable energy.India till now has been clear in its position — whichever market gives it the best price, it will source crude oil from there.

Price cap or no cap, it will remain advantage India so long as it gets crude oil at a discounted price, but it will definitely distort the oil market, particularly the price dynamics in the long term, making it more volatile. For a consumer like India, it is important to maintain a clear stance and keep its energy basket well expanded. What remains to be seen is how consistent will New Delhi be on the policy front.

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