G-7 Agree On Russian Oil Price-Cap Scheme

In what we are sure will be heralded as a critical step forward in the globally unified response to Putin’s invasion of Ukraine, G-7 finance ministers have agreed to implement a price cap for global purchases of Russian oil – a measure the US hopes will ease energy market pressures and slash Moscow’s overall revenues.

“We confirm our joint political intention to finalize and implement a comprehensive prohibition of services which enable maritime transportation of Russian-origin crude oil and petroleum products globally,” G-7 finance ministers said in a joint statement.

“The provision of such services would only be allowed if the oil and petroleum products are purchased at or below a price (“the price cap”) determined by the broad coalition of countries adhering to and implementing the price cap.”

No details were offered as to the mechanism for the buying-cartel but the stated goal set out by G7 leaders was two-pronged:

to limit upward pressure on global oil prices

to curb Russia’s revenues from oil sales.

To achieve those goals, the allies agreed to explore a new mechanism that aims to impose a ceiling on Russian oil prices. The idea behind this price cap is to permit countries that have not imposed import bans to buy Russian oil as long as it is priced at or below a predetermined price. The cap could be enforced via limits on availability of European insurance for Russian oil cargoes as well as shipping services and US finance. While G7 leaders have not indicated where the price cap would be set, it must be lower than the $80/bbl at which Russia’s Urals grade trades today (a $32/bbl discount to Brent) and higher than Russia’s marginal cost of maintaining production levels, estimated at around $40/bbl to ensure Russia’s earnings are reduced while production is maintained.

A $50-60 per barrel price cap would likely serve the G7 goals of reducing oil revenues for Russia while assuring barrels continue to flow. Of course, for the price cap to work, oil importers like India China and Turkey—which have significantly increased their purchases of heavily- discounted Russian grades – would need to agree to participate to access even cheaper oil.

But it remains unclear how effective a price-cap regime would be, particularly since some of Russia’s biggest buyers (India and China) haven’t agreed to join.

“Quite extensive measures are going to have to be taken to ensure that companies don’t’ find ways around price limitations,” said Richard Watts, the managing director at Geneva commodities trading advisory HR Maritime.

“This was the challenge in Iraq’s food-for-oil scheme in the 1990s. The question is how does the G-7 police this?”

Furthermore, as we previously detailed, there are three scenarios as to what happens next:

Scenario 1: Russia does not cooperate and retaliates – a 3 mbd cut would likely deliver a $190/bbl oil price

Scenario 2: China and India don’t cooperate – the end of the European insurance dominance

Scenario 3: Russia fully re-routes exports from west to east but loses pricing power, prices stabilize in low-$100s

There has so far been no reaction to the headlines…

Which we suspect reflects the market’s reality check that this G-7 plan has no chance of becoming operational as to implement a cap, diplomats will have to convince European Union member nations to amend its sixth round of sanctions on Russia over the invasion of Ukraine – and that may still prove to be tough. That package, which prohibits the purchase of Russian oil starting Dec. 5, included a ban on the use by third countries of the bloc’s companies for oil-related insurance and financial services.