Reducing Russia’s energy revenues has been a tough nut for Western governments to crack until now.
After President Vladimir Putin launched a full-scale invasion of Ukraine on February 24, the United States and the European Union imposed sanctions on Russian energy imports in a bid to undermine the Kremlin’s ability to finance the war.
While the volume of Russia’s oil and gas production has fallen due to those sanctions, that has been offset by rising energy prices, driven higher in large part by fears of further disruptions to the economy. supply from Russia in an already tight market.
Even with Russian oil selling at a steep $30 discount to world market prices of between $100 and $120 due to sanctions, the Putin government is still earning more per barrel today than in the months before the invasion.
Now, Western nations are working on a new strategy to target the price Russia receives for its oil to reduce revenues while hoping to prevent supply shortages from deepening, Treasury secretary said on June 20. from USA, Janet Yellen.
The goal is to “push down the price of Russian oil and depress Putin’s income, while allowing more oil supply to reach the world market,” he said.
Oil accounts for about a third of Russia’s federal budget revenue and a sharp drop in its price, due to market forces or a price cap, could seriously affect the government’s ability to finance its war in Ukraine.
US President Joe Biden may discuss the issue with his counterparts at a summit of the Group of Seven major industrial countries in Germany on June 26-28.
However, some analysts have thrown cold water on the prospects of imposing a price cap, saying it would be difficult to implement and monitor.
“I think right now they are hitting straws,” said Ed Chow, an energy analyst at the Center for Strategic and International Studies in Washington.
It may “sound good” on paper, “but in practice [it] it won’t work,” Chow said.
Yellen seemed to suggest that one way the West could enforce the cap is to ban insurance for ships delivering Russian oil above a certain price per barrel.
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The European Union, the largest consumer of Russian energy, formally approved earlier this month a plan to phase out maritime imports of Russian oil by December and Russian oil products by February 2023, a move that will force Moscow to seek other markets.
China and India have been hoarding most of the Russian oil that the EU has given up.
The EU and Britain also agreed to ban their companies from insuring tankers carrying Russian oil, which could potentially limit the amount delivered to Asia, thereby worsening global oil supply shortages and driving up prices further. The International Group of Protection and Indemnity Clubs in London insures about 95 percent of the world’s oil transport fleet, according to Rystad Energy, an Oslo-based research firm.
The new policy being considered by the G7 would apparently create an exception to allow such shipments of Russian oil to continue if they fall below a certain price.
But a price cap for Russian oil may not mean a discount for its buyers. Why not? Because the West is looking for ways not only to deprive Moscow of money it can use to finance the war, but to put that money to work for Ukraine.
Amos Hochstein, senior adviser for global energy security at the US State Department, told a Senate hearing earlier this month that the Biden administration and European allies are looking at a “variety of options” to rebuild Ukraine. with Russian energy revenues.
He said the administration wants to make sure “no one benefits” from Western sanctions placed on Russian energy, a reference to the $30 per barrel discount India and China are currently receiving.
However, China could help Russia get around the price cap, and presumably any revenue diversion, “by accepting inferior Russian insurance,” Rystad said in a June 23 note.
‘No return to earnings’
Craig Kennedy, a fellow at the Davis Center for Russian and Eurasian Studies at Harvard University, earlier this year proposed an alternative policy to reduce the energy income of the Kremlin and set aside money for the reconstruction of Ukraine.
Kennedy suggested that Western nations ban all imports of Russian oil except those purchased through a specialized agency, which would receive the buyer’s market price but pass only the cost of production to the Russian company, or about $20- $25 per barrel, reserving the remaining cash in a fund for the reconstruction of Ukraine.
Kennedy argues that the Kremlin is in a weak negotiating position vis-à-vis Brussels because Russia’s energy infrastructure, including rail, pipeline and ports, is largely geared towards exporting oil to Europe.
Russia was exporting about 4.5 million barrels a day of oil and oil products, or almost half of its production, to Europe before the invasion of Ukraine in February.
The Kremlin would be hard-pressed to sell much of that oil to China and India because of those nations’ commitment to energy diversification, Kennedy said.
Russia would account for more than 40 percent of oil imports to China and India in such a case, he said.
Russia would therefore face a dilemma: sell to Europe under a price ceiling regime or cut production, hoping that a price increase would break Brussels’ resolve.
However, cutting production for an extended period could cause irreparable damage to oil fields, Kennedy and Chow said.
“Most of the Russian oil wells have poor flow rates and poor economics,” Kennedy said. “A large-scale extended shutdown would mean painstakingly shutting down tens of thousands of these marginal wells, many of which could never turn a profit again. It could also compromise complex pressure maintenance programs. [that are] fundamental for the profitability of the field”.
However, Rystad said that Putin “has already shown his willingness” to retain energy supplies by cutting natural gas exports to several European countries this year.
Would a rate be better?
Brian O’Toole, a former senior adviser to the US Treasury Department, said that, in general, a policy of maximum prices without clear implementation and enforcement could cause markets to go astray and lead to further price increases.
Interference in markets can “screw things up in a way that people didn’t anticipate and have negative collateral consequences as a result,” said O’Toole, who is now an analyst at the Washington-based Atlantic Council.
Chow suggested that the West impose a tariff instead, with those profits reserved for Ukraine’s reconstruction, saying it’s an easier concept to implement.
For example, a $50 tariff on Russian oil imports could reduce the price the Kremlin receives to $50-$70 per barrel, compared to the current market price range of $100-$120.
“We know how to impose and enforce tariffs because we do it on thousands of products,” he said.