As the war in Ukraine drags on, the European Union is picking up arms against Vladimir Putin and his Russian army. Although not using traditional weapons such as tanks, guns, and missiles, the EU is hoping that weaponizing trade and capping the price of oil will aid Ukraine in winning the war before the cold harshness of winter sets in. So far, the jury is still out on whether this move will make an impact on the economy or on Vladimir Putin’s behavior with Ukraine.
A Decision Rendered
Earlier in the year, the United States and its Western allies agreed that they would create a price cap for oil, hitting Russia where it hurts in the hopes to stop the war. They also agreed to decide on the details by early December, though getting to the actual number has proven difficult, with Poland holding out until just this week.
The president of the EU, Ursula von der Leyen, said “Today, the European Union, the G7 and other global partners have agreed to introduce a global price cap on seaborne oil from Russia.” The EU hopes that this move will decrease Moscow’s bottom line while also balancing energy markets so EU-based operators can export the oil to third-party countries, as long as it is still priced below the cap. It will also fortify the Russian sanctions.
The 27 member states agreed on capping the price at $60 a barrel. Though much of the discussion had centered around $65 to $70 dollars a barrel, in the end the members realized that price point would not hurt the Kremlin as much as they wanted the sanctions to hurt. Estonia and Poland wanted the cap to be even lower, but finally capitulated so the sanctions could begin.
“Today’s oil price cap agreement is a step in the right direction, but this is not enough,” Estonian foreign minister Urmas Reinsalu tweeted Friday. “Intent is right, delivery is weak.”
There is a fine line to this game, however. If the EU slashes the price too low, Russia could come back at them by slowing output, which would cause turmoil in the markets. The EU agreement also adjusts the cap so it will always be 5% below the given market rate.
“We still believe that the price cap will help limit Mr. Putin’s ability to profiteer off the oil market so that he can continue to fund a war machine that continues to kill innocent Ukrainians,” National Security Council coordinator for strategic communications John Kirby told reporters.
A Nuanced Game
There are some intricacies that take effect with the price cap. Designed so that companies who offer insurance, shipping, and other services for Russian oil will ensure that these prices take effect, the companies will withhold their services in moving the Russian oil if the cap is not adhered to.
This is making investors nervous, investors that are already worried about the embargo on Russian oil which travels by sea, and how this situation will play out. “There’s so much uncertainty and doubt and lack of clarity about the policy that no one’s really confident about how to act,” said Richard Bronze, head of geopolitics at the research firm Energy Aspects.
Overall, oil prices have plummeted since summer, mostly on the heels of China’s profound coronavirus lockdowns and the global recession. With OPEC and Russia’s big production cut in October, there has actually been very little impact on the prices. Some experts think the US embargo may push the prices higher. And China seems ready to end the draconian lockdown, which will further affect prices of oil.
Russia Comes Out Swinging
Russia, as could be expected, is speaking out about the new oil cap. Russia Deputy Prime Minister Alexander Novak is lashing out at the “gross interference” by the West, which he says contradicts the rules of free trade. “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 Novak, who is the Russian government official in charge of the country’s oil, gas, atomic energy and coal.
Since World War II, selling oil and gas has been one of Russia’s most important ways to earn foreign currency. Russia is currently working out its own deal to ban the export of oil and petroleum to any countries that are applying the price cap, insisting that they will ship to India and China instead. Putin continues to warn of an energy crisis if the United States and its allies continue with the sanctions. In September, Putin threatened the West that he would cut off energy supplies if price caps were instituted, saying that Europe would be “frozen” like a wolf’s tail in a well-known Russian fairy tale.
And Russia will not go down without a fight. Reports have suggested that Russia has circumvented the situation by putting together its own fleet of vessels to avoid the sanctions. If they have their own boats, or “shadow fleet,” they do not have to worry about the insurance or shipping companies affected by the price cap.
Along with the Russian workaround, not everyone thinks that the cap will solve the problem. “The introduction of the cap on the price will probably not remove all the volume, some will find its way to the markets,” Angelina Valavina, head of EMEA Natural Resources and Commodities at the Fitch Group, told CNBC’s “Street Signs Europe” Monday.
The world also runs the risk that nations will buy Russian oil at the cap limit but then resell it at a higher price in Europe, causing a further problem for the already slowing European economy.
As the cap takes effect, it does not seem like the sanctions are having much effect in the short term. “Russia’s ESPO oil blend from the Far Eastern port of Kozmino was selling for around $79 a barrel in Asian markets on Monday – almost a third higher than the price cap imposed on Russian oil by the G7 and European Union,” according to Refinitiv data and estimates from industry sources. Russia exports up to 65 million tons of ESPO Blend oil per year via the Eastern Siberia-Pacific Ocean (ESPO) pipeline, and this includes up to 35 million tons through the port of Kozmino.
The western world is working hard to staunch the flow of resources that Putin has at his disposal for fighting the war in Ukraine. Rather than taking up arms with tanks and guns, they are trying a price cap on oil to hurt Russia’s revenues and potentially put a stop to this war. But time will tell whether these caps are successful, or if they have just poked the bear.
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