How would a G-7 price cap on Russian oil work?

The G7 floated the idea of ​​an oil price cap, but experts doubt its effectiveness.

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The world’s seven largest industrialized economies have floated the idea of ​​a Russian oil price cap to further reduce the Kremlin’s ability to fund its attack on Ukraine and try to protect consumers from soaring oil prices. energy.

The G-7’s pursuit of a Russian oil price cap is not without challenges, however, with energy analysts highly skeptical of the integrity of the proposal.

For its part, the Kremlin has warned that any attempt to impose a price cap on Russian oil will do more harm than good.

How did the idea come about?

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The bloc received around 25% of its oil imports from Russia and was one of the Kremlin’s largest buyers. Stopping these oil purchases is an attempt to damage the Russian economy after the unprovoked invasion of Ukraine, but it is difficult to end it overnight given that some countries in the EU are heavily dependent on Russian fossil fuels.

US President Joe Biden pitched the idea of ​​an oil price cap to the rest of the G-7 leaders over the weekend of June 25-26 and his counterparts agreed to consider how to do it. The G-7 is made up of the United States, Canada, France, Germany, Italy, the United Kingdom and Japan.

German Chancellor Olaf Scholz said the idea was very ambitious and needed “a lot of work” before it could become reality.

A spokesperson for the European Commission, the executive arm of the EU, said in an email to CNBC on Friday: “We share the concerns of the G7 countries about the burden of rising energy prices and of market instability, and how these aggravate inequalities at national and international levels.”

“In this context, as requested by European leaders, the Commission will continue its work on ways to curb the rise in energy prices, in particular by assessing the feasibility of introducing temporary caps on import prices, as appropriate,” the same spokesperson said, adding that discussions are being addressed. emergency.”

How might a price cap work?

Energy analysts have wondered exactly how the G-7 could impose a price cap on Russian oil, warning that the plan could backfire if major consumers are not involved, and that time could miss to make it achievable.

“I’m one of those scratching their heads,” Neil Atkinson, an independent oil analyst, told CNBC’s “Squawk Box Europe” on Thursday.

“Such a thing could only work if you get all the key producers and, more importantly, all the key consumers to work together, and then find a way to implement the plan you come up with,” he added.

“And the reality is that the biggest consumers of Russian oil, or among the biggest consumers of Russian oil, are China and India.”

A tanker moored in a gas and oil quay at the port of Constanta in Romania.

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China and India have “benefited enormously” from discounted Russian crude, Atkinson said. Russian oil sold at a steep discount of $30 or more to international benchmark Brent futures at $110 a barrel – and China and India snatched it up.

Atkinson also pointed to a lack of unity on Russia’s invasion of Ukraine given that China and India have not explicitly condemned the Kremlin.

“Anyway, the Russians aren’t going to sit there idly. They can play games with supplies of oil and in fact gas… they can play with the head of the G-7 in some ways, so I think this plan is really a non-starter,” Atkinson said.

Do we really think that Russia will accept this and not retaliate? I think that sounds like a very, very good theoretical concept, but it just won’t work in practice.

Amrita Sen

Co-founder and research director at Energy Aspects

“To me, honestly, the mechanism doesn’t work,” Amrita Sen, co-founder and director of research at Energy Aspects, told CNBC’s “Squawk Box Europe” on Friday.

“They haven’t thought about it, they haven’t talked to India and China… Do we really think they’re going to accept this? And do we really think Russia will accept this and not retaliate? I think that sounds like a really, really good theoretical concept, but it just won’t work in practice.”

Sen said the idea that countries around the world are on the same page as Western policymakers, especially when it comes to energy security, is “the biggest misconception right now.” She added: “I think it really needs to go away.”

For Claudio Galimberti, senior vice president of energy research company Rystad, the most direct mechanism for imposing a cap on Russian oil prices is through insurance.

“The International Group of Protection & Indemnity Clubs in London covers around 95% of the world’s tanker fleet. Western countries could try to impose a price cap by letting buyers keep this insurance, as long as they agree to pay no more than a certain price cap for Russian oil on board,” Galimberti said in a note.

“However, there are many obstacles that could derail such a plan,” he added.

Among the most obvious examples, Galimberti said, is that Russia could simply decide not to sell at the prices set by the cap, especially if the benchmark is very low and close to the cost of production.

President Vladimir Putin has already shown his willingness to suspend the supply of natural gas to so-called “hostile countries” who have refused to meet his demands for payment gas against rubles.

China is the “next most likely hurdle,” Galimberti said, as Beijing could decide, for geopolitical reasons, “to lend support to Russia by accepting lower Russian insurance and thus facilitate an escape from capping price”.

“Nevertheless, a price cap is certainly a measure worth considering at this stage, even if the clock is ticking, as the EU is determined to ban imports of Russian oil by the end of the year.” , said Galimberti.

How did Russia react?

Russia has warned that any attempt to cap the price of Russian oil could wreak havoc on the energy market and push commodity prices even higher.

Deputy Prime Minister Alexander Novak on Wednesday described Western leaders’ decision to consider imposing a price cap as “another attempt to intervene in market mechanisms that can only lead to market imbalance. . which would lead to [a] price hike,” according to Reuters.

Novak said he was confident Russia would restore oil production to pre-sanctions levels in the coming months, largely because a significant amount of Russian crude had been diverted to Asian markets.

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