By Osama Rizvi
- Last week, the G7 agreed to implement a price cap on Russian oil later this year, and Russia has already reacted by halting flows of Nord Stream 1.
- Realistically, for a price cap to work effectively, the G7 will have to convince both China and India to join the effort.
- With inflation soaring and electricity prices in Europe breaking records, it certainly seems like a big gamble, a gamble that could send oil prices into the stratosphere.
The Russo-European gas war entered a new phase recently when Russia’s Gazprom announced that they will halt the flow from Nord Stream 1 indefinitely (I have written in detail about this development here). This happened immediately after the G7 countries agreed to impose a price cap on the country’s oil in order to reduce Russia’s burgeoning revenues from energy sales – there has been a 38 percent uptick in Russian earnings from energy exports since last year. Meanwhile, European countries are grappling with extraordinarily high energy prices. The recent price cap on Russian oil sales will likely make things even worse for Europe, so the question is, is it worth it?
A price cap requires a “global commitment” if it is to be effective. If the last few months have taught us anything, it is that energy security concerns will triumph over idealism.
The Russian oil price cap will force buyers of its oil to comply with a ceiling that is below market price but a little above the cost of production. The countries not complying with it will face a “comprehensive prohibition of services”. These services include shipping insurance, a market that European companies dominate. The ban will go into effect on December 5th (for oil) and February 5th (for refined products). Although there are precedents for stopping countries from exporting oil, as in the case of Venezuela and Iran, imposing a different price on a specific country is a new tactic.
The biggest challenge in making this price cap really effective is bringing India and China, two of the largest oil consumers, on board. Both countries are already buying crude from Russia at a discounted price. In March 2022, oil imports by China and India combined were more than Russia’s exports to the EU by volume. China imported a record amount of Russian oil in June ‘22 with Russia overtaking Saudi Arabia as China’s largest supplier of oil for two months in a row. India has recently even overtaken China as the largest buyer of Russian crude as it bought six vessels of ESPO in August.
Natural gas price has risen 10 times as compared to last year and electricity prices have climbed by multiples as well. In the UK, the price of a megawatt hour has touched $590, which is five times that of last August while an average household may soon pay 80% more if the new Prime Minister doesn’t intervene.
In an environment where prices are soaring and inflation is at a multi-decade high, the price cap initiative has the potential to significantly worsen the current energy crisis. The fact that the technical fault in Nord Stream 1 coincided with the announcement of price caps is symptomatic of the tit-for-tat nature of this conflict.
Realistically, the price cap will only work if India and China are on board with the initiative. As discussed above, it appears that getting either nation to join the initiative will be a major challenge. Additionally, the whole enterprise could well backfire if Russia stops selling oil altogether, driving up prices internationally. Due to rising commodity prices, Russia’s current account surplus has already ballooned to $167 billion, which is three times more than a year ago. The country will earn more than $337 billion this year in energy sales. If the price cap goes into effect, almost 8 mbpd of Russian exports could go offline as G7 countries are responsible for about 90 percent of global shipping insurance and the country may not be able to find enough tankers for its oil.
It seems the downside risks of the price cap initiative outweigh the upside. Especially in the current context of high inflation, accumulating debt levels, and heightened social unrest, a further spike in oil prices around the world could push several countries to the brink of disaster.