G7 oil price cap a perilous gamble – POLITICO

Johannes Nordin is a junior researcher at the Institute for Security and Development Policy.

Just before Russian Gazprom completely choked off gas flows through the Nord Stream I gas pipeline, G7 leaders had agreed in early September to put in place a price cap on Russian energy exports. By taking advantage of Europe’s central position in the global marine insurance industry, these measures aim to reduce Russia’s bloated energy revenues not only from sanctioning states, but also from third countries.

However, the eleventh-hour mechanism has serious risks and unintended consequences that should not be ignored.

The G7 price cap is meant to align with the European Union’s sixth sanctions package and aims to prevent a price spike when the EU oil embargo comes into force. Not to be confused with separate EU-wide gas price cap proposals, the G7 initiative works through shipping and insurance premiums – instead of penalizing buyers or suppliers. Russian energy transporters, causing an upward compression of world prices, it seeks to exert downward pressure on Moscow’s oil revenues by charging higher insurance premiums for energy deliveries, unless they do not respect an as yet unspecified price ceiling.

Sitting above Russia’s marginal production costs, but below today’s inflated prices, this price cap can be discounted at around $60 per barrel (bbl).

Given its technical complexity, short implementation timeframe and low efficiency if other large Russian energy consumers opt out, experts remained wary of the vague proposal. Despite diplomatic efforts to solicit their support, so far neither Turkey, China nor India – the three biggest importers of Russian fossil fuels outside the EU – have responded positively to calls for join a sanctions regime. In fact, all three have increased their Russian energy imports.

In addition, while around 90% of the world’s tanker fleet is insured by the London-based International Group of Protection & Indemnity Clubs, China and India have already accepted Russian National Reinsurance insurance. Company, controlled by the state, after the forced exit from Russia of the International Group of Protection & Indemnity Clubs. Association of Classification Societies.

In the meantime, Beijing has again called for dialogue rather than sanctions, underscoring global energy security concerns. Ankara, meanwhile, went further, with Turkish President Tayyip Erdoğan mocking that Europe was « reaping what it had sown » with its « provocative » policies towards Russia. By contrast, Delhi has pledged to study the proposal carefully, although it has recently invoked its “moral duty” to ensure affordable energy.

Several South Asian countries are already experiencing blackouts, overvalued in global markets, their currencies slipping against the dollar. Indian External Affairs Minister S. Jaishankar thus accused Western critics of hypocrisy, pointing out that the EU buys more Russian energy than all other countries combined and that US secondary sanctions are still blocking alternative providers. Referring to Europe’s silence on various issues in Asia, he further chastised the outdated mentality that « Europe’s problems are the world’s problems », but not the other way around.

Economic and historical ties with Moscow and mutual aversion to unilateral sanctions certainly play an important role in the overall equation. Yet, from the perspective of Beijing and Delhi, their continued energy purchases have kept global prices from skyrocketing even further by not adding to the crowded bidding war for the same limited oil supplies.

Given the Kremlin’s continued willingness to retaliate against sanctions, there is also genuine concern about further escalation, and Moscow’s recent threat to halt energy exports to countries adhering to price caps and The Organization of the Petroleum Exporting Countries (OPEC+) decision to cut September oil production levels is unlikely to prompt a review.

However, proponents of price caps maintain that the positive effects always outweigh the negatives.

They note indirect impacts, pointing to Russian energy producers rushing to negotiate discounted oil contracts to hedge against losses. A price cap could thus help non-participating countries to negotiate agreements with even greater discounts.

Meanwhile, Russia’s top consumer, China, is unlikely to increase its imports significantly, given the high emphasis on energy diversification. And circumventing the price cap will further drive up transportation costs and erode Moscow’s profits.

Finally, supporters decry Russia’s threat to cut supplies, pointing to the outsized role of oil revenues in state finances, the country’s limited storage capacity and potential infrastructure damage that could result from the shutdown. from production.

While the first points seem sensible, the last rests on the unproven assumption that Moscow – a strategic player particularly “adept at negative-sum games” – would necessarily prefer some revenue to none.

But given extremely inelastic global oil demand, even a supply-demand imbalance of a few hundred thousand barrels per day can cause price spikes. And with U.S. emergency oil reserves at multi-decade lows, OPEC+ favoring high prices, and Iran and Venezuela still under sanctions, there is little spare capacity left. In addition, soaring natural gas prices are already driving a major shift from gas to oil around the world. So the Kremlin could very well bet that a strategically timed price shock in world markets would weaken Western resolve more than it hurt Russia.

Taking into account the price cap and partial retaliation, Goldman Sachs projects that average oil prices will climb to $125/bbl for Brent Crude in 2023. More alarmingly, JPMorgan estimates that Russia could cut daily production by up to 5 million barrels without excessively damaging its economy, by compressing prices. at $380/bbl in the worst case.

Given these systemic risks, experts advocate energy tariffs as a less complex alternative to a price cap, which would obviate the need to monitor, enforce and adjust sanctions over time.

A tariff approach requires less political capital to persuade recalcitrant countries, resulting in less intra-EU friction. Tariff-inflated prices also suppress relative demand for Russian energy and save time finding alternative suppliers. Revenues can then be reallocated to mitigate consumer price increases, as well as the Ukrainian war effort.

In contrast, Moscow’s energy revenues do not automatically translate into greater combat resources. While a combination of exchange controls, falling imports and rising energy revenues have so far saved the rouble, Russia remains the most sanctioned country in the world, with imports severely restricted in quantity and quantity. quality.

So far, moves to wean Europe off Russian energy before adequate substitutes are in place – and Russian retaliations – have driven up global prices and fomented resentment among developing nations. overpriced. Attempts to shame nations reluctant to take sides – as with India – and hints of potential sanctions for continued non-agricultural trade with Russia – for example, in Africa – have only fueled historical grievances with the perceived arrogance of the West. And predictably, the Kremlin has captured these frictions in its disinformation campaigns about the war.

Meanwhile, high energy prices have paradoxically led countries to pay Russia more for fewer imports, with the ensuing energy crisis catalyzing the greatest intervention in Russia’s energy market. EU history, and Moscow is still on track for a 38% year-on-year increase in energy exports. income in 2022.

The loss of the European market will undoubtedly seriously harm the Russian fossil fuel economy in the medium to long term. But in the short term, these setbacks could have been entirely avoidable.

Unfortunately, politically speaking, it is now too late for tariffs.

Unlike a price cap, tariffs cannot co-exist with a full embargo, preventing the EU from “saving face by not backing down” on sanctions. And against a backdrop of growing public discontent and soaring energy bills, European governments understandably worry about the effects on EU unity, should the Pandora’s box of sanctions be opened for questioning, even slightly.

Given these political limitations, EU and G7 leaders must redouble their efforts to quickly bring alternative energy providers back. They must also be more humble towards those unwittingly caught in the crossfire of sanctions.

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