When you cross the event horizon of a black hole, there is no obvious break, no discernible boundary — and yet there is no return. So is the case with the price cap on Russian crude, which came into effect on Friday. Trading goes on, prices have even fallen, but the oil market has entered a new orbit.
The interdict on oil from Russia is actually two measures, often confused: a near-complete ban on seaborne oil sales to the EU (the UK, US, Canada and Australia had already banned purchases), and a ceiling on the price of Russian oil sales to other countries. Oil sold above $60 per barrel cannot use insurance or shipping services from the EU or G7 countries, which control most global provisions.
Outwardly, the market has taken the measures in its stride. Brent crude closed at $76.10 per barrel on Friday, the lowest of the year. Russia has switched its crude exports largely to Turkey, India and China, while Europe has filled the gap with the Middle East and the US. A queue of tankers at the Bosporus Strait was blamed on overzealous Turkish enforcement, and anyway, affected non-sanctioned Kazakh rather than Russian oil. They both ship from the same port.
Last week, Urals crude, Russia’s main grade, exported from the Baltic, was selling for just $45 per barrel, well below the cap. That was part of the argument from Washington and Brussels: India and China would not comply openly with the cap, they acknowledged, but that did not matter, as long as they took the opportunity to negotiate heavy discounts.
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In a way, this calm is exactly the intention of the G7 policymakers. They want Russian crude to keep selling, to avoid a damaging price spike, but they aim to cut the revenue going to Vladimir Putin’s government.
Never in the post-1970 oil order has a buyers’ cartel attempted to set the terms. Opec wrested control of pricing from the international oil majors, then lost it to the raucous free market in the early 1980s.
The International Energy Agency, set up in 1974 as part of the industrialised countries’ counter to the oil embargo, introduced strategic stocks and emergency pooling procedures but did not organise a united front for lower prices — even though its members were far more dominant in global oil use, finance and services than they are now.
Of course, there have been US or UN sanctions on individual sellers- Iraq in the 1990s, Libya from 1996 to 2004, Iran and Venezuela — that restrict or prevent sales by a single country. In the case of Iran, those are accompanied by secondary sanctions that have scared off virtually every purchaser except China.
The measures against Russia are not that harsh, yet. But Russia is a much bigger oil exporter than any of those states. Today’s sanctions are different in design. And two factors could make them near-permanent features of a bifurcated market.
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First, sanctions tend to be very enduring. Bureaucratic endeavour has a momentum of its own. The price cap might prove ineffective or easily circumvented. More likely, as with the oil-for-food programme in Iraq of the 1990s, its weaknesses and distortions will become increasingly apparent, but it will be politically and legally impossible to remove. Such problems were seen with Muammar Qaddafi’s rapprochement with the West from 2004, and the short period when the nuclear deal with Iran functioned.
There are obvious points of escalation in the current arrangements, particularly if the war drags on and the G7 judges Russia’s economy is not weakened enough. Since Russia is apparently willing to sell at $45 per barrel, why not lower the cap accordingly? As prices have slumped since early November, they could accept the risk of Moscow’s taking some oil off the market. Or, as against Iran, start using secondary sanctions to deter uncapped buyers, or target Russia’s shadow fleet of tankers and insurers?
If the war in Ukraine moves towards a political settlement, or even if Moscow’s forces are comprehensively defeated, or the system in the Kremlin changes, the price cap and other sanctions will be a key point of leverage for the West. Russia will be demanded to concede many points in a post war arrangement. That could include remaining occupied territory in Ukraine and elsewhere, security guarantees for Kyiv, reparations, the return of prisoners and hostages, the surrender of those accused of war crimes, compensation for breaking its gas supply contracts, and perhaps the restoration of some gas flows to Europe.
Second, once politicians are given a new tool, they tend to overuse it. This is particularly so when dealing with something as slippery as the oil market, which defies their command. In miniature, this can be seen in the growing enthusiasm of the Biden administration to employ the strategic petroleum reserve to manage crude prices, even to promise future support if prices were to drop beyond its original mandate of smoothing over emergencies.
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Other US-sanctioned countries, such as Iran or Venezuela, could be dragged into the cap mechanism too, forcing these political allies into a cage-fight for remaining customers. Washington could see uses in heightening the incompatible interests between Moscow and its Opec+ colleagues.
If oil prices spike again, Russia may delay production increases from which it would not benefit. Then the temptation may grow to counter the market power of Opec+ with a more organised buyers’ cartel. And as climate policy tightens, oil importers could eventually wield a price cap to force petroleum output on a steady downwards path, while avoiding damaging boom-and-bust cycles.
For all the crude chaos in the time of Covid and conflict, Opec+ has faced a relatively straightforward job of market management. But responding to a permanently divided oil market needs tools beyond adjusting production up and down. A new mission, not just a new strategy, would keep the organisation out of the black hole.
Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis
