G7 finance ministers agreed on September 2 to impose an oil price cap on the Russian oil trade starting on December 5 that is supposed to reduce the revenue the Kremlin earns from its exports, but gave few details of how the scheme will work and be enforced.

The EU in the first half of 2022 paid Russia $52bn for oil, $24bn for natural gas and $5bn for coal, leading to an all-time record current account surplus of $166bn – a $100bn more Russia had as a surplus in the first half of 2021. A ban on coal went into effect on August 10 and is reportedly working very well. The gas saga continues for the meantime, as Europe races to fill its tanks before the cold weather sets in. Now the EU is targeting the biggest earner for Russia: oil exports.

Finance ministers from Canada, France, Germany, Italy, Japan, the UK and the US gave the go-ahead to implement the scheme, declaring that it would “build on and amplify the reach of existing sanctions”. The goal is to keep oil flowing out of Russia but to cap the amount of money the Kremlin can charge for it and reduce its taxes from the exports to next to nothing. This way the West hopes to cut the Kremlin off from funding for the war in Ukraine and at the same time avoid a spike in oil prices on the international market.

Championed by US Treasury Secretary Janet Yellen, the way it works is that G7 countries will impose a “comprehensive prohibition of services” that enable the transportation of Russian seaborne crude and petroleum products, including maritime insurance. In this way they hope to block any delivery of oil that is not sold at a price set by the West, in effect creating a parallel market for Russian oil. If enough countries come on board, then other non-aligned countries like India will refuse to buy market priced oil from Russia as they can get it cheaper elsewhere. At the very least the scheme will increase the discount Russia has to offer to non-participants, which was up to $35 per barrel shortly after the war started, but more recently has fallen back to around $15 – still a lot more than the pre-war $2 discount for Urals blend oil.

Little new was revealed at the finance ministers’ meeting, especially not the prices that oil sales to Russia will be capped at. The scheme will be enforced by the West’s ability to sanction maritime insurance companies. As some 90% of insurance companies are in Western countries it is hoped this will be enough to cut Russia off from the international oil tanking fleet and make it impossible to transport oil.

The success of the scheme will turn on winning the co-operation of non-aligned countries that have refused to participate in the seven rounds of sanctions on Russia so far. These include India, China, the Kingdom of Saudi Arabia (KSA), Egypt and others. As bne IntelliNews reported in an oil price cap Explainer, experts say the oil price cap scheme will be very difficult to make work. Enthusiasm for the West’s sanctions outside the G7 countries is only lukewarm.

Russia hits back with NS1 shut down

The next day on September 3 Russia struck back by turning the screw on its gas deliveries to Europe again. Russia’s state-owned gas giant Gazprom announced there was a new problem with the Portovaya compressor station, a leaky oil value, and that it would shut down Nord Stream 1 completely for an indeterminate period until repairs can be affected.

As bne IntelliNews reported, Europe’s gas storage tanks are now more than 80% full, a month ahead of the deadline to reach that mark set by the European Commission at the start of the war in Ukraine, but Europe will still struggle to get through the winter with no more gas imports, as the tanks are not big enough to cover the demand for the whole of the heating season.

Nord Stream 1's shut-down was widely interpreted as the Kremlin ratcheting up its economic war with the West and countering the oil price cap scheme by intensifying the energy crisis in Europe.

Gazprom said the main turbine at the compression station was leaking oil and provided a picture on its Telegram channel as evidence. A Siemens delegation participated in the inspection, Gazprom said, and confirmed the problem. Repair work cannot be done in situ and needs a “specialised workshop.” Gazprom claims it does not have suitable facilities and blames sanctions on delaying the repairs.

"Siemens is taking part in repair work in accordance with the current contract, is detecting malfunctions ... and is ready to fix the oil leaks. Only there is nowhere to do the repair," Gazprom said in a statement on its Telegram channel on September 3.

The Kremlin has blamed Western sanctions for disrupting Nord Stream 1 and putting barriers in the way of routine maintenance work. Western officials have rejected this claim. Siemens Energy said sanctions do not prohibit maintenance.

Few details

Few concrete details were released along with the commitment to impose the oil price cap scheme that was first floated at the G7 summit in Bavaria in June, other than that it will come into effect on December 5 when the EU ban on imports of Russian crude is supposed to start.

In July Russia’s oil output climbed again for the third month in a row to near pre-war levels, averaging almost 10.8mn barrels per day, only marginally down from the 11mn (bpd) pumped in January immediately prior to the invasion of Ukraine.

Russian oil exports contracted by 115,000 bpd to 7.4mn bpd in July 2022 (4.7mn bpd crude and 2.8mn bpd as various oil products), the International Energy Agency (IEA) said in its August report. In total, Russia's oil exports shrank by around 0.6mn bpd at the beginning of the year. Russia’s revenues from oil export also lost $2bn and declined to $19bn amid smaller deliveries and lower oil prices in July, IEA experts said.

Russian oil exports to the US, EU, UK, Japan and the Republic of Korea tumbled by 2.2mn bpd from the start of the special military operation in Ukraine but two thirds of these volumes were redirected to other markets, according to IEA, with India, China and Turkey taking the lion’s share.

At stake is Russia's need to find new markets for about 1mn bpd of petroleum products and 1.3mn bpd of crude oil if the EU bans imports entirely – about a quarter of European imports (infographic).

However, what is not clear is whether the oil price cap scheme can be made to work or if Europe will then continue to import Russian oil. Hungary has already been granted an exemption from the oil import ban in the sixth package for Russian oil delivered by pipe.

The key question of how much the price cap will be was also not revealed, although the G7 said there will be three prices: one for crude and two for refined products that will be introduced on February 5 when the second EU ban on the more widely distributed refined products comes into force.

There has been a lot of discussion on what is the appropriate price for the cap. The idea is to make it high enough so that Russia’s oil companies can cover their costs, but low enough so that the Russian budget earns little from the exports. That balance would suggest a cap at around $60 per barrel, but others have argued for a higher price to prevent the Kremlin from cutting off oil supplies completely.

“The cap may also be effective at reducing the Russian government’s tax revenues. We don’t think a cap on the price of Urals crude would need to be too far below $80 per barrel (from $90pb currently) to push Russia’s budget into a deficit,” says Liam Peach, an emerging market economist with Capital Economics.

Even if other countries don’t sign up to the scheme, they probably will ask Russia for bigger discounts, a US official told the FT.

“In my conversations with other countries, they’re telling me that Russia is aggressively out there trying to lock in long-term contracts now at lower prices,” one senior US Treasury official told the FT. “Even if they haven’t decided to join the price cap coalition, part of their conversation with the Russians is: ‘well, given the price cap that’s coming, how should we think about lower prices?’”.

But the attempt to impose the oil price scheme will probably immediately result in a new escalation in the energy crisis, as the Kremlin said in a statement on September 1 that it will simply stop delivering oil to any country that participates in the scheme.

Russia will suspend the supply of oil and petroleum products to countries that have agreed to cap prices of Russian oil, Russian Tass News Agency quoted Deputy Prime Minister Alexander Novak as saying on September 2, which he described as “completely absurd.”

Novak’s remarks came just before a meeting of G7 finance ministers where the highly anticipated oil price cap plan was announced.

"As far as price restrictions are concerned, if they impose restrictions on prices, we will simply not supply oil and petroleum products to such companies or states that impose restrictions, as we will not work non-competitively," Novak told reporters.

"Interference in the market mechanisms of such an important industry as the oil industry, which is the most important in terms of ensuring the energy security of the whole world, such attempts will only destabilise the oil industry, the oil market," he said.

India busting insurance sanctions

The G7 intends to enforce the oil price cap by targeting insurance companies that try to insure ships carrying oil that are not participating in the scheme.

India has already blown one hole in this idea after an Indian insurance company agreed to offer Russian tankers safety certification to a Dubai-registered subsidiary of Russia’s biggest ship operator Sovcomflot on June 23. That will allow Russia to export oil to India even if the Western insurance sanctions are implemented. But the Russian fleet is not by itself big enough to carry all of Russia’s 7.4mn bpd of oil exports.

Industry participants speaking to the FT said that it would be down to the traders that book the ships to inform insurers what price the oil was being sold at, as insurers don’t usually deal with details on price. However, if there was any uncertainty insurers' default option will be to refuse to insure a ship and its cargo.

Many industry experts have expressed scepticism that the scheme can be made to work, as there is still that other 10% of leakage which will avoid the scheme.

But as Russia exports about 8mn bpd it needs an enormous fleet of ships, and the non-participating countries are probably unable to supply as many as would be needed.

The Russian ships will be insured by Russian insurance companies, which will probably be acceptable to the “friendly” nations Russia is still working with.

Sovcomflot's chief executive told reporters that the group had insured all its cargo ships with Russian insurers and the cover met international rules. Reuters reported that the Russian state-controlled Russian National Reinsurance Company (RNRC) has become the main reinsurer of Russian ships, including Sovcomflot's fleet RNRC that is controlled by the Central Bank of Russia (CBR), which has recently recapitalised the company to RUB300bn ($6bn) from RUB71bn and hiked its guaranteed capital to RUB750bn so the firm had adequate resources to provide reinsurance.

Indian authorities have also accredited the privately owned Russian insurance giant Ingosstrakh as an insurance company for shipping oil, which means vessels the company insures can enter Indian ports.

Greek shipping

The key to the effectiveness of the scheme is if the Greek shipping fleet – an EU member – can be made unavailable to Russia. As shipping is such a large part of Greece’s economy it won an exemption to the ban of providing logistical services to Russia that was part of the sixth package of sanctions.

Since then, the Greek oil transport business has been flourishing. In order to shed some light on what has become a very murky business, the Institute of International Finance (IIF) set up a web crawler to track the registrations of tankers and work out where their home port is and who they are working for.

“We have built a new database tracking the movement of oil tankers out of Russian ports. The innovation in our data is that we identify the true ownership of these vessels, which is often difficult because they are registered and flagged all over the place,” Robin Brooks, managing director and chief economist at IIF, said in a note. “It turns out that Greek-owned ships are 55% of total tanker capacity, compared to 35% in previous years.

Between March and August 2022, IIF estimated that Greek-owned vessels not only failed to avoid Russian oil, but they also had actually boosted their capacity to help carry it, allowing Russia to more than compensate from the reduction of demand from Europe. Closing this loophole will cause Russia huge problems.