The West has just jammed the oil market. The rest depends on Russia

The oil embargo, decided at the end of May, entered into force on Monday in the European Union. It was accompanied by a new price cap for Russian crude set by the G7 countries. This is intended to limit Kremlin revenue while allowing countries like China and India to continue buying Russian oil, provided they pay no more than $60 a barrel.

What happens next will likely depend on the response from Moscow, which has pledged not to cooperate with the price cap and could cut output, shaking global energy markets. Global crude prices rose 2.6% on Monday as investors nervously waited for the next move.

But the embargo is significant. In 2021, the EU imported 48 billion euros ($50.7 billion) of crude oil and 23 billion euros ($24.3 billion) of refined petroleum products from Russia. Two-thirds of these imports arrived by sea.

A ban on Russian refined petroleum products, such as diesel fuel, imported by sea will be launched in early February.

How is the price cap taken into account?

The price cap, which can be adjusted over time, is designed to be applied by companies that provide shipping, insurance and other services for Russian oil. If a buyer pays more than the cap, they will retain their services, in theory preventing the oil from being shipped. Most of these companies are based in Europe or the UK.

What do these measures seek to accomplish?

Despite unprecedented sanctions from the West, Russia’s economy and government coffers have been bloated by its lucrative position as the world’s second largest exporter of crude oil behind Saudi Arabia.

In October, Russia exported 7.7 million barrels of oil a day, just 400,000 barrels below pre-war levels, according to the International Energy Agency. Revenues from crude oil and refined products currently stand at $560 million per day.

By quickly cutting imports, Europe hopes to limit entries into Putin’s war chest, which will make it harder for him to continue his war in Ukraine.

The G7 countries do not want Russian oil taken off the market entirely, as it would drive up global prices at a time when high inflation is hurting their economies. By decreeing a price cap, they hope that the barrels will continue to flow, but will make the business less profitable for Moscow.

Will it work?

It is far from certain. Countries like Poland and Estonia wanted a lower price cap, pointing out that $60 is too close to the current market price of Russian oil. At the end of September, Russian Urals crude was trading at just under $64 a barrel.

The application could also prove to be difficult. Russia and its customers could start using more ships and insurance providers outside of Europe and the UK to circumvent the rules, relying increasingly on what is known as a “ghost fleet”.

“The capacity of this fleet has increased and it could probably handle Russian volumes for a while,” said Richard Bronze, head of geopolitics at Energy Aspects, a research firm.

Kremlin spokesman Dmitry Peskov said on Monday that Moscow “would not recognize any price cap”. Russian Deputy Prime Minister Alexander Novak said on Sunday that Russia would not export oil to countries adhering to the cap, even if it meant cutting production.

What does this mean for energy prices?

Oil prices have fallen sharply since the spring as fears of a global recession that could affect demand came to the fore. Now all eyes are on Russia’s response. Peskov said the price cap was a step towards “destabilizing global energy markets”.

According to the IEA, Moscow needs to find replacement customers for 1.1 million barrels of crude per day that were still being shipped to Europe. It may not be easy, especially as coronavirus restrictions and a slowdown in growth in China affect demand from the world’s second-largest economy.

The price cap adds to the uncertainty. Potential customers might decide that buying Russian cargo has become too risky and complex, taking another batch of buyers out of the market.

As the Kremlin has threatened, Russia could cut its oil production as a result. The IEA has estimated that Russia will cut production by an additional 1.4 million barrels per day by early 2023.

Other factors will also dictate prices. Rare protests in China have raised questions about the country’s commitment to its “zero-Covid” policy, and demand could increase if its economy picks up speed.

The European embargo on refined petroleum products in February could also be a flashpoint for energy prices, as the region remains dependent on Russian diesel. Finding alternative sources in just two months can be tricky.

— Anna Chernova contributed reporting.