The Kremlin’s financial chess: unraveling the oil price cap conundrum

The Kremlin’s financial chess: unraveling the oil price cap conundrum
Price cap

For months, after Western allies of Ukraine limited the sales of Russian oil to $60 per barrel, the price cap remained largely symbolic. Most of Moscow’s crude oil, its main source of income, cost less than that figure.

However, the cap was there in case oil prices increased, preventing the Kremlin from earning extra profits to finance its war in Ukraine. That moment has now arrived, putting the price cap to its most serious test yet and highlighting its weaknesses.

Russia’s benchmark oil, often exported through Western ships bound by sanctions, has been trading above the price cap since mid-July, pumping hundreds of millions of dollars per day into the Kremlin’s war chest.

With Russia’s profits on the rise, the war between Israel and Hamas pushing global oil prices higher, and evidence that some traders and shippers are bypassing the cap, the first signs of enforcement are emerging 10 months after the price limit was imposed in December.

However, supporters of the sanctions argue that the crackdown must go further to truly hit Russia.

Reducing oil profits “is what hits Russian macroeconomic stability the most,” said Benjamin Hilgenstock, senior economist at the Kyiv School of Economics, who advises the Ukrainian government.

Oil price cap: Russia’s economy risks

Oil revenue is the backbone of the Russian economy, allowing President Vladimir Putin to invest money in the military while avoiding a worsening of inflation for ordinary people and a currency collapse.

Moscow’s ability to sell more to the world than it buys means it is weathering the sanctions much better than expected. Its economy will grow this year while Germany’s shrinks, according to the International Monetary Fund.

However, Russia’s main source of income is at risk due to stronger enforcement action. Last week, the U.S. Treasury Department sanctioned two ship owners, while British officials are investigating violations.

Since the invasion began, oil sanctions have cost Russia $100 billion through August, said an international sanctions task force at Stanford University. But most of that, economists say, comes from the European ban on Russian oil, which has deprived Moscow of its main customer.

“There are serious problems with the (price cap) policy, but it can work,” Hilgenstock said. “With some improvements, it can be very effective.”

Ships owned or insured by Western nations “have continued to load Russian oil at all ports within Russia” in recent weeks, while prices exceeded the cap, the Helsinki-based Center for Research on Energy and Clean Air said in a report last week. “These events serve as compelling evidence of violations against the price cap policy.”

Russia’s oil revenue rose to about €200 million ($211 million) per day in September as global prices increased, the think tank said. Less oil available worldwide, with Saudi Arabia and Russia cutting production, pushed key Moscow export crude prices to $74.46 last week, S&P Global Platts said. It has been above $60 since July 11. Doing so threatens a shortage that could raise fuel costs and inflation in the United States and Europe.