G7 Price Cap on Russian Oil: What is the Mechanism, How Will It Affect Moscow’s Revenue | News18 Explains

India stood to gain from the G7-imposed price cap mechanism on Russian oil, said US treasury secretary Janet Yellen and hoped the country will take advantage of it. She said as long as India did not avail of western insurance, finance and maritime services bound by this cap, the country could buy as much oil as it wanted from Russia including at prices above the cap.

Her statement on the sidelines of a conference focused on deepening US-India ties comes at a time when foreign minister S Jaishankar, a few days before Yellen’s visit to India, said India will continue buying Russian crude as it was beneficial for the country.

India is Russia’s largest oil customer now, other than China. Being a traditional ally of Russia, India has not condemned Moscow’s “special operation” in Ukraine explicitly. Despite optimism shown by the US, however, Indian officials are wary of the untested price cap mechanism. They said India will not be following the price cap, adding that it was more important to keep oil prices and supplies stable.

Since Russia is the world’s second largest oil exporter after Saudi Arabia, shortly after Russia’s invasion of Ukraine, international oil prices spiked to record levels since 2008. In fact, a bid by the West to reduce their reliance on Russian oil, gas and oil products, as well as to cap their prices has only worsened a severe energy crunch not seen since the 1970s when an embargo was put on Arab oil.

The G7 agreed in September to enforce fixed prices on sales of Russian oil. But what exactly does this price cap mechanism entail?

What is the G7-imposed price cap mechanism on Russian oil?

Aimed at putting pressure on Russia’s revenue, once imposed the price cap will drive global oil prices lower while curbing Moscow’s revenues. According to Yellen’s interview to news agency Reuters, the price cap mechanism is designed in a manner so as to stop Russia from selling as much oil as it does now once the European Union halts imports without resorting to the capped price or significant discounts from current prices.

“Russia is going to find it very difficult to continue shipping as much oil as they have done when the EU stops buying Russian oil,” Yellen said, adding, “they’re going to be heavily in search of buyers. And many buyers are reliant on western services.”

A report published by Reuters stated that the price cap mechanism was in its final stages ahead of a December 5 deadline. The G7 countries will then cap prices of sea-borne oil shipments with a second cap from February 5. To simplify it further, this means that each load will only be subject to the price cap when first sold to a buyer on land. The initial price has not been set, but countries working together to impose the cap have agreed to regularly review the fixed price and revise it as required.

The wealthy Group of Seven, or G7, democracies and Australia are in a coalition to impose the price cap mechanism on Russian oil. The G7 comprises Canada, United States, United Kingdom, Italy, France, Germany and Japan. First promoted by the US, the concept of the price cap essentially calls for an embargo on Russian oil to punish Moscow for its invasion of Ukraine. The first plans for it were laid out by the EU in May.

The wealthier, or developed, countries want Russian crude to stay on the market so that developing nations like India and China can purchase it. Hence, the price cap is intended to target undue profits made by Russia that has launched an invasive attack on Ukraine, which is known to be close to NATO.

How is the price cap intended to work, or affect Russia’s revenues?

Yellen said the price cap will essentially give leverage to major buyers of Russian crude to push down prices they pay at present. Hence, this may prove to be highly beneficial for India and China. Russian oil “is going to be selling at bargain prices and we’re happy to have India get that bargain or Africa or China. It’s fine,” she told Reuters.

Once the cap is introduced, western countries will deny insurance, maritime services and finance for tanker cargoes priced above a fixed dollar per barrel. A historical Russian Urals crude average of $63-64 a barrel could form an upper limit.

Yellen said even with Russian tankers, Chinese tankers and a “shadow” fleet of older, decommissioned tankers and re-flagged vessels, “I just think they will find it very difficult to sell all the oil that they have been selling without a reasonable price.”

How will the price cap affect India?

Yellen’s optimism that India will hugely benefit from the price cap mechanism is not a shared sentiment by the country. Known to be longtime allies, India is now Moscow’s largest oil customer while Jaishankar made it clear only last week that the country will not stop buying from Russia.

The US treasury secretary, however, said India could go ahead and buy as much oil as it wanted from Russia but the price cap will apply to the country if it wanted to avail western financial services like insurance. She said but India could still negotiate the best discounts even if it chose to use other financial services.

Last month, India had said it will look into the proposal of the price cap mechanism. Asked if India will follow the cap, oil minister Hardeep Singh Puri told Reuters, “I think there is an exemption for Japan for Sakhalin, then there is crude which comes through the pipeline, so they have exemptions… we will have to look at it.”

India has been operating on trading discount with Russia for oil after the West shunned Moscow for the attack on Ukraine. India has so far remained non-commital to the price cap plan, but all eyes are on New Delhi as Russia has made it clear it will not deal with those operating under the fixed prices.

Puri also said India will “respond according to its supreme national interest”, adding that India was looking at sourcing crude from other sources such as Guyana and Canada.

Indian officials, however, are wary about the “untested” price cap mechanism. “I do not think we will follow the price cap mechanism, and we have communicated that to the countries. We believe most countries are comfortable with it and it is in no one’s case that Russian oil should go offline,” a government official told Reuters, on condition of anonymity, adding that stable supplies and prices were most important.

According to data available, India is the world’s third biggest oil importer, as it imports 85 per cent of its crude needs. Russia’s share of India’s oil imports surged to an all-time high of 23 per cent in September, from just about 2 per cent before the invasion.

“Russia has been a steady and time-tested partner. Any objective evaluation of our relationship over many decades would confirm that it has actually served both our countries very, very well,” Jaishankar said during a joint news conference with his Russian counterpart Sergei Lavrov during his visit to Moscow last week.

About the G7 plan, the external affairs minister said India had to look after its own interests. “And in that respect, quite honestly, we have seen that the India-Russia relationship has worked to our advantage,” he said, adding, “so, if it works to my advantage, I would like to keep that going.”

India’s Oil and Natural Gas Corp has applied to the new Russian operator of the Sakhalin-1, following the exit of ExxonMobil, to retain its stake in the oil and gas project in the Far East.

Will a price cap have the desired impact on Russia?

While the US, EU and other western allies are expecting that a price cap mechanism on Russian oil will somehow punish Moscow for its invasion of Ukraine, the country is set to skirt the fixed prices despite being hit by severe sanctions and facing numerous financial difficulties.

Oil is Russia’s mainstay when it comes to financial revenue. It has kept the economy afloat despite export bans, sanctions and the freezing of central bank assets. According to reports, however, Russia has access to enough tankers to ship most of its crude beyond the reach of the price cap mechanism.

Industry stakeholders and even US officials said months of discussions had led to the conclusion that Russia could largely skirt the cap with its own services. The two major spoilers could be looming recession and rising inflation. While Russia will face financial and technical difficulties due to the price cap, the world will be deprived of 1-2 per cent of the global supply.

Rosneft, Russia’s largest oil exporter, is expanding its tanker charter business to avoid its buyers having to find tankers, insurance or other services if the price cap comes into effect. But the US is optimistic that the fixed prices will be do more damage to Russia in the long run. It will have to take longer voyages and avail of subpar insurance and financing. Soon, the US believes, the country will be compelled to adhere to the price cap.

Russia can marshall its old ships as well as those of China and India, who have continued to buy crude from Moscow and have so far not endorsed the price cap.

(With agency inputs)

Read all the Latest Business News here