Russian Oil Price Restriction Applies, What's the Impact?

Russian Oil Price Restriction Applies, What's the Impact?

Limiting the price of petroleum or oil price cap has become one of the most popular discourses recently in the global energy arena. After the European Union intervened in the price of Russian gas, this time the G7 and the Price Cap Coalition tried to limit the price of Russian oil by direct intervention to slowly weaken the fiscal break-even point of Russian oil. Revenue from Russia's oil exports is expected to fall dramatically with the price cap in place.

Of course, in its implementation, all members of the Price Cap Coalition will apply these restrictions with adjustments to their respective domestic policies. The Price Cap Coalition includes 27 member countries of the European Union (EU), G7 members (United States, Canada, France, Germany, Italy, Japan, and the United Kingdom), and Australia.

Russian oil price restrictions will take effect after December 5, 2022, for crude oil and February 5, 2023, for refined oil products with a price limit of 60 US dollars per barrel for seaborne crude oil of Russian origin. This will go into effect simultaneously in all jurisdictions of the Price Cap Coalition.

The policy also provides room for a transitional price adjustment, which will not apply to oil purchased above the price limit, loaded onto ships before December 5, and unloaded before January 19, 2023.

The price is set at what has historically been the financial break-even point for Russian oil, which is above the cost of producing it and comparable to the price Russia sold it for before it invaded Ukraine.

However, the cap would be above Russia's production costs of between 30 and 40 US dollars per barrel. The price gives Moscow an incentive to continue producing and selling oil without having to close oil wells.

As an economic weapon

The oil price limit is considered an “economic weapon” to limit Russia's space to finance wars, while at the same time maintaining the supply of oil to the global market. The price cap is specifically designed to reduce Russia's oil export earnings while keeping global energy supplies stable.

The price caps are claimed to also help tackle inflation and keep energy costs stable at a time when high costs, especially rising fuel prices, are weighing on economies around the world. Although it is considered that price restrictions will greatly help ease the energy burden for developing countries and low-income countries, in fact, price restrictions will dim the free market mechanism in the oil and gas sector.

This will exacerbate the long-term energy market mechanism which has been disrupted due to the war between Russia and Ukraine which has quite severe impacts, such as a shortage of natural gas in Europe and an increase in oil prices worldwide. Increases in energy prices can prove especially dangerous for an economy with high vulnerability to energy price shocks.

This is what must be anticipated. The reason is, Russia will not remain silent and will respond to the treatment of the Price Cap Coalition. If that happens, the coveted oil price limit will benefit developing countries, including Indonesia, instead, it will give the impression of mere populism. Don't let a policy that is considered a way out of ending the Ukrainian war backfire on the stability of the world oil trade, especially for cross-continental energy trade traffic.

You see, price capping operations will rely heavily on vital elements of the global oil trade, such as the maritime services industry, which includes insurance, trade transaction services, and other key services that support the complex transport of oil around the world.

Traders, brokers, and importers also rely on these services to protect and finance their trade, and ship owners rely on insurance to protect their vessels. In addition, almost all major ports and canals require ships to carry protection and indemnity insurance.

The G7 also controls around 90 percent of the maritime insurance and reinsurance product market. The Price Cap Coalition will ban a range of services, including maritime insurance and shipping-related trade finance Russian crude unless importers purchase oil at or below US$60 per barrel.

Importers buying Russian oil at or below price caps will have easy access to a range of oil trading services.

On 5 February 2023, this service ban will be extended to sea transportation of petroleum products of Russian origin, unless the products are sold at or below price limits to be announced before 5 February 2023.

However, Russia is considered not to give up and comply with the price limit easily. Russia could retaliate by cutting off the last remaining supply of natural gas to Europe. Russia says it can easily stop shipments to countries that comply with the restrictions.

A greater threat will be faced by many developing countries if Russia goes through with its plan to stop selling oil to countries that help limit the price of Russian oil. This can result in a deeper reduction in oil production.

This, in turn, would shrink the already severely tight global oil supply, inevitably pushing oil prices higher and contributing to soaring inflation that the world is struggling to suppress.

Potential to damage the market mechanism

What needs to be noted, however, is the biggest risk associated with price cap initiatives normalizing future market intervention. If it can happen once, in the future it can happen again, and maybe it will be a natural thing.

If this kind of intervention becomes chronic, so to speak, it will mark the end of the free market and the beginning of a new era for authoritarian regimes to regulate the market. Of course, this will set a bad precedent in maintaining natural market mechanisms and in the long term will be very detrimental to developing countries and economically vulnerable countries.