Is Hitting Russian Oil A Double-Edged Weapon?

The European Union introduced an embargo on purchasing Russian crude oil, limiting the possibility of insuring ships transporting this raw material. In addition, the G7 countries introduced a $60 price cap on Russian oil. How will these decisions affect Russia's income? Why do some countries not want sanctions? How will commodity markets react?

It is no secret that oil resources are not limited. Sooner or later, they will end, although we prefer to believe that later. Oil is still one of the primary raw materials that fuel the world's economies and the lives of millions of people. Oil drives the Russian war machine, and attempts to limit the proceeds from the sale of oil to the Russian budget so far have yet to bring significant results. And here is another attempt made, which consists of the following:

• embargo of Russian crude oil to EU countries,
• price cap per barrel of Russian oil set by the G7,
• restrictions on the certification and insurance of Russian ships.

Triple Hit On Russian Crude Oil

On Monday, December 5, the European embargo on purchasing Russian crude oil came into force. The embargo was already agreed upon in June by the European Union. In addition, also on Monday, a ban on insuring ships carrying Russian oil came into force unless it is oil sold at prices set by the West. The import ban is part of the postponed mechanism of the sixth sanctions package, which the European Commission approved at the end of May.

However, there have been voices that more is needed and that there must be a second parallel channel through which it will be possible to hit the Russian oil industry. The answer is the maximum price for purchasing Russian oil, which will come into effect on December 5.

Price Cap At Market Price Level

However, the maximum price set by the EU, together with the G7 group, is a contentious issue. Some countries wanted it to be as low as possible, while others feared that the price cap mechanism would cause a complete collapse of the market. Still, others are entirely opposed to the sanctions and have vowed to buy Russian oil at market price.

Eventually, it settled at $60 a barrel. However, this price is close to the current market price, which is why a provision has been made that this price will be reviewed and possibly adjusted every two months so that the limit is at least 5% lower than the average market price of Russian oil.

Oil prices fell in November and early December 2022 following drops in US stock exchanges (Source: SimpleFX).

Will Embargo Break Russia?

The embargo, restrictions on maritime transport insurance, and the price cap mechanism are just coming into force. This means that their results are yet to come. Let us also remember that the sanctions package includes significant technological sanctions. The effectiveness of these is difficult to assess after a month, two months or half a year, but maintaining these restrictions for longer will generate serious problems for the Russian energy sector.

The second thing is the time horizon. Consequences of Russia's confrontation with the West for the future functioning of the Russian energy sector, even if we limit it to the situation on the sales markets. If Western countries stick to these decisions, Russia will lose a significant part of its strategic export market. Let us recall that before the war in Ukraine, the European market accounted for over 50% of Russian oil exports.

So if the embargo persists, it could deal a massive blow to the Russian economy. The forecasts of the European energy agency, included in the "World Energy Outlook" report published in October, should alarm Russia. The report clearly shows that if the European embargo on oil and petroleum products is consistently maintained together, Russia will irretrievably lose its position in crucial energy markets over the next decade.

Embargo of Russian Oil. Double-Edged Weapon?

On the issue of the oil embargo and price cap, however, there are voices that the price cap mechanism will only benefit Russia and the countries that support it.

• First, Russia took advantage of the time window between May and December to prepare for the European embargo. They have already successfully diverted some of their supplies by tankers to Asia, particularly India. They will continue to attempt to move their oil to other countries, such as China, India, Pakistan, Venezuela, and Iran, with these countries gaining substantial discounts. This will enable them to rebrand and pass it on even further.
   
• Secondly, if Russia reduces the supply of raw materials to the market and persuades its OPEC+ partners to reduce production, this would increase oil prices. This would benefit Russia as it could sell more expensively and reduce losses due to lower production. However, Europe would face the issue of high prices and another oil crisis.

Price Cap Will Raise Oil Price to $200?

In the case of the price cap mechanism, adverse effects can also be seen for the countries that have imposed it. The first problem is the amount of this price, which sometimes exceeds the market price. Moreover, some calculate that Russian exports are profitable when the price of a barrel of crude oil is $25-30.

But the numbers themselves are only one of the problems. The second is which countries will join the price cap initiative. For many Asian countries, it is essential to maintain good relations with Russia, and now they can also benefit financially from it. 

There is also the question of how Russia will react to the price cap mechanism. A few months ago, Putin announced that Russia would not sell energy resources to countries that would join the mechanism.

The effect on global energy markets could be as follows: if supply drops dramatically, the price of oil could skyrocket, even to $140-200 per barrel. As a result, the Russians could de facto earn more by selling less oil. Will that happen? The tug of war has just begun.

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