Analysis

The oil price cap and embargo on Russia work imperfectly, and defects must be fixed

Violations of the G7 price cap on Russian oil are becoming evident, but Western countries still can tighten rules and reduce the cash flows to Russia.

Publishing date
12 July 2023
EU Russian Oil Price Cap Illustrations

The unprecedented and extensive sanctions to limit Russia’s oil export income, including the European Union embargo and an oil price cap imposed by the G7 in December 2022, have successfully reduced Russia’s export earnings and budget revenues. In the wake of the sanctions, Russia’s current account surplus fell to $23 billion in January-to-May 2023 from $124 billion in the same period a year earlier 1 Bank of Russia, ‘Estimate of Key Aggregates of the Balance of Payments of the Russian Federation’, 11 July 2023, https://www.cbr.ru/eng/statistics/macro_itm/svs/bop-eval/. . The Russian finance ministry also reported about a 50 percent year-on-year drop in government oil revenues in January-May 2023, and a widening budget deficit 2 Ministry of Finance of the Russian Federation, 'Brief information on the execution of the federal budget' (in Russian), https://minfin.gov.ru/ru/statistics/fedbud/execute/. .

Less clear however is the impact of each different measure initiated by the West to punish Russia for its invasion of Ukraine. Evidence indicates that the oil embargo has had more of an effect than the price cap, in part because the cap has been set too high and enforcement is lacking.

Because of the EU embargo, European buyers of Russian oil have essentially disappeared, and Russia is accepting price discounts to maintain export volumes from the Baltic and Black Sea ports that have traditionally supplied Europe. Russia’s tax revenues have fallen as prices in this market are used to calculate taxes from oil. In an attempt to prop up oil prices, Russia announced on 2 April 2023 a production cut of 500,000 barrels per day 3 Reuters, ‘Novak says Russia to extend 500,000 bpd oil production cut until end of year’, 2 April 2023, https://www.reuters.com/business/energy/novak-says-russia-extend-500000…. . The finance ministry also changed the oil price benchmark it uses to calculate oil taxes to take into account the shifts away from exports to Europe 4 Rosemary Griffin and Elza Turner, 'Russia to use Dated Brent in tax calculations to protect state budget from Urals discount', S&P Global, 16 February 2023, https://www.spglobal.com/commodityinsights/en/market-insights/latest-ne…. .

The price cap, meanwhile, was intended as an innovative step to reduce Russia’s revenues while keeping its oil flowing to the global market. It allows G7/EU providers of shipping services, including shipowners and insurance companies, to remain involved in the trade with Russian oil as long as the oil is sold below a certain price. This threshold was set at $60/barrel for crude oil. There was scepticism about the price cap regime’s effectiveness when it was announced, citing the potential for circumvention. But the problems appear to be more fundamental.

For a major segment of the Russian export market – shipments of Urals-grade crude from Baltic and Black Sea ports – the EU embargo has driven down prices so much that the $60/barrel cap has become irrelevant. As for exports from Pacific Ocean ports, which never supplied Europe and where, therefore, the EU embargo could not have an impact, prices have stayed above the $60/barrel threshold. But G7/EU companies remain involved to a significant degree, indicating that the cap is not enforced properly. The introduction of the cap did, however, ensure that Russian oil remained on the market (Hilgenstock et al, 2023), and global prices did not rise because of lower supply. This objective was a key concern of the sanctions coalition.

Because of these defects, financial-sector sanctions should be adopted to strengthen oil price cap implementation and curb Russia’s ability to accumulate assets abroad.

Price cap violations are occurring

Evidence of potentially widespread violations of the price cap has emerged at Russia’s Pacific port of Kozmino (Hilgenstock et al, 2023). Data on shipments shows that in the first four months of 2023, half of the oil was exported on vessels either owned or insured by G7/EU entities (Figure 1, top bar). At the same time, 96 percent of exports for which price information is available were priced above the cap’s $60/barrel threshold, with an average price of more than $70/barrel (Figure 1, bottom bar). This means that at least 24 million barrels with a price above $60/barrel appear to have been transported on vessels that fall under the cap’s regulations 5 Price information is not available for shipments that appear in trade data under transaction terms other than FOB (free on board), on which the price cap is applied. . These violations are likely the result of straightforward falsification of the records 6 See European Commission oil price cap frequently asked questions, as of 30 June 2023, https://finance.ec.europa.eu/system/files/2023-06/guidance-russian-oil-….  oil buyers are required to provide to G7/EU shipping and insurance companies to demonstrate price-cap compliance.

Figure 1: Potential price cap violations in January-April 2023

1

Sources: Equasis, Kepler, Russian authorities, authors' calculations

To address these problems, financial institutions should be required to inform implementing agencies (such as the US Office of Foreign Assets Control, the UK Office of Financial Sanctions Implementation and similar agencies in EU countries) of any transactions under the cap that they facilitate, and to notify them of suspicious activities. Regulators should also require G7/EU insurance and shipping companies to retain full documentation on trades, contracts and transaction prices. Sanctions should be enforced on a ‘strict liability’ basis, meaning commercial participants would be liable for violations. Additional financial institutions in Russia and third countries should be subject to sanctions.

‘Shadow reserves’ available to Russia are a problem

Russia’s export earnings from oil remain substantial, at about $50 billion in January-April 2023 (Hilgenstock et al, 2023). As the Bank of Russia has not been able to conduct reserve operations in US dollars or euros because of sanctions imposed in early 2022, Russian banks and corporates acquired $147 billion in new assets abroad in 2022 7 Bank of Russia, ‘Estimate of Key Aggregates of the Balance of Payments of the Russian Federation’, 11 July 2023, https://www.cbr.ru/eng/statistics/macro_itm/svs/bop-eval/.  (Figure 2), and little is known about their physical locations or currencies of transaction. These funds may not formally belong to the Russian government, but they could be used to increase monetary and fiscal policy space.

Figure 2: Russian balance of payments flows in 2022

2

 

Source: https://www.cbr.ru/vfs/eng/statistics/credit_statistics/bop/bal_of_paym…

Western sanctions on the Bank of Russia and the National Wealth Fund immobilised assets and banned transactions; they did not affect flows into reserve funds held by Russian entities that may not formally belong to the state but could be used to buttress its finances and enable the government to circumvent energy sanctions and capture oil market arbitrage. The ownership structures of these entities are opaque. Russian energy companies may employ third-country shipping companies, oil traders and refineries to generate revenues in excess of the price cap.

Western central banks and bank supervisors should identify the exact nature and physical location of these ‘shadow reserve’ funds and remove them from the reach of the Russian regime, perhaps by imposing sanctions on third-country financial institutions 8 Alan Rappeport and Emily Flitter, 'Treasury Warns Foreign Banks Against Helping Russia Evade Sanctions', The New York Times, 13 May 2022, https://www.nytimes.com/2022/05/13/us/politics/russia-sanctions-evasion…. .

Since February 2022, sanctions appear to have restricted access to a substantial amount of Russia’s reserves, but information on these assets is limited. Roughly $312 billion is estimated to have been immobilised (Figure 3), but this number is based on Bank of Russia data. Coalition authorities should improve the transparency and credibility of sanctions enforcement by identifying these assets, publicly disclosing the information and ensuring that they these funds are effectively kept out of reach. The EU has taken an important step by expanding reporting obligations for frozen assets in its tenth sanctions package 9 See European Commission, questions & answers of 25 February 2023, https://ec.europa.eu/commission/presscorner/detail/en/qanda_23_1187. . Based on these new requirements, it found that it had immobilised more than $215 billion in Bank of Russia assets 10 Stephanie Bodoni and Alberto Nardelli, ‘EU Blocks More Than €200 Billion in Russian Central Bank Assets’, Bloomberg, 25 May 2023, https://www.bloomberg.com/news/articles/2023-05-25/eu-has-blocked-200-b…. .

Figure 3: Estimated composition of official reserve assets

3

Source: http://cbr.ru/eng/hd_base/mrrf/mrrf_m/

Shifts in the currency composition of Russian exports and imports have materialised since February 2022. Between the start of the full-scale invasion and the end of 2022, the share of US dollar and euro transactions in Russian goods trade fell from around 80 percent to slightly less than 50 percent, and the shares of ruble- and yuan-denominated transactions rose (Bank of Russia, 2023. Additional sanctions may compel Russia and China to cooperate further, while strengthening the negotiating power of China (and other emerging economies) over Russia. New financial sanctions should increase pressure on Russia’s financial resources.

References

Bank of Russia (2023) ‘ОБЗОР РИСКОВ ФИНАНСОВЫХ РЫНКОВ No. 2’, February, available at https://www.cbr.ru/Collection/Collection/File/43828/ORFR_2023-02.pdf

Hilgenstock, B., E. Ribakova, N. Shapoval, T. Babina, O. Itskhoki and M. Mironov (2023) ‘Russian Oil Exports under International Sanctions’, Yermak-McFaul International Working Group on Russian Sanctions & KSE Institute, April, available at https://kse.ua/wp-content/uploads/2023/04/Russian_Oil_Exports_under_International_Sanctions_23Q1_UPDATE26042023.pdf

A version of this analysis was published by the Peterson Institute for International Economics.

[1] Bank of Russia, Estimate of Key Aggregates of the Balance of Payments of the Russian Federation, 11 July 2023, https://www.cbr.ru/eng/statistics/macro_itm/svs/bop-eval/.

[2] Ministry of Finance of the Russian Federation, 'Brief information on the execution of the federal budget' (in Russian), https://minfin.gov.ru/ru/statistics/fedbud/execute/.

[3] Reuters, ‘Novak says Russia to extend 500,000 bpd oil production cut until end of year’, 2 April 2023, https://www.reuters.com/business/energy/novak-says-russia-extend-500000-bpd-oil-production-cut-until-end-year-2023-04-02/.

[4] Rosemary Griffin and Elza Turner, 'Russia to use Dated Brent in tax calculations to protect state budget from Urals discount', S&P Global, 16 February 2023, https://www.spglobal.com/commodityinsights/en/market-insights/latest-news/oil/021623-russia-to-use-dated-brent-in-tax-calculations-to-protect-state-budget-from-urals-discount.

[5] Price information is not available for shipments that appear in trade data under transaction terms other than FOB (free on board), on which the price cap is applied.

[6] See European Commission oil price cap frequently asked questions, as of 30 June 2023, https://finance.ec.europa.eu/system/files/2023-06/guidance-russian-oil-price-cap_en.pdf.

[7] Bank of Russia, Estimate of Key Aggregates of the Balance of Payments of the Russian Federation, 11 July 2023, https://www.cbr.ru/eng/statistics/macro_itm/svs/bop-eval/.

[8] Alan Rappeport and Emily Flitter, 'Treasury Warns Foreign Banks Against Helping Russia Evade Sanctions', The New York Times, 13 May 2022, https://www.nytimes.com/2022/05/13/us/politics/russia-sanctions-evasion-treasury.html.

[9] See European Commission, questions & answers of 25 February 2023, https://ec.europa.eu/commission/presscorner/detail/en/qanda_23_1187.

[10] Stephanie Bodoni and Alberto Nardelli, ‘EU Blocks More Than €200 Billion in Russian Central Bank Assets’, Bloomberg, 25 May 2023, https://www.bloomberg.com/news/articles/2023-05-25/eu-has-blocked-200-billion-in-russian-central-bank-assets#xj4y7vzkg.

About the authors

  • Elina Ribakova

    Elina Ribakova is a Non-resident fellow at Bruegel. She is also a Non-resident senior fellow at the Peterson Institute for International Economics and a Director of the International Affairs Program and Vice President for foreign policy at the Kyiv School of Economics. Her research focuses on global markets, economic statecraft and economic sovereignty. She has been a senior adjunct fellow at the Center for a New American Security (2020–23) and a research fellow at the London School of Economics (2015–17).

    Ribakova has over 25 years of experience with financial markets and research. She has held several senior-level roles, including deputy chief economist at the Institute of International Finance in Washington, managing director and head of Europe, Middle East and Africa (EMEA) Research at Deutsche Bank in London, leadership positions at Amundi (Pioneer) Asset Management, and director and chief economist for Russia and the Commonwealth for Independent States (CIS) at Citigroup.

    Prior to that, Ribakova was an economist at the International Monetary Fund in Washington (1999–2008), working on financial stability, macroeconomic policy design for commodity-exporting countries and fiscal policy. Ribakova is a seasoned public speaker. She has participated in and led multiple panels with leading academics, policymakers, and C-level executives. She frequently collaborates with CNN, BBC, Bloomberg, CNBC, and NPR. She is often quoted by and contributes op-eds to several global media, including the New York Times, Wall Street Journal, Financial Times, Washington Post, The Guardian, Le Monde, El Pais, and several other media outlets.

    Ribakova holds a master of science degree in economics from the University of Warwick (1999), where she was awarded the Shiv Nath prize for outstanding academic performance; and a master of science degree in data science from the University of Virginia (2023).

  • Benjamin Hilgenstock

    Benjamin Hilgenstock is a Senior Economist at KSE Institute (Kyiv School of Economics) focusing on international sanctions on Russia and their impact on the Russian economy, including in the areas of energy, trade, and finance. He was previously an Economist at the Institute of International Finance working on macroeconomic analysis of key emerging markets, primarily in Central/Eastern Europe and including Russia, Ukraine. He was also an analyst with the International Monetary Fund’s Research Department. He holds an MA from Johannes Gutenberg-Universität Mainz, extensive experience abroad.

  • Guntram B. Wolff

    Guntram Wolff is a Senior fellow at Bruegel. He is also a Professor of Economics at the Université libre de Bruxelles (ULB). 

    From 2022-2024, he was the Director and CEO of the German Council on Foreign Relations (DGAP) and from 2013-22 the director of Bruegel. Over his career, he has contributed to research on European political economy, climate policy, geoeconomics, macroeconomics and foreign affairs. His work was published in academic journals such as Nature, Science, Research Policy, Energy Policy, Climate Policy, Journal of European Public Policy, Journal of Banking and Finance. His co-authored book “The macroeconomics of decarbonization” is published in Cambridge University Press.

    An experienced public adviser, he has been testifying twice a year since 2013 to the informal European finance ministers’ and central bank governors’ ECOFIN Council meeting on a large variety of topics. He also regularly testifies to the European Parliament, the Bundestag and speaks to corporate boards. In 2020, Business Insider ranked him one of the 28 most influential “power players” in Europe. From 2012-16, he was a member of the French prime minister’s Conseil d’Analyse Economique. In 2018, then IMF managing director Christine Lagarde appointed him to the external advisory group on surveillance to review the Fund’s priorities. In 2021, he was appointed member and co-director to the G20 High level independent panel on pandemic prevention, preparedness and response under the co-chairs Tharman Shanmugaratnam, Lawrence H. Summers and Ngozi Okonjo-Iweala. From 2013-22, he was an advisor to the Mastercard Centre for Inclusive Growth. He is a member of the Bulgarian Council of Economic Analysis, the European Council on Foreign Affairs and advisory board of Elcano. He is also a fellow at the Kiel Institute for the World Economy.

    Guntram joined Bruegel from the European Commission, where he worked on the macroeconomics of the euro area and the reform of euro area governance. Prior to joining the Commission, he worked in the research department at the Bundesbank, which he joined after completing his PhD in economics at the University of Bonn. He also worked as an external adviser to the International Monetary Fund. He is fluent in German, English, and French. His work is regularly published and cited in leading media. 

Related content