The West wants to go further on Russian oil. Inflation makes it hard

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Russia makes so much money energy exports as they were before its invasion in late February. Meanwhile, inflation is rising globally, adding to political pressure on leaders such as US President Joe Biden, UK Prime Minister Boris Johnson and French President Emmanuel Macron.

As leaders of major economies gather in Germany on Sunday for a G7 meeting, they will try to reach a consensus on what to do next. Unfortunately, on oil, few good options are available.
Several measures are being discussed, ranging from price caps on Russian energy imports, centralization of purchases by the European Union, insurance bans on ships and the targeting of countries that continue to buy from Moscow. They all have downsides, and some could push prices even higher, risking supporting the West’s drive to punish Putin.

“There are tools available to go further after Russia, but they come at significant costs directly to consumers in the United States and Europe,” said Robert Johnston, associate principal fellow at the Columbia Center for Global Energy Policy.

Imposing sanctions on countries that continue to hoard large volumes of Russian crude oil, including China and India, would wreak havoc on global markets that are already under severe pressure. And while Treasury Secretary Janet Yellen recently said the United States wants to discuss a Russian oil price cap, such a complex mechanism may not be the solution the West is looking for.

“It distorts the market at a time when the market certainly needs to work well, and there are too many workarounds,” Johnston said.

Russia continues to cash in

The United States, United Kingdom and Canada have announced bans on imports of Russian oil. More importantly, Europe will follow suit for Russian oil it imports by sea, a huge step given its long-standing reliance on energy supplies from Russia. The bloc says the ban will apply to 90% of Russian oil imports by the end of the year.

European customers have already retreated. Russian oil exports to Europe fell to 3.3 million barrels per day in May, down 170,000 barrels per day from the previous month, according to the International Energy Agency.

But a rise in exports to Asia helped offset much of those losses. China – taking advantage of huge price discounts – saw its imports hit 2 million barrels a day for the first time. Imports from India also increased, hovering around 900,000 barrels per day in May.

“We are actively engaged in redirecting our trade flows and foreign economic contacts to reliable international partners, primarily BRICS countries,” Putin said on Wednesday, referring to the bloc of developing economies that also includes Brazil, the United States. India, China and South Africa.

Russia sells barrels of its Urals crude for around $35 cheaper than Brent global benchmark, which last traded at nearly $113 a barrel. But because prices have risen sharply this year due to the aftershocks of the pandemic and the war, they still made tons of money.

Revenue from Russian oil exports rose by $1.7 billion in May to around $20 billion, according to the IEA. That’s well above the 2021 average of around $15 billion.

“The Russians always get a pretty good price,” Johnston said.

Senior US administration officials have said managing this momentum will be a priority at the G7 meeting. Speaking to reporters on Wednesday, they outlined their goal: to maximize the pain of Putin’s regime, while minimizing the ripple effects for the rest of the world.

“We expect them to talk, how can we take action that further reduces Russia’s energy revenue?” said an official. “And how can we do that in a way that stabilizes global energy markets and alleviates the disruptions and pressures we’ve seen?”

What tools are left?

To make it harder for China, India and other countries to continue importing Russian oil, Europe intends to gradually introduce a ban on insuring ships that carry Russian crude. Should the UK join, as expected, it would be a blow to the global fuel transport system, given the market dominance of Lloyd’s of London insurance. The Biden administration fears the measure could send prices skyrocketing.

Yet Mai Rosner, an activist with the nonprofit Global Witness, said Western countries must go further to quickly remove Russian oil from the market, as any delay gives market players time to find solutions. creative ways to bend the rules.

“These piecemeal sanctions leave loopholes for the fossil fuel industry to exploit,” Rosner said.

The United States, with the support of Europe, could adopt so-called secondary sanctions targeting third countries that have continued to do business with Russia, as they have with Iran and Venezuela. The US government has not ruled out this possibility.

But such a move would generate so much turmoil that experts consider it unlikely, especially as the growing number of political leaders in the West face the fastest price increases in decades.

If China and India were to find replacement barrels, the price of oil could easily top $200 a barrel, according to Darwei Kung, portfolio manager for commodities at DWS.

“It’s hard to see a world where the United States puts [such] sanctions on Iran, Venezuela and Russia at the same time,” Johnston said. “Oil has to come from somewhere.”

A customer fills up his van at a Shell service station in London on Monday June 13, 2022.

Biden has increasingly stressed that tackling 40-year high inflation is a top priority ahead of the midterm elections in November.

Macron, who recently lost the legislative support he enjoyed for his first term, has pledged to tackle a growing cost of living crisis, while Britain’s Johnson – who suffered two huge by-election defeats last week – appointed a “Cost of Living Business Czar” to work with the private sector on possible solutions.

Capping the price of Russian crude is a solution that has been floated. This would mean that Russia is not completely cut off from the market, but would be forced to sell oil at such a low price that it could not profit from it.

A price cap “would depress the price of Russian oil and depress Putin’s income while allowing more oil to reach the world market,” Treasury Secretary Yellen said last week.

Countries like Germany have said they are ready to look into this option. But it’s unclear how the West could enforce such a policy, or even how it would entice countries like China and India to sign on.

“I think the more complicated the system, the more likely there are to be challenges,” Kung said. “[The] market system works because, in a way, it is very simple. It’s very effective.”

Western governments could also try to ease constraints by increasing supply or letting prices rise so high that demand begins to fall. Neither is a simple calculation.

Some countries in the Organization of the Petroleum Exporting Countries, or OPEC, have the capacity to increase production, and Biden plans to visit Saudi Arabia to cement ties next month. But much of the cartel’s capacity is already exhausted.

In the event of a global recession, partly because fuel prices are so high, demand for energy would drop and prices could start to fall on their own. But it would be deeply painful, involving job losses and economic damage, especially for low-income families.

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