Russia’s war machine revs up as the West’s plan to cap oil revenues sputters

The United States and its allies in the Group of 7 nations set two goals in 2022 when they enacted a novel plan to cap the price of Russian oil: restrict Moscow’s ability to profit from its energy exports while allowing its oil to continue flowing on international markets to prevent a global price shock.

A year and a half later, only the latter goal appears to have worked. Energy prices have been relatively stable across the world, including in the United States, which helped devise the plan. But Russia’s war effort in Ukraine is intensifying, making it increasingly clear that efforts by Western allies to squeeze Moscow’s oil revenues are faltering.

A variety of factors have allowed Russia to continue profiting from strong oil revenue, including lenient enforcement of the price cap. Russia’s development of an extensive “shadow” fleet of tankers has allowed it to largely circumvent that policy. That has allowed the Russian economy to be more resilient than expected, raising questions about the effectiveness of the coordinated sanctions campaign employed by the G7.

The Biden administration maintains that the strategy has been effective and that the price cap has imposed costs on Russia and forced it to redirect money that it would have used in Ukraine to finance an alternative oil ecosystem.

Treasury Secretary Janet Yellen said in an interview Sunday that the price of Russian oil was not the only measure of their profits, noting that Russia has had to invest significant resources in response to the cap.

“We’ve made it very expensive for Russia to ship this oil to China and India in terms of acquiring a shadow fleet and providing insurance,” Yellen said on her flight to Europe, where she is holding meetings in Germany and attending a gathering of finance ministers in Italy. “We still think it’s working.”

Keeping oil flowing has been an important priority for the Biden administration, which has been eager to avoid the kind of spike in gasoline prices that angered American drivers two years ago.

The cap forbids shipping companies and maritime insurers that are based in the G7 countries from handling Russian crude unless the shipment is below the $60-per-barrel limit set by the coalition in late 2022.

After it was enacted, the price of Russian oil fell below the $60 cap in early 2023, but by the end of last year was trading above $70 a barrel. As Russia built up its own supply of tankers and insurance alternatives, it redirected its exports to countries such as China, India and Turkey, which now make up the bulk of its sales. This year, Russia also adopted a so-called price floor that is designed to extract more tax revenue from its oil producers on the oil that they sell.

A report published this month by S&P Global said that 76.6 per cent of Russian oil exports, or 3 million barrels per day, were transported in April on tankers operated by companies that were not based in the G7 or backed by western insurance. The volume of Russian oil exports last month was the highest it has been since December 2022 and tax revenues from oil doubled from April 2023.

In April, the International Monetary Fund upgraded its 2024 outlook for Russia’s growth to 3.2 per cent, noting that most of its oil was being exported at prices above the $60 cap.

Russia’s private fleet of tankers and alternative insurance services have blunted the impact of the price cap, which does not apply to oil transactions using ships and insurance that fall outside the realm of the G7 countries. In response to an inquiry by the British government, a group of international insurers said last month that the price cap had become “increasingly unenforceable as more ships and associated services move into this parallel trade.”

Finance ministers from the G7 who are gathering in Italy later this week are expected to discuss the price cap as part of their continuing deliberations about how to tighten sanctions on Russia and provide more aid to Ukraine. As part of that effort, they have been warning international financial institutions and countries such as China that they could also face sanctions if they facilitate the sales or transfers of weapons components to Russia.

However, major changes to the policy appear to be unlikely for now.

Energy and sanctions experts said that the leaks in the price cap were the result of design flaws that were largely associated with American interests in keeping Russian oil flowing.

“It’s hard to argue that the price cap is working,” said Edward Fishman, a senior research scholar at Columbia University. “It’s undeniable that Russia has more quickly than US policymakers thought was possible shipped a lot of on non-Western ships and found alternatives to western insurance.”

Fishman, a former State Department official who oversaw Russia sanctions during the Obama administration after Russia annexed Crimea in 2014, noted that the price cap included a large loophole that allowed banks to continue facilitating Russian energy transactions. To truly make the cap effective, he said, the price cap would need to be applied to any shipper that transports oil above $60 and buyers would need to face the threat of secondary sanctions.

“Just as Russia can adapt to sanctions, so too can the US and the G7,” Fishman said. “Unfortunately, we have not adapted.”

Robin Brooks, a senior fellow in the Global Economy and Development program at the Brookings Institution, said that the United States should have pushed for a lower price level for the cap and that tougher enforcement would discourage evasion and likely cause the price of Russian oil to fall. Brooks suggested, however, that Europe was responsible for many of the problems with the cap and noted that Greek vessels had been supporting Russia’s oil trade.

“The main issue is that there have been a lot of oil tankers that have been sold to the shadow fleet,” Brooks said, arguing that shipowners should have to document who is buying their vessels. “The EU has not done what needs to be done.”

In the United States, the Treasury Department said this year that it would be enforcing the price cap more rigorously. It announced more sanctions on Russian ships and warned against evasion tactics, such as the use of inflating shipping costs to mask oil prices that are actually being sold above the cap.

“We certainly did take steps to enforce the price cap more strictly, both in terms of service providers in the G7 and making more rigorous requests for documentation,” Yellen said.

During a speech in India last month, Eric Van Nostrand, Treasury’s assistant secretary for economic policy, said that the new measures were succeeding in increasing the discount for Russian oil compared with global oil prices. He also pointed out that the policy fulfilled the goal of keeping oil prices under control.

“The price cap is helping maintain a steady supply of energy to global consumers and businesses,” Van Nostrand said.

But critics of the price cap contend that encouraging Russian oil sales to China and India is only enriching the coffers of the Kremlin and that the United States should be pursuing more rigorous oil sanctions similar to those that it has imposed on Iran.

“The only way to bring this war to any reasonable form of conclusion is to dry up the hard currency that’s keeping Russia's war machine  running,” said Marshall Billingslea, a former assistant secretary for terrorist financing in the Treasury Department during the Trump administration.

Describing the price cap as a bait and switch, Billingslea added: “It had the appearance of doing something without actually affecting the global energy market, which effectively means not degrading Russian revenues.”