Understanding the Russian oil ‘Price Cap’

The Russian-Ukraine war and the subsequent sanctions have given rise to a new term ‘Price cap’, that is often bandied around during discussions. This is an attempt to demystify the term, explain what it is and the connection between ‘price cap’ and insurance.

Russia is the third largest exporter of crude oil in the world. The Russian economy derives a substantial portion of its revenues from crude oil exports. Following the Russian invasion of Ukraine, the US and EU stepped in to impose additional economic sanctions against Russia. In doing so, they were mindful of the facts that 1) Not all countries around the world approved of the sanctions 2) The heavy reliance on Russian crude by countries, including those in the EU 3) Need to ensure that global oil prices do not shoot up following any total sanctions against Russia. 4) The need to ensure that Russia’s earnings from oil are reduced so that there were less funds available to them for financing the war against Ukraine.

So, while the European Union agreed to a total ban on Russian crude oil transported by sea, it was mindful of the fact that some members such as Slovakia, Hungary, Poland & Czechia were highly dependent on Russian crude oil and hence exempted oil, delivered through the Druzhba pipeline from the sanctions. What about the rest of the world, one may ask? This is where the ‘Price Cap scheme’ comes into play.

The European Union (EU), the G7 countries plus Australia, jointly called the ‘Price Cap Coalition’, came out with the Price-Cap legislation and guidance with effect from 5th December 2022. The three stated objectives were — to maintain the supply of Russian oil to world markets, to prevent an upward surge in global oil prices but at the same time reducing Russia’s earnings from oil exports. After much deliberation, the initial price-cap was set at US $ 60 per barrel, which should be the delivered cost at the named destination. It was agreed that this price-cap would be reviewed periodically. Any country importing Russian crude oil through sea MUST ENSURE that the total price paid at destination is below the price-cap of US$ 60. One may wonder, how can the ‘Price-Cap Coalition’ control the price at which a third country buys crude oil from Russia. There lies the catch!

Major cost components in importing crude oil, apart from the basic oil price is the cost of hiring vessels, financing cost and insurance of the cargo & vessels (including P & I). Firms providing these stated services from the EU, G7 or Australia can render these services ONLY if there is documentation to prove that the transaction has been done at a price below the ‘ Price-cap’. In other words, the services of financing, insurance, transportation and intermediation will be available only if the deals for Russian crude oil are executed at or below the price-cap. As most of the large banks, insurers, reinsurers, P & I Clubs, tanker-owners and charterers are American or European, implementation of the price-cap becomes effective. P & I Clubs, shipowners and charterers will now be required to check the price of Russian oil cargoes on board ships they own, charter or insure. These checks will take the form of contractual attestations provided by their contractual counter parties stating that for the relevant period the price will not exceed the Price Cap.

Theoretically, a country that is not part of the Price-Cap coalition, such as China or India can buy Russian crude at prices above the Price-cap, but in practice it is just not possible, since they do not have that many tankers of their own, that can be insured/reinsured/ protected by their own P & I Clubs and even the crude oil cargo insurance would need reinsurance support. Best solution — War should end, Peace should reign & Free Trade can happen. let us put on our ‘Thinking-caps’ on how this can be achieved soon.