The West wants to go further with Russian oil. Inflation makes it difficult

Russia is making so much money from energy exports as it was before it invaded in late February. Meanwhile, inflation is rising globally, adding to political pressure on leaders such as US President Joe Biden, British Prime Minister Boris Johnson and French President Emmanuel Macron.

As the leaders of the major economies meet in Germany on Sunday for a G7 meeting, they will try to reach a consensus on what to do next. Unfortunately, in oil, there are few good options available.
Various measures are being discussed, from maximum prices on Russian energy imports, centralized purchasing by the European Union, insurance bans on ships and targeting countries that continue to buy from Moscow. They all have drawbacks, and some could drive prices up even higher, risking popular support for the West’s determination to punish Putin.

“There are tools available to go further after Russia, but they come at significant costs directly to consumers in the US and Europe,” said Robert Johnston, a senior research associate at Columbia’s Center for Global Energy Policy.

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

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

Russia is still charging

The United States, the United Kingdom and Canada have announced bans on imports of Russian oil. More significantly, Europe will do the same for Russian oil it imports by sea, a big step given its long-standing dependence on Russian energy supplies. The bloc says the ban will apply to 90% of Russian oil imports by the end of the year.

European customers have already withdrawn.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

But a surge in exports to Asia helped offset a large part of those losses. China, taking advantage of huge price discounts, saw its imports reach 2 million barrels per day for the first time. Imports from India have also soared, hovering around 900,000 barrels per day in May.

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

Russia is selling barrels of its Urals crude for about $35 cheaper than Brent global benchmark, which was last trading near $113 a barrel. But because prices are up sharply this year due to aftershocks from the pandemic and war, they’ve still been making tons of money.

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

“The Russians are still getting a pretty good price,” Johnston said.

Senior US administration officials said dealing with this dynamic will be a priority at the G7 meeting. Speaking to reporters on Wednesday, they outlined their goal: to maximize pain on the Putin regime while minimizing spillover effects for the rest of the world.

“We hope they will talk, how can we take measures that will further reduce Russia’s energy income?” an official said. “And how do we do it in a way that stabilizes global energy markets and lessens the disruptions and pressures that 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 ban insuring ships carrying Russian crude. If the UK does join, as expected, that would deal a severe blow to the global fuel transportation system, given Lloyd’s of London’s dominance of the insurance market. The Biden administration is nervous that the move will send prices soaring.

Still, Mai Rosner, an activist with Global Witness, a nonprofit organization, said Western countries must go further to get Russian oil off the market quickly, as any delay buys market participants time to find creative ways to circumvent the rules.

“These piecemeal sanctions are leaving loopholes for the fossil fuel industry to take advantage of,” Rosner said.

The United States, backed by Europe, could enact so-called secondary sanctions targeting third countries that have continued to do business with Russia, as it has with Iran and Venezuela. The US government has not ruled it out.

But such a move would create so much confusion that experts see it as unlikely, especially given the mounting political backlash facing leaders in the West over the fastest price rises in decades.

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

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

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

Biden has increasingly emphasized that fighting the highest inflation in 40 years is a top priority ahead of the midterm elections in November.

Macron, who recently lost the legislative backing he enjoyed during his first term, has vowed to tackle the growing cost of living crisis, while the UK’s Johnson, who suffered two big defeats in by-elections last week, appointed to a “Cost of Living Business Tsar” to work with the private sector on possible solutions.

Capping the price of Russian crude is one solution that has been kicking around. That would mean that Russia would not be completely cut off from the market, but instead would be forced to sell oil at such a low price that it would not be able to make a profit.

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

Countries like Germany have said they are open to considering the option. But it is not clear how the West could enforce such a policy, or how it would get countries like China and India to sign onto it.

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

Western governments could also try to ease restrictions by increasing supply or allowing prices to rise so high that demand begins to fall. Nor is it 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 shore up relations next month. But much of the cartel’s capacity is already maxed out.

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

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