How will the G7 oil price cap work?

Since the war in Ukraine began, a central target for Western governments has been to try and limit Russia's revenues from its energy exports.

Sanctions have had scant success in that regard. Higher-than-expected oil export volumes and rising gas prices have driven Russian energy revenues up. According to a Russian economy ministry document seen by Reuters, Moscow expects energy export volumes to surge by a massive 38% this year.

That's a major reason why late last week the G7 nations — that's Canada, France, Germany, Italy, Japan, the UK and the US, as well as the European Union — agreed to a Russian oil price cap, aimed at curbing the Kremlin's revenues.

What is the plan?

G7 countries have already placed embargoes on their own purchases of Russian oil, due to come into effect in the coming months in the case of the European Union. As a result, this plan targets key logistics services they control — such as shipping and insurance — which other countries need to buy Russian oil.

The oil cap plans will be implemented at the same time as the EU embargo takes effect. There will be two price caps, one for crude and one for refined products. The crude cap will apply from December 5 with refined products to follow from February 5, 2023.

The G7 says the aim is to prevent insurers and shipping companies from moving Russian seaborne crude and petroleum products unless they have been purchased at or below an unspecified price threshold.

G7 countries control around 90% of the market for global shipping insurance. Russia requires a huge amount of vessels to export its oil and could struggle to find enough tankers to meet its needs if western insurers refused to cover its cargo.

The G7 says it wants the level of the price cap to be agreed upon in the near future by a "broad coalition of countries." That may mean big energy consumers not in the G7, such as India and China. However, those countries have not yet given any indication that they will participate.

"The price cap is specifically designed to reduce Russian revenues and Russia's ability to fund its war of aggression whilst limiting the impact of Russia's war on global energy prices," G7 finance ministers said in a joint statement.

They added that the level of the price cap would be based on "a range of technical inputs."

How will oil price cap work?

The US government was the big driver of the scheme. After the agreement was reached, US Treasury Secretary Janet Yellen said: "By committing to finalize and implement a price cap, the G7 will significantly reduce Russia's main source of funding for its illegal war, while maintaining supplies to global energy markets by keeping Russian oil flowing at lower prices."

That is the central goal of the plan — to keep Russian oil flowing but at reduced prices, so as not to further drive up price inflation.

The idea is that lower- and middle-income countries that have not imposed Russian oil import bans will still be able to purchase Russian oil. However, they will be barred from using various insurance and shipping services if they exceed the price cap. The G7 hopes the fact that they can still purchase the oil will make them more likely to participate.

What does Kremlin say?

Shortly before the price cap deal was announced, Kremlin spokesperson Dmitry Peskov said such a move would be an "absurd decision" and would lead to chaos in international oil markets.

Russia says that it will not sell any oil to countries that participate in the oil cap plan. "Companies that impose a price cap will not be among the recipients of Russian oil," Peskov said.

On the same day the deal was agreed, Russia announced it had cut gas supply to Europe through the Nord Stream 1 pipeline indefinitely. It blamed European sanctions for the move, saying it could not carry out urgent maintenance.

What are the risks with the plan?

There is the chance that non-G7 countries will simply not sign up. German Chancellor Olaf Scholz is among those who have been skeptical because of this. He said last month: "You cannot do it unilaterally but only in close co-operation with many others. Otherwise, it will just come to nothing."

Western governments hope that even if countries don't sign up, buyers of Russian oil will expect lower prices because of the scheme. This could indirectly impact the Kremlin's earning power as a result.

However, Russian oil is already a lot cheaper at present than many alternatives. That's a major reason why countries such as Indiahave suddenly become big purchasers of Russian oil in 2022. These countries could simply choose to continue purchasing Russian oil at the same or larger volumes.

Another possibility is that Russia will export less oil to try and drive up global prices, in much the same way it has done with its gas supply to Europe. However, that itself carries risks for Moscow. A substantial reduction of its production can harm its reservoirs and cut its capacity in the longer term.

Perhaps the key area of concern is enforcement. With the details of the plan not yet revealed, there is uncertainty over how exactly the G7 will enforce the price cap plan. Shipping insurers have already expressed concern that they could be responsible for checking what price the oil they are scheduled to carry traded at.

The ultimate viability of the plan will depend on the small details.

Edited by: Ashutosh Pandey