WASHINGTON, DC – With fewer headlines about the war in Ukraine, public support for taking costly steps to sanction Russia is waning. In one crucial area, however, the G7 and the European Union have figured out how to impose significant harm on Russia in a way that also supports the global economy.
As its full-scale invasion of Ukraine enters its 14th month, Russia is counting on the West to lose interest. With fewer headlines about the war, public support for taking costly steps to sanction Russia is waning. In one crucial area, however, the G7 and the European Union have figured out how to impose significant harm on Russia in a way that also supports the global economy. It is time to tighten this pressure on the Kremlin.
Before February 24, 2022, almost half of the Kremlin’s revenue came from taxes on oil and gas exports, and it raked in more money whenever global commodity prices increased. As the tanks rolled, oil prices surged, and cashflow for the Kremlin followed suit. Through much of 2022, Russia reaped an enormous windfall from the war premium on oil, effectively financing its invasion. Meanwhile, high oil prices posed a major threat to a global economy gingerly trying to emerge from the pandemic.
The problem was that Russia exported so much oil that conventional tools for imposing sanctions on an oil exporter wouldn’t work. Implementing a broad-scale embargo on Russian oil could have caused global oil prices to spike, hurting countries far and wide. And, to the extent that Russia would have been able to sell around the embargo, every barrel it exported would become more valuable, perhaps pushing revenue even higher than before.
The price cap on Russian oil – implemented by the G7, the European Union, and Australia for crude oil starting December 5, 2022, and for petroleum products starting February 5, 2023 – was designed to thread the needle, keeping Russian oil on the market while reducing the profits flowing into the Kremlin’s coffers. If Russia kept exporting at its historic pace, global oil markets were more likely to remain stable. But with reduced oil revenues, the Kremlin would find it harder to buy tanks or ammunition for its brutal war or increase pension payments to placate the population or keep the ruble stable. The EU, which historically imported about half of Russia’s crude oil and over 90% of its petroleum products, banned imports from Russia when the price caps entered effect, making it even harder for the Kremlin to find export markets.
Specifically, since December 5, companies in the G7, the EU, and Australia cannot provide services for any oil shipment from Russia unless the price paid is below the cap. If the oil shipment travels on a Greek tanker or is insured by a British firm, that service provider must be able to produce an attestation that the price paid is below the cap (currently set at $60 per barrel for crude oil). Service providers from the coalition of countries imposing the cap have long been important for Russian oil exports. For example, before the cap was imposed, over 90% of Russian oil exports were insured by a company located in the EU, the United Kingdom, or the United States.
Much evidence suggests that the price cap is working as designed. Russian oil continues to flow, and oil markets appear unconcerned about a loss of Russian supply. When Russian officials announced on February 10 that they would remove about 5% of Russia’s oil from the market in March, the market was unimpressed. Prices rose by less than 3%. Overall, since the price cap was imposed, Russian crude oil shipments have risen slightly, and the price has been largely stable.
Moreover, the price cap appears to be depleting the Kremlin’s coffers. The price for Russia’s Urals grade crude – which historically went to destinations in Europe – fell sharply relative to global prices just as the price cap and EU embargo came into effect.
The price cap does not apply to all Russian oil exports. If the oil is carried on a Russian-owned tanker, insured by a Chinese company, and does not involve services from any of the coalition countries, the price cap is not binding. Much of the oil that comes out of Russia’s Eastern ports headed for China does not involve G7 and EU services. Even for these trades, though, the price Russia received fell relative to global benchmark prices, suggesting that the cap provides leverage to buyers even if it doesn’t apply to a particular trade.
Global oil markets are opaque, and some suggest that reported prices do not reflect what Russia is receiving. The ultimate proof that the cap is working as intended is that Kremlin statements and actions suggest that revenues are down. For example, in early February, Russia’s finance ministry announced a threefold increase in foreign-currency sales to make up for lower oil revenues. And, according to data from the ministry, government oil revenues in January 2023 were nearly 60% lower than in March 2022, just after the invasion.
We have suggested formalizing the process for adjusting the caps with a dedicated policy committee that meets at regular intervals to assess the effectiveness of the cap and announce further tightening, as appropriate. The US Treasury’s sanctions enforcement agency, the Office of Foreign Assets Control, and its counterparts in other G7 countries, the EU, and Australia, also must ensure that oil monies aren’t flowing back to Russia through other channels.
Meanwhile, excess funds earned from Russian oil exports last year are still on deposit in foreign-currency accounts, including at Gazprombank. Now would be a good time to freeze those accumulated balances, in effect imposing an ex post price cap. This would not discourage continued oil exports, because new revenues would not be subject to the freeze, so long as the sales take place at or below the price cap.
The US and its allies achieved a profound feat of economic statecraft by designing and implementing a novel mechanism to deprive Russia of revenues it was likely counting on to fund its brutal war. Now it is time to increase the pressure on Russian public finances.
Simon Johnson, a former chief economist at the International Monetary Fund, is a professor at MIT's Sloan School of Management, a co-chair of the COVID-19 Policy Alliance, and a co-chair of the CFA Institute Systemic Risk Council. He is the co-author (with Daron Acemoglu) of the forthcoming Power and Progress: Our Thousand-Year Struggle Over Technology and Prosperity (PublicAffairs, May 2023).
Lukasz Rachel is an assistant professor at University College London.
Catherine Wolfram is a visiting professor at Harvard Kennedy School.