Tanker Sun Arrow loads its cargo of liquefied natural gas from the Sakhalin-2 project at Prigorodnoye port in Russia on October 29, 2021. , Photo Credit: AP
the story So Far: According to reports this week, Japan is buying oil from Russia at a price above the $60 per barrel price cap imposed by the West. This has led to speculation that Japan could violate an agreement reached last year to limit the price of Russian oil.
Why is there a price cap on Russian oil?
The G-7 countries, the European Union and Australia imposed a price cap of $60 a barrel on oil bought from Russia starting in December. The move was part of wider economic sanctions imposed by the West to punish Russia following its invasion of Ukraine. The West wants Russia to make as much money as it can by selling its oil, but without seriously affecting the global oil supply. Since Russia contributes about 10% of global oil supply, any significant reduction in Russian oil supply could push up oil prices. It is estimated that it costs Russia about $20-$45 to produce a barrel of oil. Therefore, the West believes that, at $60 a barrel, Russia will still keep its oil production stable.
Why is Japan breaking ranks with the West?
In the first two months of the year, Japan bought about 750,000 barrels of oil from Russia at a price of about $70 a barrel. Japan’s oil imports contribute little to Russia’s overall oil output, which stood at about 10.7 million barrels per day last year, and thus do not significantly undercut the West’s efforts to restrict the Kremlin’s oil revenues. However, Japan’s decision to buy oil above the price cap once again brings to the fore the strong incentive countries are facing to reduce the West’s $60 per barrel price cap. It should also be noted that, even when the price cap was first implemented last December, Japan made an agreement to buy Russian oil from Sakhalin-2 in Russia’s Far East to protect its energy security. Exception won.
Will other countries follow Japan?
Japan is not the only country weakening the West’s $60 price cap on Russian oil. For example, countries like India are believed to be paying more than $60 per barrel to buy oil from Russia. As oil prices rise, the likelihood of a rift developing among the signatories to the oil price cap regime also increases. When buyers are willing to pay more than $60 a barrel to secure supply, oil traders will be happy to eliminate sanctions and supply from Russia. Critics of the oil price cap warned that the price cap could be difficult to enforce because it works against strong economic incentives and because it could be impossible to keep track of all shipments in such a large, opaque oil market.
Will rising oil prices threaten the West’s price cap?
On Monday, OPEC and Russia decided to cut their oil production by 3.66 million barrels per day, sending oil prices up 6%. Russian Ural, the main crude sold by Russia, also climbed above $60 a barrel, thus surpassing the West’s price ceiling. When the West first imposed its price cap, it had no effect on Russia’s oil production or revenue as Russian Urals was trading below $60 a barrel. But now that Ural is trading above $60 a barrel, things may be different. The West will hope that its cap will keep Russia’s oil revenues in check despite rising oil prices. Russia, which has seen its oil revenues fall due to lower oil prices and the West’s embargo on Russian oil, would be hoping to bypass the Western sanctions by selling oil above the price ceiling. This will test the West’s ability to effectively enforce the price cap.