While violations of the G7 price cap on Russian oil are becoming apparent, there is still room for Western countries to enhance regulations and decrease the cash flows directed towards Russia.
The extensive and unprecedented sanctions imposed on Russia to limit its oil export income, including the European Union embargo and the G7 oil price cap in December 2022, have effectively reduced Russia’s export earnings and budget revenues. As a result of these sanctions, Russia’s current account surplus dropped from $124 billion in January-to-May 2022 to $23 billion in the same period in 2023. The Russian finance ministry also reported a significant year-on-year decrease of approximately 50% in government oil revenues and a widening budget deficit during January-to-May 2023.
The impact of each measure initiated by the West to punish Russia for its invasion of Ukraine, however, is less clear. Evidence suggests that the oil embargo has had a more pronounced effect compared to the price cap, mainly because the cap has been set too high and lacks effective enforcement. Due to the EU embargo, European buyers of Russian oil have essentially vanished, leading Russia to offer price discounts to maintain export volumes from the Baltic and Black Sea ports that traditionally supplied Europe.
This decline in prices has resulted in reduced tax revenues for Russia as taxes are calculated based on market prices. In an attempt to stabilize oil prices, Russia implemented a production cut of 500,000 barrels per day on April 2, 2023. Additionally, the finance ministry adjusted the oil price benchmark used for calculating oil taxes to account for the shift in exports away from Europe.
On the other hand, the price cap was introduced as an innovative measure to decrease Russia’s revenues while ensuring the continuous flow of its oil to the global market. The cap allows G7/EU providers of shipping services, such as shipowners and insurance companies, to participate in trade with Russian oil as long as the oil is sold below a specified price threshold, which was set at $60 per barrel for crude oil. However, doubts were raised about the effectiveness of the price cap regime, pointing to potential circumvention.
Moreover, for a significant segment of the Russian export market, particularly shipments of Urals-grade crude from Baltic and Black Sea ports, the EU embargo has driven prices down to a level where the $60 per barrel cap has become irrelevant. In the case of exports from Pacific Ocean ports, where the EU embargo had no impact since they never supplied Europe, prices have remained above the $60 per barrel threshold. Nevertheless, G7/EU companies remain significantly involved, indicating inadequate enforcement of the cap.
While the introduction of the price cap ensured that Russian oil remained available in the market and prevented a rise in global prices due to reduced supply, there are evident flaws in its implementation. Therefore, it is suggested that financial-sector sanctions should be implemented to strengthen the enforcement of the oil price cap and restrict Russia’s ability to accumulate assets abroad.
Price cap violations are occurring
Instances of price cap violations have been observed, indicating potential widespread non-compliance with the regulations. At the Pacific port of Kozmino in Russia, evidence suggests that in the first four months of 2023, approximately half of the oil exports were transported on vessels owned or insured by G7/EU entities (see Figure 1, top bar). Furthermore, out of the exports for which price information is available, around 96 percent were priced above the $60/barrel threshold set by the cap, with an average price exceeding $70/barrel (see Figure 1, bottom bar).
This implies that at least 24 million barrels with prices above $60/barrel were transported using vessels subject to the cap’s regulations. These violations likely stem from the falsification of records by oil buyers, who are required to provide evidence of price-cap compliance to G7/EU shipping and insurance companies.
Figure 1: Potential price cap violations in January-April 2023
To tackle these issues, it is necessary to introduce measures that enhance transparency and accountability. Financial institutions should be mandated to report to relevant implementing agencies, such as the US Office of Foreign Assets Control, the UK Office of Financial Sanctions Implementation, and similar agencies in EU countries, about any transactions they facilitate under the price cap. They should also be required to notify authorities of any suspicious activities they come across.
Regulators should mandate G7/EU insurance and shipping companies to maintain comprehensive documentation of trades, contracts, and transaction prices. Sanctions should be enforced on a “strict liability” basis, holding commercial participants accountable for any violations. Furthermore, it is essential to extend sanctions to additional financial institutions in Russia and other countries to strengthen the effectiveness of these measures.
Price cap violations: ‘Shadow reserves’ available to Russia are a problem
Despite the impact of sanctions, Russia continues to generate significant export earnings from oil, amounting to approximately $50 billion between January and April 2023. Due to the restrictions imposed in early 2022, the Bank of Russia has been unable to carry out reserve operations in US dollars or euros. As a result, Russian banks and corporations have acquired $147 billion in new assets abroad in 2022 (Figure 2), and there is limited information available regarding the location and currency of these transactions. While these funds may not officially belong to the Russian government, they have the potential to expand Russia’s monetary and fiscal policy capabilities.
The Western sanctions imposed on the Bank of Russia and the National Wealth Fund have effectively immobilized assets and prohibited transactions. However, these measures have not impacted the flows into reserve funds held by Russian entities that may not officially belong to the state but can be utilized to support its finances and enable the government to navigate energy sanctions and exploit opportunities in the oil market. The ownership structures of these entities are opaque, and Russian energy companies may engage third-country shipping companies, oil traders, and refineries to generate revenues that surpass the price cap.
To address this issue, Western central banks and bank supervisors should identify and safeguard the “shadow reserve” funds by implementing sanctions on third-country financial institutions. While the sanctions imposed since February 2022 have limited access to a significant portion of Russia’s reserves, information about these assets remains limited. It is estimated that approximately $312 billion has been immobilized based on Bank of Russia data (Figure 3).
Coalition authorities should enhance transparency and credibility in enforcing sanctions by publicly disclosing information about these assets and ensuring effective measures to keep them out of reach. The EU has taken a step in the right direction by expanding reporting obligations for frozen assets in its recent sanctions package, revealing that over $215 billion in Bank of Russia assets have been immobilized.
Since February 2022, there have been noticeable shifts in the currency composition of Russian exports and imports. The share of US dollar and euro transactions in Russian goods trade has declined from around 80 percent to slightly less than 50 percent, while the shares of ruble- and yuan-denominated transactions have increased (Bank of Russia, 2023). Further financial sanctions may encourage greater cooperation between Russia and China while strengthening China’s (and other emerging economies’) bargaining power over Russia. The implementation of new financial sanctions should intensify pressure on Russia’s financial resources.
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