Russian President Vladimir Putin badly miscalculated when he sent unprepared troops into Ukraine in February, expecting to quickly conquer his neighbor to the west. More than four months later, Russia has suffered grievous losses and its forces are mired in brutal battles for small patches of terrain.
Putin’s financial planning has been a lot shrewder. After Russia launched the invasion on Feb. 24, the United States, Europe and other allied nations imposed some of the toughest sanctions ever levied against a large country. Those will force a sharp contraction in Russia’s economy this year.
But so far, sanctions haven’t dented the oil and natural gas revenue that is the Russian government’s largest source of hard currency and the main source of funding for Russia’s military. In fact, Russia’s revenue from oil and gas sales have soared by 80% since the war began. Russian production has dropped, but higher prices—caused by the war itself—mean Russia is earning more by selling less. The Center for Strategic and International Studies estimates that Russia is earning $1 billion a day from oil and gas sales, while spending a mere $325 million per day on the war and other military expenditures.
Putin has never explained his timing for the Feb. 24 invasion, but it’s possible he saw energy markets that were already tight amid the rebound from the COVID pandemic and knew they’d get tighter still once he invaded, strengthening rather than weakening his financial lifeline.
The conundrum for Ukraine’s allies is that they can’t stop buying Russian energy without pushing oil prices even higher and harming their own economies. That risks blowback from voters in democratic nations that might get sick of sanctions pushing their own energy prices sky high. The United States purchased relatively small amounts of Russian oil and oil products before the war, and has been able to ban those purchases with little effect on domestic prices. But European nations and other countries are far more dependent on Russian energy, giving Putin the upper hand when it comes to cutting off his top source of revenue.
So the United States and other Ukraine allies are considering novel ways to target Russia’s energy revenue without pushing prices even higher. The latest plan, championed by Treasury Secretary Janet Yellen, would be price caps on Russian oil—a maximum amount Ukraine’s allies would be willing to pay for oil from Russia. The cap would be drastically lower than the market price for oil and close to Russia’s cost of production, which is very low. The average cost of production in Russia is around $25 per barrel, and as low as $3 or $4 per barrel on the most efficient rigs. That means Russia can pump oil profitably at prices that would be ruinous for many other producers, including most in the United States.
In theory, there would be several types of leverage to force prices of exported Russian oil that low. Most of Russia’s oil exports move by ships that are owned and insured by Europe and its allies. There is no outright ban on those services at the moment, but a price-cap regime would impose a ban. Then, there would be exemptions granted only for servicers that enforce the price caps.
Buyers would pay a price higher than Russia’s cost to produce. But the amount above the cost of production would go into an escrow account outside Russia that could be used to rebuild Ukraine or serve some similar purpose. Russia would only get the cost of production or maybe a little bit more.
Russian crude already trades at a discount to world prices because of other sanctions that raise risks and costs to shippers and buyers. The Russian “Urals” price has been running $30 to $40 below global prices, such as Brent crude. The price cap would have to offer a larger discount than that to buyers. If the global price were $110, for instance, the Urals discount price might be $75. Ukraine’s allies could set the buyer’s price for Russian oil at $50 to entice buyers.
This would give big oil purchasers such as China and India—not overtly participating in sanctions on Russia—incentive to go along with the price-cap plan because they’d be getting an even bigger discount on oil. Russia would get $25, if that were the cost of production, and the other $25 would go into the escrow account. Every other buyer would pay whatever the global market price is.
Would it work? Um ... The United States and its allies imposed similar schemes on Iraq in the 1990s and on Iran since 2019 with mixed results. Edward Fishman, a senior fellow at the Atlantic Council, calls the plan a “tried and true method” that has generally allowed Iranian oil to reach markets while much of the revenue stays out of the country. “The Biden administration should advance a price cap without delay," he wrote on June 27. “In parallel, Congress should advance legislation that codifies a process for the cap to be set and enforced.” Congressional action isn’t necessary but it would show unified US support for the idea.
Not so fast, say some critics of the idea. Brian O’Toole, also at the Atlantic Council, argues that enforcement would be difficult and cheating probably rampant. “Failure to establish a clear enforcement mechanism would lead to confusion among brokers and cheating,” he wrote in a counterpoint essay. “Uneven enforcement would spook an oil market already struggling to adjust to existing sanctions and supply rerouting.” Europe has already shown divisions on whether and how to shunt Russian energy exports. The European Union, for instance, plans to cut its purchases of Russian oil by 90% by the end of the year. Critics say the deadline should come sooner and be closer to 100% than 90%. It also remains to be seen if the EU will meet its own target.
For President Biden, facing November midterm elections that could bounce his fellow Democrats from controlling one or both houses of Congress, a price-cap plan could carry near-term political risks. The disruption caused as the buyers' cartel implements its plan could temporarily push global oil prices even higher, and gasoline prices along with them. Global oil prices would come down if the price caps started to work. But they might not come down if Russia found ways to skirt the caps or shippers got tangled in even more red tape. U.S. gas prices near $5 per gallon are already an existential threat to Biden’s presidency.
There are a few other ideas for crimping Russia’s energy revenue without hurting global supplies, such as tariffs on Russian exports that could help offset higher consumer prices by funding rebates, or eliminating Russia’s ability to receive foreign currencies for energy sales, which helps it prop up the ruble. All are complicated, with uncertain outcomes that would take months to have an effect. Ukraine’s allies are obviously reluctant to join the fight against Russia on gory battlefields, but they may not win in the world more genteel financial markets, either.