Oil Price Threshold: Action and Reaction

The introduction of a price threshold for Russian oil has been discussed for several months. The idea was announced back in early September in a statement by the finance ministers of the G7 countries. Its essence was to prohibit the transportation of Russian oil and oil products by sea in the event that the contract price exceeds a predetermined price level. Along with transportation, there are related services—insurance, financing, brokerage services, etc. A “price threshold coalition” was formed, which, along with the members of the G7, included Australia and the EU member states.

Washington, London and Brussels have already developed legal mechanisms for the new restrictions. On December 5, oil price restrictions should come into force, and in February, they are expected to be applied to oil products. The initiators of the sanctions expect attempts to circumvent new sanctions and are trying to cement possible loopholes in advance. What kind of workarounds are expected among the Western countries, and what are the chances they’ll be able to impose a price cap on other countries?

In the bottom line, the participants of the "threshold coalition" do not have to seek the entry of more countries into their ranks. It is enough to threaten with secondary sanctions or coercive measures in case of revealed violations, or simply block insurance services or financial transactions passing through Western insurance companies and banks in violation of the prescribed norms.

By building up pressure on the Russian oil sector, the US and other initiators of sanctions will use their rich experience of restrictions against Iran. At one time, Washington managed to "globalise" its ban on the import of Iranian oil and services related to such imports. Iran continues to survive under the sanctions, although it has suffered losses. There is no doubt that Russia will also retain efficient ways to supply its oil to foreign markets. However, as in the case of Iran, the sanctions will increase the cost of Russian oil exports.

The introduction of a price threshold for Russian oil has been discussed for several months. The idea was announced back in early September in a statement by the finance ministers of the G7 countries. Its essence was to prohibit the transportation of Russian oil and oil products by sea in the event that the contract price exceeds a predetermined price level. Along with transportation, there are related services—insurance, financing, brokerage services, etc. A “price threshold coalition” was formed, which, along with the members of the G7, included Australia and the EU member states.

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Washington, London and Brussels have already developed legal mechanisms for the new restrictions. On December 5, oil price restrictions should come into force, and in February, they are expected to be applied to oil products. The initiators of the sanctions expect attempts to circumvent new sanctions and are trying to cement possible loopholes in advance. What kind of workarounds are expected among the Western countries, and what are the chances they’ll be able to impose a price cap on other countries?

The price threshold for oil is a relatively new and non-standard variety of economic sanctions. The most common and universal instrument of modern sanctions are restrictions on exports and imports, as well as blocking sanctions. The latter entails a ban on any financial transactions with individuals or organisations included in the lists of blocked persons. The Russian oil industry has already faced a wide range of export and import restrictions. The US, EU, UK and a number of other countries have introduced or are gradually introducing bans on the supply of oil and petroleum products from Russia. They have largely blocked the supply of equipment for the domestic energy sector. Even before the start of the special military operation, a number of large Russian oil companies were subject to sectoral restrictions in the form of a ban on long-term lending and a ban on deliveries in the interests of individual projects. It turned out to be more difficult to impose blocking sanctions. A number of top managers and major shareholders of Russian oil assets were included in the lists of blocked persons. However, the West did not dare to block the companies themselves; Russia is too large a supplier of oil to the world market. Blocking the financial transactions of Russian suppliers would lead to a panic in the market and an astronomical rise in prices. Collateral damage is the only thing stopping the West from blocking Russian oil companies.

A price cap was proposed as a softer measure. The US and its partners are betting on the fact that Western companies control significant volumes of transportation and insurance. They are also betting on the dominance of the US dollar in global financial markets. Russian producers are being driven towards a situation in which they will either have to sell oil within the price threshold, or it will simply not be delivered. In addition, such cargo will not be insured, and financial transactions involving banks from the “threshold coalition” will become impossible. Moscow has already threatened to stop supplies to those countries that go ahead and implement the decisions of the "coalition". But the “coalition” itself has largely given up on Russian oil anyway. India, China and other friendly countries may not join, but Western carriers will not deliver Russian oil there.

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The initiators of the sanctions expect a number of schemes to be attempted to circumvent the new measures. The first is the formal observance of the price threshold, but manipulations with the price of transportation or other related services. The US Treasury is warning carriers, insurers, bankers and other market participants in advance that commercially unreasonable rates will be considered a sign that the price cap regime is being violated. The concept of commercial justification is not disclosed, but the signal itself is fixed. Another possible circumvention option is the distortion of documentation, which can take place both on the supplier's side and be the result of collusion between the supplier and the carrier. In this case, carriers are recommended to keep all the documentation of the transaction for five years, and insurance and other service providers must have a clause in contracts that the oil being transported is below the price threshold. The presence of such archives does not insure against violation in itself. But it allows the regulator, in case of suspicion, to quickly check the history of transactions. Companies can get off relatively lightly for unintentional violations, but deliberate circumvention is fraught with criminal prosecution. Another way around is to mix Russian oil with an oil of a different origin. So far, clear criteria for such proportions have not been defined, although the US Treasury calls for caution in such transactions. In determining these proportions, the EU may take into account the clarifications of the European Commission on mixtures subject to import restrictions.

The experience of US law enforcement practice shows that there will be violations of the sanctions regime, and US regulators have developed mechanisms for detecting them. The EU and the UK have less experience, which does not exclude the active prosecution of violators. However, the indicated methods of circumvention still seem to be “mouse fuss”, which will not systematically solve the problem for Russia. In Moscow, much more ambitious steps can be developed.

The most obvious measure is to build up Russia's own tanker fleet. Reports of such steps have appeared in the foreign media, although reliable estimates are difficult. In the hands of the US, the EU and other initiators, there is a means to counteract. They can simply add Russian oil tankers to the lists of blocked ships. Then their service in foreign ports will be significantly hampered. Secondary American sanctions and fines are feared even in friendly countries. The experience of secondary US sanctions being used against the Chinese COSCO Shipping Tanker and some other companies for the alleged transportation of Iranian oil in 2019 can serve as a warning. The European Union has also provided for a mechanism to punish ships carrying Russian oil above the price ceiling. Violating ships will be denied financial, insurance and other services in EU jurisdiction. The wording of paragraph 7 of Art. 3n of EU Council Regulation No 833/2014 suggests that we are talking about any ship, regardless of the country of origin.

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Similar problems may also arise when a Russian insurance company is set up to serve bulk oil shipments, or if one or another company from friendly countries is involved. Here, the United States and its allies also have the instrument of secondary sanctions in their hands. The same goes for financial transactions. Operations in the currencies of the initiating countries will be blocked. Here again the question of settlements in national currencies comes to the fore. The big question is, whether the banks in friendly countries run the risk of the same secondary sanctions in case of transactions above the price threshold. The legal mechanisms for such sanctions specifically for the price threshold have not yet been spelled out. However, they may appear at any moment, or the initiating countries, primarily the United States, may provide an explanation of the application of already existing norms to the price threshold. This happened recently with explanations of possible sanctions for using the Mir payment system in the interests of blocked persons.

In the bottom line, the participants of the "threshold coalition" do not have to seek the entry of more countries into their ranks. It is enough to threaten with secondary sanctions or coercive measures in case of revealed violations, or simply block insurance services or financial transactions passing through Western insurance companies and banks in violation of the prescribed norms.

By building up pressure on the Russian oil sector, the US and other initiators of sanctions will use their rich experience of restrictions against Iran. At one time, Washington managed to "globalise" its ban on the import of Iranian oil and services related to such imports. Iran continues to survive under the sanctions, although it has suffered losses. There is no doubt that Russia will also retain efficient ways to supply its oil to foreign markets. However, as in the case of Iran, the sanctions will increase the cost of Russian oil exports.

First published in the Valdai Discussion Club.