The tanker Sun Arrows loads its cargo of liquefied natural gas from the Sakhalin-2 project in the port of Prigorodnoye, Russia on October 29, 2021.
| Photo Credit: AP
The story so far: Japan has been purchasing oil from Russia at a price above the $60 per barrel price cap imposed by the West, according to reports this week. This has led to speculation that Japan may be breaching an agreement reached last year to cap the price of Russian oil.
Why is there a price cap on Russian oil?
The G-7 countries, the EU, and Australia imposed a $60 per barrel price cap on oil purchased from Russia starting in December. The move was part of the wider economic sanctions imposed by the West to punish Russia following its invasion of Ukraine. The West wants to restrict the amount of money that Russia can make by selling its oil, but without severely affecting global oil supply. Since Russia contributes about 10% of global oil supply, any significant reduction in Russian oil supplies could send oil prices soaring. It is estimated that it costs Russia about $20-$45 to produce a barrel of oil. So, the West believes that, at $60 per barrel, Russia would still keep its oil output steady.
Why is Japan breaking ranks with the West?
In the first two months of the year, Japan purchased about 750,000 barrels of oil from Russia at a price of about $70 per barrel. Japan’s oil import contributes very little to Russia’s overall oil production, which was about 10.7 million barrels per day last year, and thus does not significantly subvert the West’s efforts to restrict the Kremlin’s oil revenues. However, Japan’s decision to purchase oil above the price cap once again brings to the fore the strong incentives facing countries to subvert the West’s $60 per barrel price cap. It should also be noted that, even when the price cap was first imposed last December, Japan had won an exception to purchase Russian oil from Sakhalin-2 in Russia’s Far East to protect its energy security.
Will more countries follow Japan?
Japan is not the only country that is undermining the West’s $60 price cap on Russian oil. Countries such as India, for instance, are believed to be paying more than $60 per barrel to purchase oil from Russia. As oil prices rise, the chances of a rift developing even among signatories to the oil price cap arrangement grow higher. When buyers are willing to pay more than $60 per barrel to secure supplies, oil traders will likely be happy to subvert sanctions and deliver supplies from Russia. Critics of the oil price cap had warned that implementing the price cap may be difficult because it works against strong economic incentives and because it may 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 output by 3.66 million barrels per day, sending oil prices soaring 6%. Russian urals, the flagship crude oil sold by Russia, also soared above $60 per barrel, thus breaching the West’s price cap. When the West first imposed its price cap, it had no effect on Russia’s oil output or revenues as Russian urals were trading well below $60 per barrel. But now with urals trading above $60 per barrel, things might turn out to be different. The West would hope that its price cap would keep Russia’s oil revenues in check despite rising oil prices. Russia, which has seen its oil revenues drop due to subdued oil prices and the West’s ban on Russian oil, will be hoping to turn the corner by bypassing Western sanctions and selling oil above the price cap. This will test the West’s ability to effectively implement its price cap.