Oil War between Russia, Europe and US explained. Will the new G7 price cap work!?

Starting from 5^th December 2022 the European countries, UK and USA implemented a masterplan to impose something called the oil price cap on Russia. Whereby they would limit the purchase of oil at $60 a barrel and this has sent yet another shockwave all across the world. Because in response to that Russia has announced a ban on all oil exports to G7 and all other countries that follow this price cap. This is what marks the beginning of yet another round of economic warfare between Russia and 8 of the most powerful countries in the world including Canada, France, Germany, Italy, Japan, UK, US and even Australia.

Just like the gas war and sanctions this economic battle is going to have a lasting impact on India, China and every other country in the world and India is literally stand on thin line of diplomacy in this critical economic warfare. So what is this price cap strategy and how does this work? What is Europe’s plan to paralyze the Russian oil power. What is Russia doing to counter Europe and win war in Ukraine?

Before we get started here is a quick summary of what exactly happened since the war started in February 2022.

1. Russia invaded Ukraine
2. EU and UK and us sanctioned Russia so that they can cripple the economy of Russia and force them to withdraw from Ukraine
3. Since more than 40% Europe’s oil came from Russia, Russia took advantage of it and started decreasing the supply of oil as a result the oil prices spiked and the oil price went from $70 a barrel in November to more than $116 a barrel in July 2022. So guess what? Russia is making more money after the sanctions than before the sanctions because now they could sell less oil at almost double the price. The average revenue of Russia during 2021 from march to July was close to $50 billion but in 2022 this revenue has almost doubled to more than $90 billion. So you see Russia’s major source of income which is oil, it’s still making them $20 billion every single month. So Europe’s sanctions are not helping at all. Infact they’re back firing heavily on Europe itself.

What is the Oil Price cap Strategy?

Europe and the G7 countries came up with a strategy whereby they said they would join hands together to form something called the buyers monopoly, in simple words together they decided not to buy Russian oil above $60 per barrel. Now the big question here is why can’t they just ban Russian oil because 60% of Russia export revenue is coming from oil itself. So if these countries stop buying oil, Russia will not have the money and the war would stop. Isn’t it?

Well the problem is …Russia is the second largest producer of oil and produces over 11% of the entire worlds oil supply which is about 10 million barrels per day and that translates to 3 billion barrels a month. So if you see if Russia’s 3 billion barrels of oil is taken out of the market, it will create a 3 billion barrel oil shortage. So this way Saudi and other middle eastern countries will take advantage of it and will increase their prices. This is exactly the reason why the oil price shot up to $100 per barrel after Russia started cutting oil supplies to Europe and according to JP Morgan if the Russian oil is banned and is completely taken off the market, the oil price will shoot up to $380 dollars per barrel.
So if at $100 a barrel the entire EU and UK economy got shattered can you imagine what would happen if it hit $380 a barrel. So moral of the story is that you just cannot take out Russian oil from the market. This is the reason why G7 and Australia have come up with something called the price caller strategy whereby these countries have chosen the price cap to be 60 dollar and this price cap has been decided such that this price is low enough to restrict Russia’s income but at the same time it is still slightly profitable for Russia so that they can get incentivized to keep producing oil. So now Russia’s cost of prod stands at 20-40 dollars a barrel and they can make 20-40 dollars profit per barrel. This is how the price caller strategy has been deployed to curb the cost of oil.

How the G7 Price Cap will hurt Russia?

Look at the chart you will see that India and China are two of the biggest oil buyers in the world. So in both started buying oil from Russia we got discounted oil and Russia got its oil revenues. India’s oil purchase from Russia has gone up from less than 1% to over 20% of our total oil purchases and similar is the case with China. So even now Russia’s oil export has just gone down from 10 million barrel to 7 million barrels per day. So even though G7 has applied price cap now, Russia can easily sell oil to India, China and other countries.

So how will this price cap prevent Russia from selling oil to other countries?

Well this is where you need to understand the super powerful monopoly of the European counties and the global shipping industry. So see this shipping industry is a very very capital intensive business so if you want to take care of all the element in the supply chain like vessels, containers, maintenance of ports, insurance and warehousing you will incur billions of dollars in just working capital. So if the market goes down you will directly go out of business which is why for each of the services there are individual companies that give services to shipping companies to all across the world and these individual companies in certain sectors are such a monopoly that you will be shocked to know that half of all sea borne Russian oil is transported on Greek vessels. And around 95% of it is insured through the London based international group called P&I clubs and here is where the G7 countries have brought in a complex and super strict system to prevent even other countries from buying Russian oil at more than 60 dollars a barrel.

To tell you about it this is a document from the US govt and here you can see that the entire stakeholder ecosystem is divided into 3 tiers.

The 1^st tier consists of commodity broker and traders who are supported to retain the price info the oil that is being shipped and then their supposed to pass it onto the tier 2 and 3 stakeholders

The instruments of their check will be invoice, contracts and other form of proof of payment and then we have 2^nd tier of SH where we have financial institutes providing trade finance, shipping and vessel agents. These entities are support to receive the attestation from tier 1 stakeholders and pass it onto tier 3 stakeholders.

Stakeholders from tier 3 are the most powerful in the system which are insurers, reinsurers and ship owners and this is where all the attestation will be scrutinized before the insurance or vessel service is given to the shipping company

If these attestation do not comply with rules the entire ship will go uninsured which makes this business extremely risky. So if any of these companies try to buy Russian oil at about 60 dollars a barrel they will not be given insurance nor will they receive these Greek vessels. So if India and China try to buy oil at more than 60 dollars even thought G7 cannot control India or China, the oil brokers and the shipping companies none would get insurance. As a result, the Russian oil cannot be sold at more than 60 dollars a barrel even in India and china. This is how G7 and Australia are choking the Russian oil revenue to win the economic war against Russia.

So is the game over for Russia?……

How Russia is going to bypass Oil Price Cap Strategy?

Well there are actually 3 very big gaps in this price cap system that Russia can cleverly leverage to sell their oil to India, China and Malaysia like countries. The big question is with such a stringent system and such powerful countries and companies at play how can Russia circumvent these sanction and this actually has a very very interesting explanation. Lets have a look at these gaps and then we will understand how will this affect India.

1. Gap is something that has already been discovered by Iran, because even they got sanctioned. So what they did was they turned off something called the Automatic Identification System(AIS) in the ships. For those who don’t know these are basically location trackers on the ships that can tell you if these vessels are coming from Russia or not and usually these ships turn off their AIS in a pilot infested zone. Suddenly now these ships are going off radar for no reason at all and after the war has begun this dark activity amongst the Russia affiliated crude oil tankers is up by 600% compared to the before war period. So after turning off the location they conduct a ship to ship cargo tgransfer and then take the oil to the rest of the world. This is the reason its very difficult to tract if the containers are coming from Russia or not. As a result, if the oil is not tagged as Russian oil if can obviously be sold at higher than 60 dollars a barrel. This is the 1^st hack that Russia has discovered
2. Russia is building its own insurance mechanism and this is because of the simple math. If Russia relied on European insurance companies then they will have to sell oil at 60 dollars. Instead of selling it at 80 dollars . so considering the 10 million barrels shipping, Russia will lose 200 million dollars a day, 6 billion dollars a month and 72 billion dollars a year. So even if its makes a super heavy investment of 50 billions into providing its own insurance, it will still make 22 billion dollars in profit. This is why Russia is setting up its own insurance system and Chinese companies are doing this. So again the G7 can reject insurance to Indian ships with Russian oil only if they have European insurance. But if they have Russian insurance nobody can stop these ships from selling oil at 70 or 80 dollars a barrel to India.
3. Russia has announced a ban on oil export to any country that is abiding by the price cap. Which means all these countries will have to be at the mercy of Saudi and other middle eastern countries and like I said before why would they sell oil at 60 dollars a barrel when they know for sure that they can mint money with this leverage. So from February 1^st onwards after the ban will be applied the cost of oil is expected to range between 70-80 dollars or might even touch 100 dollars a barrel.

So again the purpose of price cap which is to get cheap oil is completely defeated and as long as India and china keep buying Russian oil backed by Russian insurance the 2^nd purpose that is cutting Russia’s revenue has also been defeated.

How will this affect India and other Neutral Countries?

1. India is a diplomat in this war both scenarios are beneficial. If price cap works well we will get oil at less than 60 dollars a barrel which is great. Inflation will be under control , RBI can decrease repo rate and then home loan interest will go down. Any geopolitical event affect your economics and your country’s economics. Do not ignore them and don’t keep on asking how geo politics is related to business.
2. With code recovery the oil prices have been over the roof and that has killed the profits of airliners like indigo and spice jet. So oil price will go down it will be very good for every fuel sensitive industry. So again the Russian price cap directly affects the entire aviation industry. If price go up inflation will shoot up, repo rate will go up, bank charges more interest. Construction business will see drop in profit
3. If price cap does not work. Either Russia will keep on selling oil through the black market or the EU and US will go to the middle east and they will increase their oil price and that will shoot up the prices for Europe, whereas Russia can keep on making money from India and china. So that again gives Russia 20 billion dollar monthly revenue advantage for 2023.

Coming few months are very critical for the global economy and only time will tell how these economic warfare strategies would play out. If you found this article interesting and insightful please do share.
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