EXPLAINER: What’s the effect of Russian oil price cap, ban?

FRANKFURT, Germany (AP) — Western governments have agreed to cap the price of Russia’s oil exports in an attempt to limit the fossil fuel earnings that support Moscow’s budget, its military and the invasion of Ukraine.

The cap is set to take effect Monday, the same day the European Union will impose a boycott on most Russian oil — its crude that is shipped by sea. The EU reached a deal for a $60-per-barrel threshold Friday, and the Group of Seven nations and Australia signed off on the deal later in the day.

The twin measures could have an uncertain effect on the price of oil as worries over lost supply through the boycott compete with fears about lower demand from a slowing global economy.

Here is what to know about the price cap, the EU embargo and what they could mean for consumers and the global economy:

WHAT IS THE PRICE CAP AND HOW WOULD IT WORK?

U.S. Treasury Secretary Janet Yellen has proposed the cap with other Group of 7 allies as a way to limit Russia’s earnings while keeping Russian oil flowing to the global economy. The aim: hurt Moscow’s finances while avoiding a sharp oil price spike if Russia’s oil is suddenly taken off the global market.

Insurance companies and other firms needed to ship oil would only be able to deal with Russian crude if the oil is priced at or below the cap. Most insurers are located in the EU or the United Kingdom and could be required to participate in the cap.

HOW WOULD OIL KEEP FLOWING TO THE GLOBAL ECONOMY?

Universal enforcement of the insurance ban, imposed by the EU and U.K. in earlier rounds of sanctions, could take so much Russian crude off the market that oil prices would spike, Western economies would suffer, and Russia would see increased earnings from whatever oil it can ship in defiance of the embargo.

Russia, the world’s No. 2 oil producer, has already rerouted much of its supply to India, China and other Asian countries at discounted prices after Western customers shunned it even before the EU ban.

WHAT EFFECT WOULD DIFFERENT CAP LEVELS HAVE?

A $60 cap will not have much impact on Russia’s finances, said Simone Tagliapietra, an energy policy expert at the Bruegel think tank in Brussels. That “will almost go unnoticed,” he said, because it would be near where Russian oil is already selling.

Russian Urals blend sells at a significant discount to international benchmark Brent and fell below $60 for the first time in months this week on fears of reduced demand from China due to outbreaks of COVID-19.

“Up front, the cap is not a satisfying number,” Tagliapietra said, but it could prevent the Kremlin from profiting if oil prices suddenly shoot higher and the cap bites.

“The cap might be lowered over time if we want to increase the pressure on Russian President Vladimir Putin,” he said. “The problem is: We have already spent a lot of months waiting for a measure to dent” Putin’s oil profits.

If the cap had been as low as $50, it would cut into Russia’s earnings and make it impossible for Russia to balance its state budget, with Moscow believed to require around $60 to $70 per barrel to do that, its so-called “fiscal break-even.”

However, a $50 cap would still have been above Russia’s cost of production of between $30 and $40 per barrel, giving Moscow an incentive to keep selling oil simply to avoid having to cap wells that can be hard to restart.

Robin Brooks, chief economist at the Institute for International Finance in Washington, tweeted last week that a $30 cap would “give Russia the financial crisis it deserves.”

The wrangling over where to set the cap highlighted the disagreement on which goal to pursue: hurting Russia’s finances or taming inflation, with the U.S. coming down on the side of controlling price increases, said Maria Shagina, a sanctions expert at the International Institute for Strategic Studies in Berlin.

With Monday’s deadline looming, she said that “$60 is better than not agreeing at all. They can obviously revise it later on to reflect conditions on the market … and tighten it.”

WHAT IF RUSSIA AND OTHER COUNTRIES WON’T GO ALONG?

Russia has said it will not observe a cap and will halt deliveries to countries that do. Russia could retaliate by shutting off shipments in hopes of profiting from a sharply higher global oil price on whatever it can sell around the sanctions.

Buyers in China and India might not go along with the cap, while Russia or China could try to set up their own insurance providers to replace those barred by U.S., U.K. and Europe.

Russia also could sell oil off the books by using “dark fleet” tankers with obscure ownership, as have Venezuela and Iran. Oil could be transferred from one ship to another and mixed with oil of similar quality to disguise its origin.

Even under those circumstances, the cap would make it “more costly, time-consuming and cumbersome” for Russia to sell oil around the restrictions, Shagina said.

The greater distances involved in shipping oil to Asia means up to four times more tanker capacity is needed — and not everyone will take Russian insurance.

“You need to tap into this dark fleet, and it’s not limitless,” she said. “Iran and Venezuela are using it, rather effectively, but you might face competition with the same targets. … This cat-and-mouse game is always inherent in sanctions mechanisms.”

WHAT ABOUT THE EU EMBARGO?

Russian producers likely won’t be able to reroute all their oil from Europe, formerly their biggest customer, and some will likely be lost to the global market — at least at first.

Analysts at Commerzbank say the EU embargo and cap together could result in “a noticeable tightening on the oil market in early 2023” and expect the price of international benchmark Brent to climb back to $95 per barrel in coming weeks. On Friday, Brent slid to $85.48 a barrel.

The biggest impact from the EU embargo may not come Monday but on Feb. 5, when Europe’s additional ban on refinery products made from oil — such as diesel fuel — come into effect.

Europe still has many cars that run on diesel. The fuel also is used for truck transport to get a huge range of goods to consumers and to run agricultural machinery — so those higher costs will be spread throughout the economy.