Thread by @edwardfishman

Today, the G7 formally endorsed a price cap on Russian oil sales. This plan has been in the works for months. Many doubted it would get across the finish line.

Bottom line: This is a big deal. It will erode the Kremlin's most critical source of revenue: oil exports (🧵):

(1) First things first: Oil is the lifeblood of Russia's economy. In recent years, oil has accounted for 30-40% of the Kremlin budget. But sanctions have caused a 15% decline in Russia's non-oil revenues. The result is that oil is playing an increasingly essential role for Putin.

(2) To date, Western sanctions have not made a dent in Russia's oil revenues. While the US and several allies placed an embargo on Russian oil months ago, Russia has increased sales to China, India, and other countries, keeping the overall volume of its sales roughly constant.

(3) Russia has already been selling oil at a steep discount—>$20 lower than Brent prices. Yet global oil prices have been so high this year that the Kremlin's total oil revenues have remained substantial. Russia has earned ~$20 billion selling oil each month this year.

(4) These oil profits have cushioned the Russian economy amid a torrent of sanctions (though sanctions are still biting—Russia's economy is poised for a contraction of >5% this year). If you're looking for a reason Russia's economy hasn't yet collapsed, look no further than oil.

(5) We saw a similar phenomenon with Iran sanctions before 2012. From 2006-12, sanctions effectively froze Iran out of the global financial system. But the economy continued to grow. Iran's economy didn't fall off a cliff until the US rolled out global oil sanctions in 2012.

(6) Revenue = volume x price. The Iran oil sanctions focused on cutting volumes of Iran's oil sales. There was a debate at the time about whether to push for volume or price reductions; volume won because of ease of implementation and monitoring (counting ships isn't so hard).

(7) By contrast, the G7 Russia oil sanctions will focus on price. Iran exported about 2.5m bpd of crude oil at the beginning of 2012. Russia today exports 7.5m bpd of crude oil + refined products. Big cuts into Russia's volumes would squeeze global supply and push prices upward.

(8) How will the G7 price cap work? For starters, there will actually be two price caps: one for crude oil, another for refined products. Implementation day for crude oil will be December 5 of this year, when the EU maritime insurance ban is set to begin and US GL-8C expires.

(9) Details will be hammered out in the coming months. But we do know that the G7 will prohibit the provision of all services (payments, insurance, financial services, brokering, bunkering, piloting, etc) for shipments of Russian oil that exceed the price cap.

(10) Firms that provide these services will need to submit an attestation that the underlying oil cargo complies with the price cap. If the US or EU catches any company misrepresenting the price or submitting a fraudulent attestation, they can impose sanctions on that company.

(11) This threat of sanctions is the "stick." But the success of this policy will hinge even more on the "carrot"—the opportunities for China, India, and others to buy Russian oil at even larger discounts than they do today.

(12) Will China or India endorse the policy? No way. But will they comply with it? I suspect that, by and large, Russian and Indian companies will comply. Non-compliance would involve taking on big risks and paying more for unproven insurance, shipping, and other services.

(13) In other words, compliance by China and India would be an act of charity to Putin. It would be harmful to Chinese and Indian interests. That's why my instinct is that compliance may not be perfect, but it will largely work as intended: cutting the price of Russian oil.

(14) Will Russia comply? The Kremlin has already threatened not to sell oil to anyone that complies with the price cap. But the costs to Russia of turning off the taps would be grim. Moscow cannot afford to go without oil revenues—even for a short time.

(15) While we don't yet know what the initial price cap will be—or what the process will entail for selecting it—we do know that it will be set above Russia's marginal cost of production. So Russia will have strong economic incentives to continue to sell oil.

(16) The likeliest outcome is that the policy works, even as Beijing claims that it is not complying and Moscow swears that it won't sell to anyone that does comply. All the while, sanctions on investment in Russia's energy sector will further erode Russia's production capacity.

(17) Could it fail? Of course. This is a first-of-its-kind policy. But in many ways, it requires less of a mental leap than the Iran oil sanctions of 2012—which cut Iran's volumes by more than 60% and locked up all of its oil revenues in restricted accounts outside of Iran.

(18) The Biden administration deserves credit for doggedly pushing this policy and persisting against major headwinds. (I first wrote about it almost 4 months ago.) And the other members of the G7 deserve credit for being willing to take the risk. foreignaffairs.com/articles/russi…

(19) The 2012 Iran oil sanctions were ultimately unilateral—they originated in US Congressional legislation (NDAA FY2012), and we had to threaten secondary sanctions to implement them. Yes, US allies played ball and complied with the policy. But they were not co-authors of it.

(20) The Russia oil price cap of 2022, on the other hand, is backed by the full weight of the G7. That alone is an impressive feat. /end

Minor correction to (8) above: There will actually be *three* price caps: one for crude oil, one for high-value refined products, and one for low-value refined products. The refined product caps will debut on February 5, 2023.