How Europe can slash the Kremlin’s fossil fuel revenue with price caps

As September 2022 came to a close, EU member states have spent EUR 100 billion on Russian fossil fuel imports since the beginning of Putin’s invasion of Ukraine. Price caps would have reduced this amount by EUR 14 billion since the beginning of July, demonstrating the importance of introducing price caps on all Russian fossil fuel exports to the EU.

The European Commission proposed price caps on gas imported from Russia in September, a plan that has since been under political deliberations. The Commissioner for Energy Simson in late September stated her view on the necessity of a price cap on Russian gas imports. European Commission president von der Leyen announced a price cap on Russian oil recently in response to Russia’s steps to annex Ukrainian territories and escalate the war. G7 finance ministers said they intend to implement price caps on Russian oil in early September, and President von der Leyen in late September laid the legal basis for it in the EU.

Europe has the levers to implement global price caps

Russia is manipulating fossil fuel markets, driving the prices up by constraining supply and then cashing in on the high prices. Examples include, most obviously, the cutting off of the gas supply to Europe, but also the interference with the shipments of Kazakh oil through Russia’s Novorossiysk port on the Black Sea.

Price caps are essential to prevent this manipulation and to cut Europe’s energy bill. The current energy crisis shows the dramatic consequences of this manipulation, and underlines that reducing the cost of Russian fossil fuels is crucial. Savings on imported Russian fossil fuels could also relieve European consumers, especially as the winter approaches, depending on how they are implemented.

Realizing these savings requires that prices for all Russian fossil fuels carried aboard European-owned and insured ships, regardless of their destination, as well as for all gas imported into Europe, are capped at their average level in the first half of 2021: the period before Russia started strategically manipulating gas flows, driving up global fuel prices. 

Russia is heavily dependent on the European shipping industry to enable its fossil fuel exports. 49% of ships carrying Russian fossil fuel in the past 30 days were owned by European shipping companies, and at least 59% were insured in Europe. This gives Europe a stranglehold on Russia’s exports and enables the imposition of a price cap on exports to third countries as well.

Protection of European consumers is not the only driver for price caps. Russia’s ability to sustain its genocidal war against Ukraine is dependent on fossil fuel export revenue, especially after the economic impact of sanctions has slashed other sources of Russian budget revenue. The federal budget already dipped into deficit in July 2022 as the revenue from fossil fuel exports fell modestly. This deficit could increase substantially if the upcoming ban on oil imports into the EU and the UK is combined with effective price caps on all Russian fossil fuels.

The experiences to date illustrate Europe’s pricing power. First, Russian crude oil has been trading at a 25–35% discount compared to international oil prices, as a result of a relatively modest reduction of 10–20% in oil exports from Russia to Europe. Second, our analysis showed that Russian coal exporters have failed to find alternative buyers after the EU ban on Russian coal came into effect on August 10th. Total Russian coal exports initially saw a fall equal to the eliminated European imports. Third, the European Commission recently backpedaled on the ban on using European-owned and insured ships to carry coal to third countries: the impact on global coal supply and price escalated to levels that policymakers weren’t prepared to stomach. As EU countries failed to enforce the shipping ban, Turkey and India picked up quite a bit of the slack.

These examples show how comprehensive a stranglehold Europe has on Russia’s fossil fuel exports. In the short term, while Russian fossil fuel supply cannot be completely cut off from the world market, the EU must use their power to slash the excessive fossil fuel profits that support Russia’s war machine.

How the price caps could be implemented

The following approaches display how European policymakers can implement effective price caps on Russian fossil fuels: 

While Russian coal exports to Europe have stopped completely and gas exports have decreased dramatically, the EU continues to import crude oil, oil products, LNG and pipelined gas worth approximately EUR 260 million per day. This is 60% less than before the invasion, but still a substantial amount, contributing to financing the Russian invasion of Ukraine. Setting price caps on Russian fossil fuels would have cut the EU’s import bills by EUR 11 billion since the beginning of July, after the measure was first discussed at a high level at the G7 Summit. This amounts to 35% of the value of the EU’s imports from Russia. Russia’s revenues from fossil fuel exports could have been slashed even more, by 14.1 billion, had the price caps been applied to all fossil fuel cargoes carried to third countries aboard ships insured or owned by European stakeholders. 

  • Any buyer wanting to use European ships for transport of Russian fossil fuel must file paperwork with the enforcing authority showing that the price paid does not exceed the price cap.
  • The reach of the price cap mechanism can be expanded by sanctioning all ships and shipowners that fail to comply. If any ship that has contravened the price caps is banned forever from entering any European or G7 port, that creates an incredibly strong incentive for compliance.
  • In the case of gas, prices paid to Russia are linked to prices in Europe’s main gas exchange (TTF). Creating a new exchange for non-Russian gas, and imposing a price cap or surcharge on Russian gas, would decouple the prices.
  • An alternative way to slash prices paid to Russian exporters for seaborne cargoes of Russian fuels would be to impose an elevated tonnage tax. All countries with a significant maritime cargo fleet already levy tonnage taxes, so this would be a matter of increasing the rates. The proceeds could be used to support Ukraine with money and material, and/or for income transfers that would compensate for the effects of high energy prices.

For further background on the economics of price caps, please see here.

The way forward

After more than seven months of war in Ukraine, the EU has an opportunity to leverage its pricing power through setting price caps on Russian fossil fuel imports. This would lessen Putin’s revenues that fund his war in Ukraine, lessen Europe’s fossil fuel bills and contribute to solving the increasingly severe cost of living crisis that European citizens are experiencing. The recent experiences of the European coal ban substantially cutting Russian coal exports, and Europe’s reduced demand for Russian oil slashing its global market value, illustrate that European policy matters. The bloc is thus clearly well positioned to introduce a smart price cap policy.