U.S., Europe Ready Biggest Squeeze on Russian Oil as War Tension Mounts

The world's leading economies are moving closer to dealing the most lethal blow to Russia's oil industry since the start of the war in Ukraine, setting up a risky confrontation that could reshape the European energy market as tensions mount between Moscow and the West.

Europe has continued relying on Russian energy products since the invasion, even though revenue from the sale of oil and natural gas has helped fund President Vladimir Putin's war effort. The delicate balancing act will be upended later this year, however, when the Group of 7 nations finalizes a plan to place a cap on the price of Russian crude oil exports.

The move is intended to limit Moscow's profit margin in the short-term, while ensuring Europe is not cut off from a vital energy source overnight as the EU navigates a years-long shift away from Russian fossil fuels. The price cap would work in tandem with an EU ban on seaborne crude oil exports from Russia set to take effect on December 5, and a separate ban on refined oil products slated for early next year.

But it's unclear what Russia's response will be. Moscow has threatened to stop selling its oil to nations that comply with the unprecedented price cap, a move that would roil the global energy market and could raise gas prices in the U.S. and elsewhere.

"It's a question of who blinks first," said Lauri Myllyvirta, the lead analyst for the Centre for Research on Energy and Clean Air (CREA), a think tank based in Finland.

"The price cap is a very smart idea," Myllyvirta said. "It's a measure that's needed in order to put maximum pressure on Russia, But it's contentious. The stakes are very high."

The moment represents a tipping point for Europe, with the potential to change decades of energy policy and impact Russia's ability to carry out its war in Ukraine.

Russia's economy, which relies heavily on revenue from oil and gas exports, has been crippled by sanctions put in place by the U.S. and its allies. But up until now, President Joe Biden and European leaders have avoided leveling sanctions that would severely impact Russia's energy exports, allowing oil and gas to keep flowing through much of the year.

"We're really going after Russia's biggest whale," said Olga Khakova, the deputy director for European energy security at the Atlantic Council. "The price cap would put Russia into a much bigger financial strait than it's already in."

The Russian energy sector hasn't escaped entirely unscathed in the months since Putin launched the invasion. Last month, European imports of Russian crude oil were down 21% from September, 2021, according to an analysis by CREA. Russia's natural gas exports have fallen approximately 90% percent since the start of the war in late February.

The decline in Russian energy exports has been driven by a drop in demand in Asia, where China's pandemic lockdown policies have slowed economic growth, and decline in demand in Europe, where countries have started pivoting to clean energy and non-Russian sources of natural gas, energy analysts said.

But high oil prices and increased demand from countries like India have helped Russia offset the lost revenue. The European Union has imported $100 billion in Russian oil, gas and coal since the war began.

That revenue stream would go down significantly once the price cap takes effect, cutting into Russia's overall budget and making it harder for Moscow to sustain its current level of military spending.

The final details have not been announced, but it is expected the G7 nations will cap Russian oil exports at somewhere between $40 to $60 per barrel. That price would be close to Russia's production cost and eliminate much of Moscow's profit margin. Oil is currently trading around $93 per barrel for Brent crude.

Now it remains to be seen whether the Kremlin will retaliate.

The Kremlin's weaponization of natural gas in recent months offers insight into how it might approach the looming showdown over oil.

Russia kept a steady supply of natural gas going to Europe in the first half of the year, giving Europe time to boost its storage capacity ahead of the winter and easing fears of a heating shortage.

But that changed over the summer, as Russia faced growing challenges on the battlefield in Ukraine.

In late August, the Russian energy giant Gazprom temporarily shut down Nord Stream 1, the largest natural gas pipeline from Russia to Europe, citing maintenance issues. Three days later the energy company announced it was extending the shutdown indefinitely. The announcement came hours after the G7 nations reached an agreement on the price cap plan.

Then late last month, European officials announced that leaks likely caused by explosions had been found in Nord Stream 1. Leaks were also discovered in Nord Stream 2, a pipeline project linking Russia to Germany that Germany halted in February on the eve of the war.

The pipeline leaks are widely viewed in the energy industry as an act of sabotage by Russia. Moscow denied responsibility.

"This is a big problem for us," Kremlin spokesman Dmitry Peskov said on a call with reporters of the leaks to the Nord Stream pipelines after they were discovered. Peskov dismissed claims by Western officials that Russia was responsible for the attacks as "quite predictable and also predictably stupid."

In the aftermath of the attacks, natural gas has continued flowing from Russia to Hungary and a handful of other landlocked Central European countries through other pipelines. But the rest of the continent has largely had to make do without it.

"The way Russia approaches its natural gas supply is not dependent on its economic interests," said Anna Mikulska, an energy expert at Rice University's Baker Institute. Russia uses "gas as a geopolitical tool."

It would be harder for Russia to weaponize oil, Mikulska and others said.

Oil accounts for the bulk of Russia's revenue from energy exports. Russia is already selling oil at a steep discount to India and other countries that are still willing to trade with Moscow despite the international sanctions regime. Russia would take a significant financial hit if Europe forces it to sell crude oil at rock bottom prices.

Still, energy experts said Russia has options to mitigate the damage. Russia could try to ramp up exports to friendly countries, while banking on high oil prices to help blunt the pain of a drop in business with Europe.

"There have been a lot of emerging economies that have been very clear that they're happy to buy Russian oil at a discount if they can get it," said Mark Finley, an energy fellow at the Baker Institute.

The price cap could be difficult to implement and police, as would the ban on seaborne Russian crude oil exports, analysts said. Russia also stands to benefit from support from Saudi Arabia, the unofficial leader of the OPEC+ alliance of oil producing nations.

The announcement by OPEC+ last week that it would cut oil production infuriated American and European officials, who viewed it as a declaration of alignment with Russia.

"There's going to be consequences for what they've done with Russia," Biden said Tuesday of Saudi Arabia.

Whatever Russia does in response to increased pressure on its oil industry, the coming price cap represents a permanent shift in Europe's energy landscape, Khakova said.

"There's no going back," she said.

"This is the price of a really brutal breakup from Russia," Khakova added. "But it's also the price for future energy security, and not being subject to Putin's blackmail."