The West's price cap on Russian crude oil could have a catastrophic effect on Vladimir Putin’s finances and force the pariah state into imposing austerity measures this year.

The price of the “Urals” benchmark grade of crude oil exported from Russia has been falling steadily since the cap went into effect on Dec. 5. At that level, production can continue, but at a level much closer to extraction costs, thereby greatly diminishing Russian profits.

“The price on Urals crude is down sharply versus Brent since the start of the G7 cap,” wrote Robin Brooks, chief economist of the international finance industry lobby group IIF. “That’s good, as Putin gets less cash to fight his war.”

Last year, the average price for Russia’s “Urals” benchmark grade was $76.09 per barrel, the country's finance ministry said last week.

The price plummeted in December, however. In the first month of the cap, it fell to an average of just $50.47 per barrel, down nearly a third from the comparable period a year earlier.

Worse for Moscow, Urals crude recently traded at $38—below the $40 threshold that many believe to be Russia’s production cost.

“The Ministry of Finance confirmed that everything with regard to Urals prices is not just bad, but very bad,” Cetrocredit Bank economist Yevgeny Suvorov told the Moscow Times. “$40 per barrel can be a real catastrophe for the budget and economy... If it becomes clear that $45–$50 is a new normal, the finance ministry will have to switch to an austerity regime this year.”

European dilemmas

One of the dilemmas Europe has faced is how to end its dependency on Russian imports that fund Putin’s war effort at a time when the invasion itself has driven up global energy prices and filled the Kremlin’s coffers.

An oil embargo effectively imposed by the EU did not help, since it is believed Europe imported crude from ships flown under neutral third-country flags—or even EU ones like Greece—that may have secretly blended their cargo with millions of barrels of Russian oil sold at a war premium.

With Europe starving its economy of precious energy while Russia lined its pockets thanks to higher global prices, many critics argued the West’s economic sanctions had backfired.

Enter the price cap reached by the United States, Canada, France, Germany, Italy, Japan, and the U.K.—collectively, the G7 group of nations—as well as Australia.

It was designed to eliminate this sanctions backfire by enabling Russia to legally export oil via tankers either operated or financed by Western alliance companies—so long as these only pay a maximum of $60 for each barrel. Importantly, the dominant shipping insurers are based in the G7 and Europe, making it extremely difficult for third countries to circumvent this measure.

A separate price cap that applies to all refined petroleum products goes into effect on Feb. 5, some three weeks before the anniversary of Putin’s invasion. This cap is expected to impose further stress on the Russian treasury.

“Fiscal policy will struggle in 2023,” warned Natalia Orlova, chief economist at Russia’s Alfa Bank, in the Moscow Times.

However, not all experts concur that the price cap is the primary driver behind the sudden sharp price drop in Urals.

Janis Kluge from the German Institute for International and Security affairs argued the the EU’s oil embargo is making it incrementally harder for Russia to find enough replacement demand for its shipments.

“Diverting the first million barrels per day of oil away from the EU was doable," he wrote, "but diverting the second million barrels per day is much harder."

This story was originally featured on Fortune.com

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