Would A Price Cap On Russian Oil Help Curb Its Revenue?

The U.S. is discussing with its European allies a price cap on Russian oil. The goal is to keep Russian oil flowing into international markets but curb budget revenues from it to discourage Russia from continuing the war in Ukraine. Theoretically.

The situation is not dissimilar to wanting to eat your cake and have it, too. On the one hand, both the U.S. and Europe, suffering the most severe consequences of sanction action so far, are aware that banning Russian oil from international markets would hurt them even more.

On the other hand, paying for Russian oil at market prices is not a palatable option because oil—and gas—export revenues make up a solid portion of Russia’s budget, and that budget includes defense spending, and much of that defense spending is going into what Russia calls its special military operation in Ukraine, which the West calls an unprovoked war.

U.S. Treasury Secretary Janet Yellen put it rather bluntly earlier this week: “I think what we want to do is keep Russian oil flowing into the market to hold down global prices and try to avoid a spike that causes a worldwide recession and drives up oil prices,” she said as quoted by the Wall Street Journal. “But absolutely the objective is to limit the revenue going to Russia.”

One might wonder where the concept of the free market went, but in truth, the concept of the free market has been quite dead for a while now. The question is whether the idea that the U.S. and the EU have about an oil price cap could work. In other words, would Russia accept such a move?

According to common sense, it would hardly welcome the idea of having a price ceiling imposed on its export oil cargos. According to the former chief economist of the European Bank for Reconstruction and Development, Sergei Guriev, “Yes, Putin could refuse to sell oil at this price. But, given that he is already desperate enough to sell to China and India at steep discounts, and today’s energy prices far exceed production costs, this seems unlikely.”

Indeed, Russian oil is trading at a discount of some $30 or more to Brent crude. Whether there is desperation in the Russian oil equation is difficult to say, if we put emotions and wishes aside. It is clear Russia knew it would have to redirect flows to Asia from Europe should the latter try to punish it for its actions in Ukraine—and it was prepared to do so.

It is also clear, or at least it should be, that Russia cannot just redirect all the oil and fuel flows that currently go into Europe to India and China, at least not fast. What this suggests is that Russia may well be prepared to suffer some revenue pain while the redirection proceeds.

Also, Russia tends to budget on the basis of quite low oil prices. For last year, for instance, it budgeted for $45 per barrel of Brent crude. Its actual oil revenues last year exceeded initial expectations by more than 51 percent. For 2022, Moscow budgeted for Brent at $44.20 per barrel.

So, as Guriev notes, even with a price ceiling of $70 per barrel, Russia would be making a lot more from the sales of its oil than it budgeted for. China and India would only be too happy to pay even less for Russian oil. Yet the question remains whether Russia would be on board with the idea of having its opponents in this war tell it at what price to sell its crude. 

Until the ball goes to Russia’s court, however, the U.S. and the EU would have to figure out how to enforce a price cap if they agree on it. One way, according to the WSJ report, is to use the insurance industry and make it only insure Russian oil cargos below the price cap. Another is to impose secondary sanctions on Russian oil buyers, but that would have potentially unpleasant diplomatic consequences. 

The idea of a price cap on crude, not just Russian, was first floated in Europe earlier this year by Italy’s Prime Minister Mario Draghi. In May, following a meeting with the U.S. president, Draghi said both he and Biden were “dissatisfied” with the structure of global oil markets and had talked about setting a price cap on both oil and gas.

“The idea is to create a cartel of buyers, or to persuade the big producers, and Opec in particular, to increase production, which is perhaps the preferred path,” Draghi said at the time, as quoted by the Financial Times. “On both paths, there’s a lot of work to do.”

Perhaps now that OPEC+ agreed to pump more oil, theoretically, this plan would be put on the backburner. A buyers’ cartel is certainly not something you’d want to push into OPEC’s face right when you urgently need more oil.

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