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

Yves here. Perhaps I am missing something, but Treasury Secretary Janet Yellen’s oil price fixing scheme is an idea only some economists could love. Yellen proposed that US and EU agree to pay only $70 a barrel for Russian oil.

Lambert had missed this story and laughed out loud when I told him. Needless to say, this proposal marks a big change, and in a short period of time, from confident stories like How Much Oil Does the U.S. Import From Russia and Why Did Biden Ban It? in the Wall Street Journal in April. As its subhead indicated, the spin then was that Russian supply was marginal” “U.S. had until recently turned to Russian crude to service more isolated coastal markets and keep refineries running at optimal levels.”

Yellen’s cover story was that a buyer price cap was necessary to keep the Russian state, which has elected to get most of its revenue from energy price sales, from continuing to make out from current high oil prices. Russia is now making more on foreign oil sales, even with offering a sanctions discount and at reduced volumes, than it did last year.

But it’s a pretty remarkable shift to go from trying to punish Russia by not buying its energy to now pressing for a discount because you are obviously indispensable.

Oh, and despite being an unfriendly countries, the collective West is trying to get an even bigger break than Russia is giving to its besties, which is $30 a barrel, so the net price to Russia is around $90. Oil has dropped briefly to $100 a couple of times this year, but that was due to China lockdowns, an issue that will at most only be operative intermittently. Indeed, with Turkey eyeing territory in Syria and Israel playing harder ball with Iran, escalation in the Middle East could also push oil prices even higher.

The US price scheme is aggressive even in recent historical terms. Oil prices were rising due to “We’re acting like Covid is over” rebound and were solidly above $70 a barrel in the second half of the year.

Let us also remember that the US embargoed Russian oil in early March. Since then, the US has been trying to mitigate the impact via releases from its Strategic Petroleum Reserve, browbeating Saudi Arabia, and trying to make nice to Venezuela and Iran, which produce very heavy oil. Russia’s crude is moderately “heavy” and well suited to refining diesel and home heating fuel. US and Saudi crude is light and needs to be combined with heavier distillates to make some of the desired end products like diesel (yes, this is a simplification but will do for this purpose). The charm offensive to other oil producers isn’t going very well. For instance, Biden had planned to go to the Middle East in June and among other things, sit down with Saudi Crown Prince Mohammed bin Salman. That’s now planned for July, allegedly by Biden due to concerns about the stability of the Israel government and a busy calendar of June visits to Europe. Alexander Mercouris claims it was the Saudis that pushed the meeting back (see here starting at 4:06).

Mind you, if the prospects aren’t so hot for the US, they are even worse for Europe. The latest round of EU sanctions proposed to cut oil imports from Russia by 90% by late this year, with pipeline oil the main carve-out. No one with an operating brain cell believes this is achievable, even with aggressive stockpiling, unless the northern countries are willing to do serious and irreversible harm to industry, or alternatively, let non-trivial numbers of citizens freeze to death.

Some contend that Russia will be brought to heel by the difficulty of unloading more oil as the Europeans wean themselves off Russian supply. It’s more realistic to assume that it will simply be laundered through intermediaries, with Europe paying even more as a result.

And the threat of barring insurance on Russian oil cargoes also seems overestimated. The US and Europe are not the only places in the world capable of issuing guarantees. Russia itself could. So could Middle Eastern countries, which are now becoming more important financial centers as a result of nervous billionaires, and even some countries, shifting holdings there after the US/EU theft of Russian assets (they claim they are merely frozen, but if you think Russia is ever getting them back, I have a bridge I’d like to sell you).

If the West tries to impose secondary sanctions on non-Russian insurers, another Russian gambit could be to sell discounted oil (below its China-India price but still above the US-EU bid) on a humanitarian basis to countries in dire energy straits or facing debt crises, like Sri Lanka.

And the idea the author Irina Slav posits at the end, that the US may get the relief it needs from an OPEC+ production increase, is a misconstruction. The Saudi offer was largely optical. It was largely conditioned on an output gap elsewhere and amounts to only moving production forward by a few weeks.

I strongly suspect that even if the US and EU get as far as formalizing this proposal, it will be quickly shot down by a sharp-tongued senior Russian official like Dimitry Medvedev. Another way to ridicule this plan is to say Russia would entertain it if the West withdraws all of its sanctions.

By Irina Slav, a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry. Originally published at OilPrice

  • The United States has a new plan to curb Russia’s oil revenue.
  • The U.S. is in talks with European allies over a potential price cap on Russian crude.
  • The goal is to keep Russian oil flowing while limiting Moscow’s energy revenues.

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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