Russia’s oil price cap is pure fantasy

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US Treasury Secretary Janet Yellen is at the forefront of calls for a price cap on Russian oil exports. Sounds like a good idea. Don’t expect this to work.

Here is the problem. Russia earns billions of dollars by exporting oil. These dollars help fund President Vladimir Putin’s invasion of Ukraine. Meanwhile, the world needs Russian oil to keep flowing because markets are already tight and no one has spare capacity to make up for their loss. But countries in North America, Europe and parts of Asia want to cut off the flow of funds to the Kremlin war machine.

So what is the solution ? Revenue is a fairly simple product of volume multiplied by price (minus some costs). To reduce Kremlin income, you need to hit either volume or price. We do not want to reduce the volume, which leaves the price. Restrict the price at which Russia can sell its oil, and you reduce the Kremlin’s revenue without affecting the volume of oil on the international market.

Clean, simple, I wonder why no one has done this before. Why didn’t the US do this with Iran or Venezuela, rather than imposing secondary sanctions that cut off oil flows and damaged relations with trading partners in Asia? Maybe the main reason is this: it is very unlikely to actually work.

Under the plan, insurance would be withheld for shipments for which the buyer pays Russia more than a price yet to be determined. Given that around 95% of the world’s tanker fleet is insured by the International Group of Protection & Indemnity Clubs in London and some companies based in mainland Europe, a ban is certainly possible. But I’m not sure that’s enough.

The European Union has just concluded several weeks of brutal internal wrangling over oil sanctions against Russia. These sanctions, even watered down compared to the initial proposals, included a ban on insurance. Moscow has already started to set up an alternative to P&I clubs, offering insurance through the Russian National Reinsurance Company. That may be enough for some of the Indian and Chinese companies that now supply the bulk of the Russian crude market.

The plan pushed by Yellen would force the EU to revoke the sanctions it just agreed to – not an attractive option after the deadly negotiations the bloc went through to get all 27 members to agree to them. I don’t see many European countries willing to agree on new sanctions that would allow Chinese and Indian companies to buy heavily discounted crude, while their own are not allowed to buy at any price. It is more likely that the EU ban on maritime imports of Russian crude and refined products will eventually be lifted alongside the one on insurance.

We would therefore find ourselves without any attempt to reduce the volume of Russian oil exports in the hope — and it would still be only a hope — of being able to reduce their value. But the value of Russia’s crude shipments has already been hit.

Figures from the Russian Finance Ministry show that since the launch of the attack on Ukraine in February, the price of Russia’s benchmark Urals export grade has fallen against Brent, a global benchmark based on crude produced in the North Sea. This discount averaged nearly $35 per barrel between mid-April and mid-May, although it narrowed somewhat the following month from an average of $1.50 per barrel during of the 12 months preceding the invasion.

The widening of the rebate likely cost Russia about $7 billion in revenue from its marine crude exports, compared to what it would have earned if the Urals had maintained its historic price relationship with Brent. . The figure would rise to $10 billion by the end of July.

The biggest obstacle to capping Russian oil prices, however, is that Putin simply says “No”. How do you force Russia to sell its oil at a discount imposed from outside?

You could set the cap at a level that provides a small positive return to the Russian oil companies in the hope that they will decide it’s still worth pumping, but they’re not the ones making the decision. Their oil is brought to market (either directly or to export terminals on the Russian coast) through a network of Russian state-owned pipelines. Putin simply has to close the valves on these pipes and companies cannot export, even if they want to.

The Russian president has already shown that the country’s economy is of secondary importance to his imperialist ambitions, as his troops devastate eastern Ukraine. His calculation will almost certainly be that cutting off Russian oil exports will hurt the economies of buyers in Europe more than it will hurt Russia. It is therefore useless to expect him to accept a price cap imposed by the West.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Julian Lee is oil strategist for Bloomberg First Word. Previously, he was a senior analyst at the Center for Global Energy Studies.

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