The idea of placing a cap on the price of Russian oil as a means of reducing the country’s oil revenues was first floated by U.S. Treasury Secretary Janet Yellen in the spring. Since then, the idea has grown into a full-blown plan involving, besides the U.S., its partners from the G7 and the European Union. And it just got a lot riskier.
Earlier this month, OPEC+ caused a stir in Washington by agreeing to reduce its oil production quota by 2 million bpd and its actual production by some 1 million bpd. Most of the cut would come from Saudi Arabia, the UAE, and Kuwait, meaning the physical supply of oil would tighten globally.
Oil prices rose on the news but quickly subsided on persistent concerns about a slowdown in global economic growth and the increasing likelihood of several large consumers suffering through a recession.
In Washington, discussions of the Russian oil price cap have continued, but now some in the Biden administration are beginning to worry that it could backfire.
Bloomberg reported on the worries of some White House officials last week, saying that after the OPEC+ production cut decision, volatility in the oil market had increased markedly, and a price cap on Russian crude could lead to a spike in prices rather than a decline.
Another fear, and quite justified, is Russia making good on its warning that it could choose to stop selling oil to any country that has implemented a price cap on its oil. This would certainly lead to higher oil prices, with UBS estimating recently that the jump could see Brent hit $125 per barrel.
“The Russians were clear: ‘If you force us to accept the price cap, we’re simply not going to deliver crude to you,” the head of UBS Global Wealth Management commodities Dominic Schnider told CNBC.
According to Schnider, the cap could see global supply fall by another 1 million bpd as a result of the price cap, if it is indeed ever implemented, pushing crude well above $100 per barrel.
The spokeswoman of the National Security Council, Adrienne Watson, told Bloomberg the news that some in the White House had serious misgivings about the oil price cap was “false.”
She went on to say that the administration team “are full steam ahead on implementing a price cap on Russian oil with strong support from the G-7 and other partners. It is the most effective way to ensure that oil continues to flow into the market at lower prices and supply meets demand.”
Yet, it has been clear from the beginning that the G7 alone could not really make a price cap work, chiefly because they have already banned imports of Russian oil. So it was essential to get consumers such as China and India on board, which has so far proved tricky.
Indeed, India’s The Hindu reported this month, quoting Janet Yellen, that there were no attempts to convince other countries outside the G7-EU coalition to join the price cap. This happened just a couple of months after Yellen went on a tour in Asia that was partially designed to convince India and China to join the cap.
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In addition to the quite real danger of further supply shocks, there are other challenges for the price cap as conceived, including the exact way of implementing it in a world with shipping transport rules that offer a range of ways to circumvent such caps.
“It is very optimistic to believe this [price cap] can work,” Ben McWilliams, an energy analyst at Brussels-based think tank Bruegel told Euronews this month.
“In fact, I don’t believe even the architects think it will work perfectly. They just prefer a ‘leaky system’ in which Russia can still make some profit above the cap rather than a scenario in which Russia is completely forced off market.”
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These concerns were all there before OPEC+ decided to cut. With the decision, they just got bigger and heavier, even though analysts warned OPEC would not be a fan of any oil price caps because they would set a dangerous precedent that could see them become targets at any point the U.S. became unhappy with their policies.
In a way, then, the OPEC+ decision to cut production could be seen not only as a pre-emptive economic move, as the official position of the cartel states, but as a pre-emptive political move to challenge the implementation of the oil price caps.
As a result of this pre-emptive move, the caps became a lot more dangerous, and we may see an extended period of discussions yet, even though the official position of the G7 is that the caps need to be agreed upon as soon as possible. After all, these discussions have been going very well for months now, and we have yet to see a final decision.
By Irina Slav for Oilprice.com
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1- Russia will kill it by halting immediately crude oil exports to any country implementing the cap
2- Even without Russia’s cuts, the cap won’t work in a tight global oil market and a fast-shrinking spare production capacity including OPEC+’s.
3- OPEC+ cut will make the cap far more costly for Western buyers.
4- There is no benefit for China, India, Indonesia and Turkey from supporting the cap since Russia is already giving them a price discount.
5- The cap could send Brent crude to $110 a barrel.
Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert