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What Price Is Right? Why Capping Russian Oil Is Complicated.

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WASHINGTON — As the United States and its Western powers race to finalize an oil price cap mechanism aimed at draining Russia’s revenues and stabilizing global energy markets, key questions remain unresolved. Still: How should prices be set?

A group of seven countries, which formally endorsed the concept of a price cap this month, are weighing how much Russia will allow to charge for its oil as it prepares to announce details of its plans. This has emerged as a central issue that will determine the success of this novel idea, Russia’s response and the trajectory of oil prices as winter approaches. Setting prices requires coordinating a complex array of economic and diplomatic forces that govern volatile oil markets.

Time is running out, as a wrong cap on oil prices could have a severe impact on the global economy. The Biden administration fears that if the cap is not set by early December, oil prices around the world could skyrocket given Russia’s extraordinary role as an energy producer. The European Union’s oil embargo and financial and insurance services ban on Russian oil trade, when they take effect on December 5, could remove millions of barrels of Russian oil from the market, sending prices skyrocketing.

With European finance and insurance dominating the global oil market, imminent sanctions could end their own embargo by making it difficult or expensive to obtain Russian oil at a time when energy costs are already high. The price cap is basically an exception to Western sanctions that allows the sale and shipment of Russian oil as long as it is below a certain price. increase.

The idea has drawn praise from economists who see it as an elegant win-win strategy for the West. However, many energy analysts and traders have expressed deep skepticism about this notion. They believe fears of sanctions could scare financial services companies away from Russian oil, and that Russia and its trading partners will circumvent the cap through new forms of insurance and illicit trade.

The impact of the proposed oil price cap, and the potential for unintended consequences, are the two biggest problems facing countries that have endured supply chain disruptions and rapid inflation caused by Russia’s war with Ukraine. .

“We’re looking at a much more complex oil market,” said Paul Sheldon, geopolitical risk analyst at S&P Global Platts Analytics. We are in new territory on several levels.”

Exactly how the price cap will be set remains unclear.

In a joint statement this month, G7 finance ministers said the “initial” price cap would be determined by the group of countries participating in the deal, based on a set of “technical inputs”. The Treasury Department’s Office of Foreign Assets Control said last week that price ceilings would be determined by “various factors” and that countries that are part of the price ceiling coalition would make decisions by consensus. The coalition is headed by a rotating coordinator from each country.

A Treasury official said the process of setting the level of the oil price cap would constitute the next stage of the agreement, after the technical details of its implementation have been decided and more countries have signed the coalition.

When U.S. officials consider setting a price cap, they focus on two numbers. The cost of Russian oil production and the price of commodities historically available on world markets before the war in Ukraine pushed prices higher.

The Biden administration recognizes that the ceiling is set so low that Russia will have no incentive to continue producing oil if it cannot sell it at a price above the cost of production. However, setting the cap too high would allow Russia to benefit from the turmoil it caused, and would undermine the cap’s ability to sufficiently reduce Russia’s oil export revenues.

Before the war and pandemic, Russian crude oil, known as Urals, typically sold between $55 and $65 a barrel. Determining Russian production costs is more complex, as some wells have higher operating costs than others. Most estimates are around $40 per barrel.

Your price cap could fall somewhere between these numbers.

Officials are also debating whether to include transportation costs in the cap or just the oil itself. , individual limits will be established.

Oil prices have hovered around $90 a barrel for the past few weeks. Russian oil is now sold at a discount of about 30%. Some analysts believe that setting the cap at a level lower than the global benchmark price would be more effective as oil prices can fluctuate sharply.

Ben Cahill, senior fellow in the Energy Security and Climate Change Program at the Center for Strategic and International Studies, said, “Correction at a certain level could create risks because markets could fluctuate.” There is,’ he said. Setting it too high can cause the price to fall below the cap level.

“We want the price ceiling to be significantly lower than the global average to add to Russia’s economic pain,” he said.

At present, the Treasury Department does not appear to support such an idea. The United States intends the cap to be a fixed price, which is subject to periodic review and change if agreement parties agree. The frequency of reviews depends on market volatility. Setting the cap at a discount rate would add complexity and increase compliance burdens, Treasury officials said.

Ensuring compliance with price caps is another hurdle. Treasury officials, in consultation with banks and marine insurers, have developed a system to “prove” the prices paid by purchasers of Russian petroleum products and relieve financial service providers of liability for violating limits. ing.

The Treasury ministry said in guidance last week that Russian oil service providers for seaborne shipments would not be subject to sanctions as long as they obtain documentation proving that the caps have been complied with. It warned that buyers who knowingly purchased oil above the cap price using degraded insurance “could be subject to sanctions.”

It is difficult to predict the impact of price caps on global markets. Cahill suggested that essentially three layers of crude could be created. Some Russian oil is sold at cap prices, other Russian oil is sold illegally or with another form of financing, and non-Russian oil is sold by other oil producing countries.

It is unclear how many countries outside the G7 will join the agreement. The Biden administration hopes that countries such as China and India will use it as leverage to negotiate price cuts with Russia, even if they don’t formally participate.

Besides the oil price ceiling, another big wild card is Russia’s response to it. Russian officials have said they will not sell oil to countries that are part of the price cap coalition, and analysts expect the countries to do their best to foment volatility with some form of retaliation.

The U.S. wants economic logic to prevail and oil to continue to flow even when prices fall.

Deputy Treasury Secretary Wally Adiemo said last week at a Brookings Institution event that “Russia may go nuts and say it won’t go below the ceiling, but the economics of holding back oil just makes no sense. “No,” he said. “The price cap creates a clear economic incentive to sell under the cap.”

Edward Fishman, a senior fellow at the Center for Global Energy Policy at Columbia University, said price caps could work because they would create incentives for most oil trade buyers, sellers and facilitators to align toward compliance. claimed. He suggested that global oil prices could organically gravitate towards the ceiling level.

But Fishman acknowledged that Russia and its president, Vladimir V. Putin, may look at incentives differently.

“There will always be a grain of doubt in people’s minds about Putin’s rationality and his willingness to set the global economy on fire and his own to make a point,” Fishman said. Stated.

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