The West’s proposed price cap on Russian oil is no magic bullet

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Editor’s note: After months of negotiations, on December 2 the G7, the European Union and Australia agreed to impose a $60-a-barrel cap on Russian oil shipments.

Nin months after Ukraine invasion, oil money continues to fill Vladimir Putin’s war chest. Even as the West has imposed sanctions, Russian crude exports have held up and the price of Urals oil remains close to the average in 2014-20. Russia’s current account surplus this year is expected to be $265bn, second only to China. But the story is not over yet. On December 5, the European Union will finally implement a plan originally prepared in May. It will ban Russian oil imports from the sea. It also bans European companies from insuring, shipping or trading Russian crude anywhere in the world – unless the oil is sold at a price below a cap set by the West .

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Ever since the war started in February this year, the west has been stuck in a dilemma. How should he cut Russia’s fossil fuel earnings without reducing the global supply of oil and fueling inflation that hurts consumers around the world? When Europe first dreamed up their ban, they threatened to deal a major blow to Russia’s oil cash flow. European insurers and shipping companies have long held a stranglehold on energy markets. 95% of property and protection insurance for each oil tanker is handled by British companies and the them. This seemed to be a lever with which the West could control the sale of Russian oil around the world.

But even as the ban was announced there was an obvious flaw. If Russian oil fails to hit the market, global oil prices may rise, hurting Western consumers. So the American Treasury department has devised a clever plan to reduce it: to allow European companies to continue offering their services, while the oil involved is bought at a price set by the West.

On paper, this looks silly. Setting the price below the market rate that Russia receives today would reduce revenue. And as long as the price is above the cost of production (which is expected to be around $20-44 per barrel), Mr. Putin would still have a reason to pump oil. Consumers would get oil at a discount and inflation would be kept under control. Non-aligned countries like China and India would certainly jump at this bargain.

According to hard-headed oilers, however, life rarely turns out so cute. There are two uncertainties. One of them is how Mr. Putin will respond if European companies really have a stop and can restrict his ability to get some oil to market. Russia has already said it will refuse to use tankers that will join the oil cap scheme. It could cut oil exports, relying on a smaller group of tankers and insurers outside the West, and send world prices soaring.

Fear of this could explain why the West has been careful to pin the price of oil at a level that is still attractive to Russia. At the time of writing, the rate was expected to settle at around $60 per barrel, which is roughly the current market price for Urals oil. But that would mean that the embargo-and-price-cap scheme does not have much grip.

The other uncertainty is how much power the West will eventually have over global oil markets. A shortage of tankers outside the West could limit Russian supplies over the next month or two. Some types of insurance, for example, against large spills, are difficult to find outside the West. However, countries such as China, India and Indonesia want to avoid participating in Western sanctions and embargoes. They are looking for other sources of insurance every day – and, since the ban was announced six months ago, they have time to prepare.

The real balance of power in oil markets will emerge after December 5th. A brutal price spike is possible. But the lesson from this year is that, over time, the global oil system is more flexible than you might think. Just as financial sanctions have fueled efforts to circumvent the Western banking system, so the war will force China, India and others to bypass Western energy infrastructure. As weapons, sanctions and embargoes have their limits – and finite shelf lives.

Read more about our recent coverage of the Ukraine crisis.

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