The Economics Of A Russian Oil Price Cap

Energy The Economics Of A Russian Oil Price Cap James Broughel Contributor Opinions expressed by Forbes Contributors are their own. I am a senior research fellow at the Mercatus Center. Following New! Follow this author to stay notified about their latest stories.

Got it! Oct 17, 2022, 05:45pm EDT | New! Click on the conversation bubble to join the conversation Got it! Share to Facebook Share to Twitter Share to Linkedin U. S. Treasury Secretary Janet Yellen speaks during a news conference at IMF headquarters, October .

. . [+] 14, 2022 in Washington, DC.

(Photo by Drew Angerer/Getty Images) Getty Images Economists often oppose price controls, given their predictable consequences: shortages and surpluses. So it is notable that a group of prominent economists recently signed a letter to Treasury Secretary Janet Yellen endorsing a price cap on Russian oil. The economics aren’t so clear in this instance, as considerations other than market efficiency take precedence during times of war.

Therefore, it’s worth thinking carefully about what effects a price cap might have. Last September, the Group of Seven nations agreed to impose a price cap on Russian oil, and in the last few weeks, Secretary Yellen has worked hard to get other countries on board the policy too. This follows the U.

S. already banning Russian oil and gas imports. Meanwhile, Europe is instituting a ban on seaborne crude oil set to go into effect in early December, and a ban on petroleum products will follow shortly thereafter in early February.

To begin to anticipate the effects of these policies, it helps to understand that any barrel of oil is indistinguishable from another, and that no individual producer has much impact on price. So, for instance, if prices of gasoline in, say, New York, are higher than those in Connecticut, oil companies will rationally respond by sending all of their gas to New York and none of it to Connecticut. In doing so, the price will fall in New York and rise in Connecticut until the prices are the same across the two states.

That’s roughly the situation now, in which gas price discrepancies across states are mostly driven by state taxes , and to some extent transport and marketing costs. Extending this logic to international markets, it’s easy to see that if Europe and the United States ban imports of Russian oil, Russia will respond by selling its oil elsewhere. And that is precisely what it is doing.

China and India remain major customers, despite western sanctions. This is where the price cap comes in, which is a means to expand the reach of Russian sanctions to more countries. At first glance, the policy looks not so different from a ban.

If a country sets a price cap on Russian oil at $60 a barrel, as Yellen has suggested , Russia will sell its oil to countries without a cap given that the world price is about $85 now. Indeed, this is what Russia says it will do. The Russian Deputy Prime Minister recently said Russia would not deliver oil to countries with a price cap.

MORE FOR YOU Hiring Refugees: How One Big Factory Did It Biden’s Student Debt Relief Application Is Officially Live Google Cloud Next 2022 – Customers Benefit From Enhanced AI Capabilities In anticipation of this, western countries are imposing additional restrictions on finance and insurance services for transport of Russian oil. This is the main source of leverage U. S.

and European leaders have to get other countries to accept the policy domestically. Imposing the cap would grant them access to western insurance services, thereby allowing them to purchase Russian oil that might not otherwise be available. Visualization by Bhabna Banerjee SOURCE: Yahoo! Finance It’s easy to see how difficult this game of regulatory whac-a-mole is to win.

One intervention begets another, and another, and none are totally successful. Turkey, for instance, has been ambiguous about whether it will adopt the policy. Indonesia remains unconvinced , voicing concerns about oil policy being driven by geopolitics.

To-date, sanctions have not succeeded at cutting off funding for the war in Ukraine. Complicating matters further is that OPEC and its allies recently moved to cut oil production by 2 million barrels per day. This could have the effect of raising oil prices at a time when the U.

S. and Europe are trying to constrain them. U.

S. politicians are howling in response to OPEC’s proposed cuts, with some members of Congress even sponsoring legislation titled “ NOPEC . ” Sadly, U.

S. politicians probably care less about the situation in Ukraine than they do about rising gas prices ahead of an election. Not surprisingly, OPEC has different priorities.

As the economist Omar Al-Ubaydli explained recently in an article for Al Arabiya News, the international oil cartel likely wants to ward off a decline in investment that would accompany a drop in prices, as this could entail unwanted challenges for the cartel down the road. Any attempt to increase supply by pressuring OPEC will likely fail. Moreover, OPEC’s production cuts may not even raise prices by much.

In part, that’s because OPEC’s quotas are often not adhered to consistently by members. OPEC also isn’t the only game in town; there are many non-OPEC oil-producing countries, and any attempt at coordinating all their production activities will likely prove a fool’s errand. At the end of the day, a price cap could potentially reduce oil revenues to Russia, but this is far from assured.

Such an action could easily backfire , leading to further geopolitical instability. Gazprom, the Russian gas giant, is already threatening to cut off natural gas sales to Europe if a price cap is imposed. If energy prices rise in response, a price cap could well end up accomplishing the opposite of its intended goal.

Given all this uncertainty, it is hard to be optimistic about the policy. The hearts of the advocates are in the right place. The best argument in favor of the policy may be that doing something is better than doing nothing—but even that is not guaranteed.

Follow me on Twitter or LinkedIn . James Broughel Editorial Standards Print Reprints & Permissions.