The largest economies in the West agreed earlier this year to cap the price of Russia’s most valuable export and promised to discuss the details by early December. The move is aimed at reducing the flow of funds into President Vladimir Putin’s military coffers without adding to the strain on the global economy by further cutting energy supplies.
But as the deadline approaches, countries are still arguing about where the limit should be set.
“At this price point, we are talking about reducing inflation, not about reducing revenue in Russia,” said Helima Croft, head of commodity strategy at RBC Capital Markets.
At the beginning of the month, a barrel of Russian Urals oil cost a little more $70, about $24 below Brent, the international benchmark.
Meanwhile, lower prices could exacerbate the global energy crisis, especially if Russia retaliates. If he were to cut production more than expected, it would drive up fuel prices in the same way that countries like the US, Germany and Japan are trying to curb inflation.
On Thursday, Putin said the West’s plans to cap oil prices would have “serious consequences” for energy markets.
Is the price correct?
But the policy debate is dragging on, highlighting the complexity of the effort.
This will make it harder for Russian customers like China and India to continue importing millions of barrels a day. Most of the insurers that cover the transportation of crude oil are based in Europe or the UK, which cooperates with Brussels.
The oil price cap is intended to change this policy. Transportation services and insurance can be provided to tankers carrying Russian oil, provided that it is purchased at or below the price set by Western countries.
“This will help further reduce Russia’s revenues while maintaining the stability of global energy markets by continuing supplies,” the European Commission explained. “So it will also help manage inflation and keep energy prices stable at a time when high costs, especially higher fuel prices, are a major concern.”
However, it was not easy to actually set the price. Poland and other Eastern European countries want a lower limit, noting that pumping each barrel of oil costs Russia much less than $65 to $70. Thus, a cap between these prices will allow Moscow to continue to profit from crude oil sales.
Consulting firm Rystad Energy estimates that production costs for Russia are between $20 and $50 per barrel, depending on how the numbers are processed.
In addition, the Russian budget includes a forecast that in 2023 oil will be exported at an average price of about $70 per barrel. If Russia can get this price in the market, it can continue to spend mostly planned spending.
Ukrainian President Volodymyr Zelensky said on Friday that the ceiling should be set at $30 instead.
“We hear about [proposals to set the cap per barrel at] 60 or 70 dollars. Such words are more like a concession [to Russia]”, he said via video link at a conference in Lithuania.
However, if the price turns out to be too low, Russia could kick in and cut production. This could cause turmoil in the markets, given that Russia’s exports in 2022 will be about 9.7 million barrels per day, according to the International Energy Agency. This is higher than in 2021.
Breakdown is inevitable
The price level is not the only problem. Establishing a fixed price cap range – as opposed to setting a floating discount on Russian oil tied to where Brent is traded – could create logistical problems as it would need to be adjusted frequently.
According to Giovanni Staunovo, an analyst at UBS, oil traders are also skeptical about the possibility of introducing this measure. He expects parties to deals to simply look for loopholes.
“There is a strong desire to do something,” he said. “But the reality will be different.”
Some analysts think price caps will end up being less important than a European oil embargo. The bloc is buying about 2.4 million barrels a day of Russian oil, and Moscow will soon be forced to hunt for new buyers.
To limit the number of spare barrels, production is likely to decrease. This could push oil prices up no matter what.
“Due to the EU oil embargo and the planned cap on oil prices from Russia, the country’s oil production is likely to be significantly reduced,” Commerzbank said in a message to customers. “This should lead to higher prices for Brent crude in the coming weeks.”
— Claire Sebastian, Allegra Goodwin, Betsy Klein, Radina Gigova and Uliana Pavlova contributed reporting.