The economics of a Russian oil price cap

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Economists often oppose price controls, given their foreseeable consequences: shortages and surpluses. It should therefore be noted that a group of eminent economists recently signed a letter to Treasury Secretary Janet Yellen endorsing a Russian oil price cap. The economics are not so clear in this case, as considerations other than market efficiency take precedence in times of war. Therefore, it is worth thinking carefully about the effects that a price cap might have.

Last September, the Group of Seven Nations agreed to impose a price cap on Russian oil, and in recent weeks Secretary Yellen has work hard to get other countries on board the policy too. This is already following the United States prohibition Russian oil and gas imports. Meanwhile, Europe institutes a ban on crude oil transported by sea Come into force early December, and a ban on petroleum products will follow soon after in early February.

To begin to anticipate the effects of these policies, it helps to understand that one barrel of oil is indistinguishable from another and that no individual producer has much impact on prices. So, for example, if gas prices in, say, New York are higher than those in Connecticut, the oil companies will respond rationally by sending all their gas to New York and nothing to Connecticut. By doing so, the price will drop in New York and rise in Connecticut until the prices are the same in both states. This is roughly the current situation, in which gas price differentials between states are mainly due to state taxesand to some extent transport and marketing costs.

Extending this logic to international markets, it is 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 does. China and India stay large customers, despite Western sanctions.

This is where the price cap comes in, which is a way to extend the reach of Russian sanctions to more countries. At first glance, the policy does not seem so different from a ban. If a country caps the price of Russian oil at $60 a barrel, like Yellen suggested, Russia will sell its oil to countries with no cap since the world price is currently around $85. In fact, that’s what Russia says it will do. The Russian Deputy Prime Minister recently said Russia would not deliver oil to countries with a price cap.

In anticipation of this, Western countries are imposing additional restrictions on financing and insurance services for the transportation of Russian oil. It is the main source of leverage that US and European leaders have to get other countries to accept the policy domestically. Imposing the cap would give them access to Western insurance services, allowing them to buy Russian oil that might not otherwise be available.

It’s easy to see how difficult this regulation mole game is to win. One intervention begets another, then another, and neither is completely successful. Turkey, for example, has been ambiguous whether he will adopt the policy. Indonesia remains not convinced, expressing concerns that oil policy is driven by geopolitics. To date, sanctions have failed to cut funding for the war in Ukraine.

To complicate matters further, OPEC and its allies recently switched to cut oil production 2 million barrels per day. This could have the effect of raising oil prices at a time when the United States and Europe are trying to constrain them. American politicians are howling in response to proposed OPEC cuts, with some members of Congress even sponsoring legislation titled “NOPEC.”

Unfortunately, American politicians probably care less about the situation in Ukraine than about rising gas prices ahead of an election. Unsurprisingly, OPEC has different priorities. Like the economist Omar Al-Ubaydli Explain recently in an article for Al Arabiya News, the international oil cartel probably wants to avoid a drop in investment that would accompany a drop in prices, as this could lead to unwanted challenges for the cartel along the way.

Any attempt to increase supply by pressuring OPEC will likely fail. In addition, OPEC’s production cuts Maybe not even raise the prices a lot. This is partly because OPEC quotas are often not systematically respected by members. Nor is OPEC the only game in town; there are many non-OPEC oil-producing nations, and any attempt to coordinate all of their production activities is likely to prove a wild ride.

Ultimately, a price cap could potentially reduce Russia’s oil revenues, but that is far from assured. Such an action could easily backfire, leading to greater geopolitical instability. Gazprom, the Russian gas giant, is already threatening to cut natural gas sales to Europe if a price cap is imposed. If energy prices rise accordingly, a price cap may well end up accomplishing the opposite of its purpose.

Given all this uncertainty, it’s hard to be optimistic about politics. Defenders’ hearts are in the right place. Perhaps the best argument for politics is that doing something is better than doing nothing, but even that isn’t guaranteed.

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