Is a Russian price cap a good idea?
That is the topic of my latest Bloomberg column. Here is the basic idea:
Say the price of oil is $100 per barrel, and extraction costs Russia $50 per barrel. The profit on that oil is $50 per barrel. Now assume a price cap of $70 per barrel. Russian profit falls to $20 per barrel — but still, the oil will be produced. A finely tuned price control would redistribute income toward buyers of Russian oil, without much interfering with oil supply.
Enforcement would have to be through maritime services, such as insurance for the carrying ships.
But I am not sold on its workability or efficacy:
One problem is how to set the cap at the right level. The plan is to set a fixed cap, rather than at some percentage discount to world oil prices. As world oil prices change, it would therefore be necessary to adjust the cap, preferably quickly. Given that it has taken months to agree to the idea of a cap, it remains to be seen if this would be possible. And things only get worse if the Western coalition against Russia splinters, or if the relevant bureaucracies are slow.
If the price cap ends up too low and Russian oil is taken off world markets altogether, that could significantly worsen what is already a serious global economic downturn.
A second problem is that Russia might simply sell the oil to nations not participating in this agreement to cap prices, most notably China and India. But selling more to those countries might require Russia to lower the price. And while China and India are unlikely to join the G-7 plan, the very existence of the price cap gives them bargaining leverage over Russia.
The bottom line, however, remains: Any decline in Russian government revenue might be considerably less than what a plan to cap the price of oil might indicate. And that’s not even considering whatever Russia might earn from selling oil on the black market. Nations outside the G-7 would have an incentive to buy tankers, self-insure them and use them to ship Russian oil without the price cap.
But the major issue is one of escalation…
In any case worth a ponder, there are further arguments in the piece.