Jeffrey Sonnenfeld and Steven Tian
Last week’s bold announcement by the G-7 of a price cap on purchases of Russian oil has met with skepticism and ridicule from media commentators and pundits. Following months of planning, the oil price cap is a bid to limit the Kremlin’s earnings on exports of its most important commodity and reduce financial support for its war against Ukraine. After the G-7 announcement, the Kremlin immediately said that Russia would not sell any oil to countries abiding by the price cap.
The critics contend the scheme will never work—but they are wrong. Based on our conversations with officials from the U.S. Treasury and the British cabinet, other senior leaders in G-7 governments, and top business executives in several key sectors, it is clear that the critics are much too quick to dismiss the price cap. In fact, the business leaders we surveyed overwhelmingly support the plan. Here are some of the most common questions about the G-7 plan—and why the critics are wrong.
1. Why do we even need a price cap on Russian oil?
Even if you don’t care about Russia or Ukraine, doing nothing is not an option for purely economic reasons. Regardless of what happens with the proposed price cap, the European Union’s sixth sanctions package is set to ban all Russian crude oil imports by sea into the bloc starting Dec. 5 and all refined oil products—such as gasoline, diesel, and fuel oil—starting Feb. 5, 2023. It is a hard cutoff with no phased implementation, which analysts say could lead to overnight supply shocks and skyrocketing prices. The oil price cap must therefore be evaluated in terms of its effect not on the current situation but relative to the possibility of supply shocks after Dec. 5—when Russian President Vladimir Putin could benefit from significantly higher oil prices even if export volumes drop.
From this perspective, an oil price cap is a way to keep Russian oil flowing into global markets and preserve economic stability—the top priority for G-7 governments—while simultaneously limiting Russia’s profit margin on each barrel sold.
2. Won’t any price cap be undermined by countries not participating in sanctions?
Critics argue that India, China, Turkey, and many other countries will never go along with a price cap—and that an oil price cap that isn’t global will never work. While it’s true that many countries likely won’t officially sign on to the cap, they don’t need to for the plan to work. That’s because the critics ignore the fact that nonparticipating countries’ goal is to get the lowest price for buying oil, and the price cap will give them additional leverage in their negotiations with Russia. Already, India, China, and other developing nations are buying Russian oil at an unprecedented discount of as much as $30 per barrel. Russia is so desperate to find buyers of its oil that it is offering long-term, fixed-price contracts at a massive discount to try to lock in at least some future revenue. But one Asian economic minister told us confidentially that he is convinced he can negotiate a significantly better deal than even Russia’s initial offer of a $30-a-barrel discount—especially since financing, insuring, and shipping Russian oil will also be restricted under the G-7 plan. That will give him additional leverage to push these expenses onto Russia’s dime, further eating away at Putin’s profit margin. And as for China, former U.S. official Robert Hormats rightly pointed out to us that Beijing has a long-standing policy of diversifying its energy sources, from which it never diverges. That puts a ceiling on how much oil China can purchase from Russia in practice.
3. Won’t the oil price cap be easy to undermine and impossible to enforce?
When critics point to enforcement challenges, logistical hurdles, and the so-called leakiness of sanctions, they miss that compliance with U.S. government policies—especially sanctions—is a top priority for every major global business. The risk of running afoul of sanctions simply carries much more danger than the marginal benefit of taking every last penny on the table. Similar skepticism existed prior to the implementation of anti-terrorism financing sanctions and money laundering initiatives following 9/11—yet today, every major financial institution has the skills and infrastructure needed to ensure compliance. Similarly, the private sector will now find a way to adapt to the new policies to ensure compliance, especially as top CEOs privately say they much prefer the oil price cap to the alternative, a blanket ban. They are thus incentivized to proactively cooperate.
Of course, there will be some leakiness. Smaller, often privately held companies involved in financing, shipping, and commodities trading and located in Russia or other nonparticipating countries may continue to offer services for shipments of Russian oil, but at higher rates—further eating into the Kremlin’s profits. Neutral refineries will continue to process Russian crude and sell refined products into the global marketplace. But what matters most is that every major multinational business will be unwilling to finance, purchase, trade, ship, and insure Russian oil. For example, 90 percent of maritime insurance is based in the European Union or Britain and will soon shut out Russia. With ports, shipping lanes, and oil tankers off-limits, Russian oil exports will face logistical hurdles and long delays; already, Russian oil that used to be shipped from Baltic and Black Sea ports to Europe has been rerouted to Asia, where it takes around 30 days longer to arrive. All these hurdles ensure that Putin’s profit margin will be seriously eroded.
4. But what about inflation? Won’t sanctioning Russian exports send the prices of oil and gasoline skyrocketing?
Quite to the contrary: The oil price cap is explicitly designed to prevent a skyrocketing oil price, which would arise from the EU’s complete ban on seaborne Russian oil effective Dec. 5. In fact, financial markets are already signaling price stability and even lower prices over time. The oil futures market is in steep backwardation, which is the technical term for when markets are pricing the future oil price to be considerably lower than today’s. In other words, financial markets are hardly in a panic and may even welcome the oil price cap.
Furthermore, there is lingering confusion in the media over Putin’s ability to make up for lower revenues per barrel by ramping up production. These commentators ignore that Russia is one of the world’s least efficient oil producers, with one of the highest full-cost break-even prices among OPEC+ countries. (Russia’s break-even price is roughly double Saudi Arabia’s, for example.) Putin cannot make up lost profits with higher volume, especially once Russian oil is discounted to barely better than break-even prices on top of higher costs for longer ocean voyages.
5. Won’t Putin just stop selling oil, as he has threatened to do?
It is important to call Putin’s bluff. Although the Kremlin has declared that Russia will refuse to supply any country that participates in the price cap, energy exports make up make up more than half of Russia’s total government budget in most years. With Russia’s revenues from natural gas already set to decline significantly, Putin cannot genuinely afford to shut off his country’s oil spigots while its economy reels from the ever-increasing costs of the war.
Furthermore, Western buyers would hardly be disadvantaged. Oil markets have never been truly global, and there have always been discrepancies in how much different countries pay for different grades of oil from different sources. If some countries are willing to pay a few dollars above the price cap, it would not undermine the plan.
As former U.S. Special Envoy for Eurasian Energy Richard Morningstar told us, “I started as a cynic on price caps … but at this point, there is really no downside.” A closer look at the facts suggests that the critics and cynics are slipping on oil—and that the price cap might be a greater gusher than many realize.
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