Price Caps on Russian Oil: A Silver Bullet, or a Shot in the Foot?
By James Robert Balzer, Policy Briefs Writer
Over the last five months, Russia has faced one of the most severe sanctions regimes in history. And yet, it has managed to stave off a full-blown economic crisis. This has partly been the result of harsh capital controls imposed by the Kremlin. But to a large extent this has also been because of high oil prices. Notably, energy exports represent over half of Russia’s fiscal revenues, of which oil constitutes the dominant share. Prior to sanctions, Russia accounted for approximately 25% of the EU’s oil imports, providing Russia US$1 billion per day.
Consequently, the best policy for the G7 and their partners to cut off Moscow’s finances is to target its oil revenues. One instrument that could be leveraged to this end is a price cap.
A price cap could be implemented through a purchasing cartel. The allure of low prices could incentivise neutral or pro-Russian countries like India and China, respectively, to abide by the price cap. If this is not enough to persuade them, secondary sanctions could be imposed on market actors that engage in or enable non-price cap oil transactions.
While this is possible, it carries much risk. The recent energy price boom has been largely driven by uncertainty and expectations of a supply cut rather than an actual supply squeeze. Consequently, if a price cap is not rigorously enforced, it could lead to greater confusion among brokers (thereby increasing risk premiums and prices) while leaving exploitable loopholes that would diminish its effectiveness.
Another problem is that if a price cap is not accompanied by quotas or rationing across the major buyers, then lower prices could cause Russian oil sales to increase outside sanctions-abiding markets (or simply where enforcement is weak) at the expense of non-Russian supply. In such a scenario, increased volumes and market share could compensate for lower prices and allow Russian revenues to stay afloat.
The West and its partners could, of course, simply expand their embargo through secondary sanctions and consequently push Russian supplies off the market. However, this would depend on markets already having “priced in” past supply-cut expectations. If this is not the case and enforcement is questionable, it could increase prices, which would harm consumers, erode public support for sanctions, and encourage circumvention of the embargo.
Even assuming that a global embargo is put in place and enforced effectively, governments would likely ask for a gradual implementation timeline to smooth shocks for domestic industries and consumers. This would, however, allow Russia to make a lot of money until the embargo has taken full effect.
Consequently, the success of a price cap will depend on two key factors — the availability of alternative supplies and the ease of enforcement.
With regard to the former, OPEC and especially Saudi Arabia have a key role to play. Following Biden’s visit to Saudi Arabia. Riyadh agreed to increase its July and August production by 50%. This will contribute to stabilising oil prices, but it might not be enough.
Meanwhile, ease of enforcement matters because it will determine whether precious Western political capital is spent wisely on the international stage on a policy that achieves its objectives, or one that is unfeasible and even counterproductive.
Whether or not the EU, the G7, or a wider coalition agree on a price cap, several policies can and should be pursued by governments now. This includes attacking Russia’s ability to convert Western currencies and thereby severing the link between its oil revenues and public finances. Additionally, European countries should pause the closure of nuclear power plants and pursue alternative gas and oil supplies in order to pre-empt a Russian retaliatory gas cut-off. In this vein, the EU could collaborate with Turkey to develop an interconnection agreement with Bulgaria and Greece, allowing for European access to Turkish LNG terminals. Finally, governments should create greater incentives for energy efficiency in industry and encourage consumers to reduce their energy use to replenish reserves for the winter.
None of this will be easy. But Western states cannot afford the strategic cost of inaction. And if it can present a united front through to the end of the coming winter, the trans-Atlantic community will be much better placed to put pressure on Moscow to end its brutal war of aggression against Ukraine.
What we’re following …
JRB: I’m following Europe’s ongoing heatwave and what it means for action on climate change. On this note, the US and Australia recently announced a “net zero technology acceleration partnership” on areas such as long-duration energy storage and digitising power grids.
I’m also following the European Commission’s legal action against Hungary over an anti-LGBTQ law and its refusal to renew the licence of Klubradio, a broadcaster critical of Orbán’s government.
Finally, I’m following (as is everyone else, it seems) the Euro’s recent drop below dollar parity for the first time in almost twenty years and what this means for the European economy.
VD: Ever since Russia’s full-scale invasion began on February 24th, I’ve focused on developments on the military, diplomatic, and information fronts at the expense of internal Ukrainian political developments related to the rule of law and corruption. Progress in these areas will be crucial for the country’s (as well as the continent’s) post-war reform, prosperity, and stability, so recently I’ve tried to make a greater effort to stay informed on these issues. My job’s been made a bit more intriguing by the news this past week that President Zelensky has suspended the head of the country’s intelligence agency (SBU) and the prosecutor general on suspicions of treason.
What we’re reading …
VD: I recently finished Eric Protzer and Paul Summerville’s Reclaiming Populism: How Economic Fairness Can Win Back Disenchanted Voters. The book makes the important case that the wave of populism in recent years is not a result of immigration, inter-generational change, globalisation, or income inequality (or, at least not on their own), but rather of poor social mobility resulting from unequal opportunity and unfair unequal outcomes.
The book is relatively short, so I would recommend it for anyone interested in the topic (another great book which approaches the issue of illiberalism in Hungary, Russia, and the US from a cultural angle is The Light that Failed: A Reckoning by Ivan Krastev and Stephen Holmes).
In addition to the overarching argument mentioned above, there are two key takeaways of the book for me: Firstly, it’s vital that populist voters’ grievances are taken seriously and treated as legitimate; the act of discrimination, for instance, should be condemned, but rejection of and condescension towards someone in essentialist terms (“you are racist, intolerant, etc.”) only reinforces the perception that unfair economic outcomes are the result of malevolent elites and out-groups. Second, policy recommendations often take the form of one-size-fits-all laundry lists of “best practices”, but these fail to recognise that politicians have limited political capital and administrative resources to work with; a more country-specific approach that identifies “binding constraints” on equality of opportunity and fair unequal outcomes is therefore needed.
Finally, this morning I read Francis Fukuyama’s recent blog post on partisanship and the state of democracy in the US. Its message is important and something that I think everyone should read in light of current circumstances in the US and the rest of the world.