How will Europe’s oil price cap work?


An aerial view shows the Vladimir Arsenyev tanker at the crude oil terminal Kozmino on the shore of Nakhodka Bay near the port city of Nakhodka, Russia.

European insurance and trading firms will soon be blocked from handling Russian oil unless its price is below a pre-set cap.
Photo: TATIANA MEEL (Reuters)

Europe’s latest economic volley against Russia—a price cap on Russian oil—seems likely to land as a dud.

Russia can’t afford to maintain its war in Ukraine without selling its oil and gas to the global market. And much to the chagrin of Ukraine’s allies in Europe and the US, the global energy market can’t function smoothly without Russian oil and gas. Various tepid energy sanctions, including a ban on Russian fossil fuel imports by the US, have had almost no effect, as oil shipments have simply been diverted to China, India, and other buyers keen to snap it up at a discount. In November, Russian crude oil production was only about 2% less than it was before the invasion.

On Dec. 5, the EU will institute a modified embargo on almost all Russian oil. No matter who the final buyer, nearly all of that oil must first pass through the hands of Europe or UK-based traders, shipping companies, and insurers. A total EU embargo could choke off 10% of global oil supplies overnight, with likely devastating consequences for the global economy. To avert that, European shippers and insurers will now be allowed to bypass the embargo—if they agree only to deal with Russian oil below a designated price per barrel.

The arithmetic logic of the price cap on Russian oil

In theory, that price cap should be high enough that Russia is still incentivized to drill, but far enough below market value that it makes a serious dent in Russia’s profits. But in negotiations on Nov. 23, EU diplomats are settling on a price cap of about $65-70, according to Bloomberg—which is more or less the same price that Russian oil is already selling at.

Poland and other hawkish members of the bloc had pushed for $20, which would certainly do more damage to Vladimir Putin’s war chest but would also likely guarantee Russian production cuts and all the consequent turmoil to global energy prices and supply chains. In other words, European policymakers pulled their punches on sanctions in the interest of preventing further instability in the global economy.

Separately, EU policymakers also seem squeamish about a new price cap being negotiated this week for natural gas. Gas imports from Russia are not under embargo in the EU, but supplies have been cut significantly as part of Russia’s retaliation strategy, driving up electricity and home heating bills across Europe.

The new gas price cap is meant as a consumer protection measure. Once gas futures prices reach a certain point—regardless of where the gas comes from—regulators will block it from going higher, limiting the sticker shock to households and businesses. But the proposed cap—€275 per megawatt hour, and only if that price is reached for more than 10 days within a two-week period—is still far above pre-war prices. That cap will be negotiated further and possibly revised on Nov. 24.



Read More: How will Europe’s oil price cap work?

2022-11-23 07:14:00

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