The US and its allies are looking to decide on a level for a price cap on Russian oil by next week with a view to curb the fossil fuel earnings that support Moscow’s budget, its military, and the invasion of Ukraine. The cap is to be implemented on December 5, the same day when European Union will also impose a boycott on most Russian oil even as the EU is yet to arrive at a price ceiling.
Both measures may impact the price of oil amid concerns over lost supply after the ban and lower demand from a slowing global economy.
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Price cap and its impact
US Treasury Secretary Janet Yellen has initiated the cap with other Group of 7 allies to curb Russia’s earnings from flowing to the global economy. It is aimed to hurt Moscow’s finances without impacting the sharp oil price spike in case Russia’s oil gets withdrawn from the global market, reported news agency AP.
Also, insurance companies and other firms involved in shipping oil would be able to deal with Russian crude if the oil is priced at or below the cap. Most of the insurers operating in the EU or the United Kingdom may need to participate in the cap because tanker owners may not be too keen to take on Russian oil in the absence of insurance and may face obstacles in delivering it.
Impact of oil flow on the global economy
The insurance ban, imposed by the EU and UK in previous sanctions, may take much of the Russian crude off the market causing a spike in oil prices. Western economies may be at the receiving end, and Russia would see increased earnings from whatever oil it can ship in defiance of the embargo.
Russia, which is the second oil producer globally, has been rerouting much of its supply to India, China and other Asian countries at discounted prices after Western customers banned it even before the EU action.
One of the reasons behind the cap is to provide a legal framework “to allow the flow of Russian oil to continue and to reduce the windfall revenue for Russia at the same time,” Claudio Galimberti, a senior vice president of analysis at Rystad Energy told the agency.
“It is essential for the global crude markets that Russian oil still finds markets to be sold after the EU ban is operative,” he added. “In the absence of that, global oil prices would skyrocket.”
The effect on cap levels
If a cap is imposed between $65 and $70 per barrel then it will allow Russia to sell oil keeping its earnings at current levels. Russian oil is trading at around $63 per barrel, a considerable discount on the international benchmark Brent.
While a lower cap at around $50 per barrel would prove to be difficult for Russia to balance its state budget. Moscow would need around $60 to $70 per barrel to do that to ensure so-called “fiscal break-even.”
However, that $50 cap would still be above Russia’s cost of production of between $30 and $40 per barrel, providing Moscow an incentive to keep selling oil simply to avoid having to cap wells that can be hard to restart.
Countries opposing the ban
On its part, Russia said it will not observe a cap and move on to stop deliveries to countries that do. A lower cap of around $50 is expected to provoke that response, or Russia may stop the last of its remaining natural gas supplies to Europe.
China and India may not proceed with the cap, while China may develop its own insurance companies to replace those barred by the US, UK, and Europe.
Russia could also look at schemes including transferring oil from ship to ship to disguise its origins and mixing its oil with other types to skirt the ban.
What about the EU embargo?
The biggest impact from the EU embargo may not come through by December 5 as Europe still hunts for new suppliers and Russian barrels are rerouted until February 5 when Europe’s additional ban on refinery products made from oil such as diesel fuel goes into effect.
Europe still has many cars that run on diesel. The fuel also is used for truck transport to get a huge range of goods to consumers and to run agricultural machinery — so those higher costs will be spread throughout the economy.