US plan caps Russian oil price and maintains production

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Although the price of oil has fallen in recent weeks, it continues to soar, impacting gasoline prices and causing economic and political challenges in the US, UK and Europe. Increased supply from Russia would drive prices down, but the revenue from those extra sales would fuel President Vladimir Putin’s war machine.

Adding to the problem is a new round of EU sanctions aimed at targeting Russian oil imports by the end of the year. Such sanctions could push prices even higher, potentially triggering a global recession.

US Treasury Secretary Janet Yellen has offered a solution: allow Russia to continue exporting oil, but put a cap on the price Russia can charge. This would help contain oil prices while ensuring that the United States and its allies do not fund Russia’s ongoing aggression against Ukraine.

Yellen tried to convince world leaders of the plan, and the G7 leaders’ communiqué in late June expressed openness to the idea. Details are still largely unclear, but the plan would halt Russian maritime exports by denying Russian oil exporters the insurance they need to underwrite tankers – that is, unless Russia agrees to sell its oil at the ceiling price. Without insurance, vessels carrying Russian oil exports would not be able to access crucial international waterways.

The UK and Europe are able to exert considerable leverage. According to the Center for Energy and Air Quality Research, 68% of Russian crude oil deliveries this spring relied on vessels from the EU, UK and Norway. Almost all tankers were insured in the UK, Norway or Sweden.

If all goes according to plan, Russia would still sell the oil, as the price cap would be set just above the marginal cost of production. At this price, it would make economic sense for Russia to continue producing, but there would be little profit left for financing the war. And the additional oil exported from Russia would put downward pressure on world prices.

Of course, everything might not go as planned. Russia could retaliate by cutting off its oil or natural gas exports, inflicting severe damage on many US allies and global markets. Russia would bet it could endure the economic pain longer than countries that depend on its energy exports. Or Russia could circumvent the cap, offering to sell its oil to friendly countries at a price above the cap but below its open market price. Something similar is already happening under the existing sanctions regime: China and India, for example, buy oil from Russia at a discount of around $30 a barrel. And the benefits of the price cap could accrue primarily to refiners rather than households.

Still, the cap should be implemented. By not producing, Russia could inflict lasting damage to its oil wells, which it would seek to avoid. Similarly, Russia would be reluctant to flare its natural gas rather than sell it. Russia may retaliate, but a tighter grip on Russian energy revenues gives Western countries more ammunition to respond, not less. Money for peace.

Even if the cap doesn’t bring gasoline prices down much or if some countries – like China and India – refuse to comply, it would still put downward pressure on the price of oil and would reduce the risk that the next round of European sanctions could cause an energy price shock that would overturn the global economy.

Denying Russia access to the necessary insurance could be used more boldly than to put in place price caps. The United States, United Kingdom and EU could impose additional requirements on countries that want to buy Russian oil in return for insurance companies being able to guarantee tanker shipments. In addition, similar conditions could be imposed on the financing necessary for Russia to export oil.

One idea worth exploring would be to require countries that buy Russian oil below the price cap to impose a tariff. Part of the revenue from this tax could be sent to Ukraine to help it rebuild.

In the United States, it would force Congress to reverse its ban on Russian oil imports. It would be a huge political challenge for President Joe Biden’s administration. It would be just as difficult for other governments.

But it would allow the price cap to advance three goals, not just two: keep Russian oil in circulation to avoid an oil shock from impending EU sanctions; prevent the sale of this oil from financing the war in Ukraine; and using relatively cheap Russian oil to provide partial compensation to Ukraine to repair the damage caused by Putin’s brutal war.

Michael R. Strain is director of economic policy studies at the American Enterprise Institute.

Copyright : Project Syndicate

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