The price ceiling on Russian oil. What's new?

Shalom, dear subscribers. This is your favorite economics blog. And we once again have the subject of the Russian oil price cap.

The US terms

On November 22nd, the US finally rolled out a package of documents describing the mechanism of the Russian oil price cap they are promoting: https://home.treasury.gov/policy-issues/financial-sanctions/recent-actions/20221122. And it is very interesting in its own right.

First, the U.S. declares that its key objective is to keep Russian oil on the market, leaving economic incentives to do so, but at the same time to ensure a ceiling on excess profits from its sale. The price is proposed to be set equal to the current price or a little higher, with the possibility of recalculation once a quarter.

Second, the regime of sanctions on oil transportation is relaxed - Russian oil purchased below the price ceiling can be transported legally and safely insured. In order to avoid refusals, insurers will be relieved of responsibility in case the oil purchaser has lied about its origin or price.

Thirdly, there were introduced exemptions for some countries, mainly those who do not have convenient sea logistics.

Fourthly, the restrictions will not apply to oil products made of Russian oil or its "processing", i.e. dilution. In this case, suppliers must not give unreasonable mark-ups.

In summary. The rules are rather soft, because the US is trying to make them as acceptable to Russia as possible, recommending to set such a ceiling, at which the Russians are guaranteed to get a profit. In addition, there are loopholes to get around, but most likely on purpose, and those who use them can be penciled in. The Americans clearly want Russia to agree to these proposals, which would legitimize the scheme itself and allow it to expand worldwide.

But there is a very great risk here. After all, there are no guarantees in the document that the price ceiling will not start to be cut a little bit after Russia joins it, stifling its oil exports, but still leaving it profitable. In addition, the ready mechanism of the price ceiling, which the U.S. thinks all countries in the world will join, remains a threat to other oil-producing countries, because it would not be difficult to recalibrate it on them, especially if they agree to cooperate with the G7 countries in complying with the oil ceiling.

This would seem to be a cunning plan that could give the U.S. an incredibly effective tool for manipulating the oil market. But since the U.S. itself has not been buying Russian oil since spring (sanctions are prohibited), the issue was left to a meeting of EU and G7 ministers. And remember the gas circus two months ago? Well, it's repeating itself. "Boris, just don't hire idiots on this case."

The EU reaction

Since the implementation of the price ceiling mechanisms requires a change in the sanctions policy, a unanimous decision of all 27 EU countries is required. And there are big problems with that. The U.S. has proposed using a ceiling of $70 per barrel, which is $3 higher than the current price of Urals oil produced in Russia, but $30 lower than the maximum price for the previous six months. If Russia enters into a deal with such a ceiling, it will not be affected by the price ceiling if oil prices remain at current levels. BUT such low oil prices are the result of rather murky market manipulation due to the misinformation in the press in recent weeks, when the price could fall by 5-10% in a day and then rebound.

But wise European diplomats and politicians decided that 70 bucks was too expensive and the European Commission decided to discount it by 5 dollars. But even the price of $65 did not satisfy some countries. According to unnamed diplomats from unnamed EU countries, some of them are inclined to the range of $50-60, which will allow them to straighten out their economic problems. Poland, Estonia and Latvia have demarched that they will veto unless the ceiling is set at $30. In doing so, they are linking the adoption of a price ceiling to the new 9th sanctions package.

And here's the interesting thing. The cost of oil production in Russia is around $40: some fields are lower, some are higher. If we set a ceiling of $30, then Russia will have no incentive to supply oil to the West and, as Putin threatened, we will simply mothball unprofitable drilling rigs. With a $50-60 ceiling, some of the drilling rigs will also have to be mothballed, and the overall oil and gas revenues will be too small for investment in oil and gas development, as was written about back in February in RG: https://rg.ru/2022/02/19/rossijskaia-neft-s-kazhdym-godom-stanovitsia-dorozhe.html And there are no guarantees that the price of $65 will be profitable for the Russian oil and gas industry. That is why there is a good chance that the Europeans will now disrupt the big oil game for the Americans.

The Gas Ceiling

But this was not enough for the Europeans, and they decided on the wave of discussions to talk about the gas price ceiling again. This time, the document born by the EC contains not only specifics, but also mechanisms of the gas price ceiling. To tell the truth, everything here is very funny. Let me remind you that the EU wants to introduce a price ceiling for all gas suppliers because it believes that spot prices on the exchange are unreasonably high. Gas suppliers have already hinted that Europe will never see gas if the price ceiling is introduced.

And now the new document names the ceiling limit - €275 per 1 MWh (about $3,000 per 1,000 cubic meters) and, in order to prevent LNG tankers from leaving for other markets, the ceiling will not work if the difference between the TTF futures price and the LNG price is more than €58, as then the LNG tankers may leave Europe.

Seemingly reasonable suggestions, but there is a big nuance - prices above the ceiling in the EU have been... only 6 days(!!!!) this year. And some EU countries are asking a reasonable question - why such a ceiling at all? Now the prices are 3 times less than the ceiling, but 5 times more comfortable for Europe. And it seems logical that the ceiling should be somewhat lower. But the EC is afraid of the same thing the US is afraid of: that the suppliers will just wave goodbye and tell them to look for other fools. Besides, traders on the gas exchange were also a bit displeased with the lower ceiling, since in case the ceiling of €2120 per 1 MWh is introduced, the cost of risk insurance will grow due to the uncertainty with the price, due to which traders will incur losses of billions of dollars.

As a result, the EU could not reach an agreement neither on the oil ceiling that theoretically works, nor on the gas ceiling that does not work even in theory. Deadlines are approaching; both initiatives must be approved by mid-December. And so far the oil and gas exporting countries have not made their move.