Ukraine’s allies are letting Russia off the hook

For months, energy analysts have worried about what might happen on December 5, when two things will happen. First, Europe’s ban on importing Russian oil from the sea will be implemented. Second, the world’s advanced economies will impose a fixed price on Russian oil.

December 5th is here, and … not much has changed. That’s good news for oil buyers, as markets aren’t registering any unusual concerns about supply disruptions. But business-as-usual in energy markets also suggests that the West’s latest effort to curb Russia’s war-making ability is folly. Russia seems likely to continue earning billions from oil sales, which provide significant funding for Russian President Vladimir Putin’s illegal war in Ukraine.

Europe agreed in June to ban Russian oil imports, starting in December, with the lag providing a window to get oil from other sources. The boycott is intended to make it harder for Russia to sell its most valuable export and undermine oil revenues that account for 30% of Russia’s federal budget.

But Russia can sell oil elsewhere, and find new buyers as Europe looks for new sellers. The United States has developed the concept of a Russian oil price cap, or a maximum amount that participating countries will pay, as a way to reduce Russian oil revenues regardless of who buys it. . If enough major countries comply with the cap, in theory, it will force down the price each buyer pays for Russian oil, and reduce Russia’s oil revenues. Even countries that do not participate in the price cap, such as China and India, will demand lower prices for Russian crude if the price cap lowers the benchmark price.

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Making this work depends on getting the price ceiling right—and that’s where the scheme appears to falter. On December 2, the Group of Seven countries—Canada, France, Germany, Italy, Japan, the UK and the United States—plus Australia set the cap at $60 per barrel. Ukraine and some of its allies want a cap below $30. Russian oil has been sold at a discount to market prices due to existing sanctions that make purchases more complicated. Buyers demand compensation for increased risk in the form of lower prices.

The Russian oil discount is about $25 relative to the price of Brent crude (BZ=F) the European benchmark. The current price of Brent is at $83 per barrel. So the G-7 price cap of $60 is equivalent to the price buyers are already paying for Russian oil, and that’s too high for Russia to make a profit.

“We are reluctant to hit Russia where it hurts,” said Robin Brooks, chief economist at the Institute of International Finance. wrote on Twitter on Dec. 3. “That’s why we … set the G-7 price cap at $60. This is the path of least resistance in the short term, but we have given Putin the means to fight an ‘all-out war’ in Ukraine.

Poland and other Eastern European countries bordering Russia initially lobbied for a $30 price cap, as did Ukraine itself. Brooks speculates that Greek shipping tycoons whose ships carry more than half of Russia’s oil exports have pushed for a higher cap, and won, so far. Ukrainian President Volodymyr Zelensky criticized the $60 cap and basically said it was unworkable.

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Before the war, it cost Russia about $40 to produce a barrel of oil, on average, according to research firm Energy Intelligence. So Russia makes money at any price above $40. That explains why the hawks want a price cap of $30, which could force Russian losses, depending on how wide the price cap is imposed.

There are several wild cards with the price regime, and it is possible that the G-7 coalition would prefer to slip in slowly rather than risk an unequivocal plunge. Russia has said it will not abide by any price cap, raising the question of how Russia will respond if the crackdown actually begins. The most devastating thing that Russia can do is to stop exporting oil, which will raise world prices, because Russia provides 10% of the world’s supply. That caused Russia itself a lot of damage, more than just lost revenue. Russia does not have the facilities to bank an indefinite amount of oil, and shutting down rigs and other oil infrastructure could destroy equipment. But Putin is increasingly desperate as his disastrous war in Ukraine drags on and the Russian military suffers devastating defeats.

The G-7 group can also lower the price cap whenever it wants, and it can do so in a gradual way that gradually squeezes Russia. “There is an inherent tension between (1) a significant reduction in Russia’s export earnings and (2) avoiding a physical shortage in the world oil market,” wrote analysts at investment firm Raymond James. in a report on December 5. “Policymakers are mindful of current inflationary pressures and political complications arising from that.”

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Western sanctions on Russia following its February 24 invasion have hit the economy there, which could shrink by 5% or 6% this year. But it could be worse for Russia. “They managed the impact of the sanctions more effectively than most international observers expected,” Mark Galeotti of Mayak Consulting, said recently on the Geopolitics Decanted podcast. “We cannot write off the Russian system in any way.”

The economy of Ukraine, on the contrary, may decrease by 30% this year, because Russia repeatedly attacks the energy infrastructure and levels of entire cities. Rebuilding Ukraine once the war is over could cost $750 billion, which is three times the amount of all the energy revenue Russia typically earns in a year. Ukraine clearly feels more urgency than some of its allies to bring Russia to its heels, while leaders in the United States and elsewhere, largely unaffected by the road, want to help. in Ukraine as long as it does not cause political unrest at home. The shooting war, meanwhile, continues, as incrementalism fails to turn the tide one way or the other.

Rick Newman is a senior columnist for the Yahoo Finance. Follow him on Twitter at @rickjnewman

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