The Oil Price Cap 2023

The sanctions against Russia have mostly helped US petroleum companies. Europe has been coerced into a dependence on the US for its energy needs.

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What is Oilprice cap?

A government-imposed ceiling on the highest price that may be charged for a barrel of oil is referred to as an oil price cap. Typically, this step is performed to stabilise the economy and reduce inflation. The cap may be established by the government depending on a number of variables, including as local production costs, supply and demand dynamics inside the nation, and international oil prices. An oil price limit may have complicated market effects, including decreased consumer spending, decreased investment in oil production, and other unforeseen consequences.

An economy can be impacted by an oil price limit either favourably or unfavourably. On the one hand, it may contribute to reduced costs for gasoline and other petroleum goods, which might result in higher buying power and lower consumer prices. On the other side, it may deter investment in the oil sector and result in decreased production and supply, which would eventually cause shortages and higher prices. An oil price cap may also restrict oil firms’ profitability and lessen incentives for exploration and development, which may result in a reduction in a nation’s long-term energy security.

It is also important to keep in mind that setting an oil price cap is not always easy. A price limit, for instance, may prevent domestic prices from reflecting rising global oil costs, which may be the result in a shortfall in tax and royal revenue for the government. A price cap, on the other hand, may prohibit domestic prices from lowering if oil prices globally decline, which might cause domestic companies to lose their competitive edge also

The price cap

The United States and the European Union prohibited the purchase of Russian petroleum products last week. They had put a similar restriction on Russian crude oil two months earlier, On December 5. They had informed at the time that any third-party buyer paying more than $60 per barrel for Russian crude oil would be denied access to Western insurance, banking, and brokerage services. The prohibition on petroleum goods will be accompanied by a price cap, although on two levels. One level will be for commodities that sell at a premium to crude oil, such as diesel, and the other for commodities that sell at a discount, such as fuel oil. The exact figures have yet to be released.

The concept of a limit was originally floated when oil prices were in the triple digits and Russia was making more from exports than it had before the Ukraine incursion. This was infuriating for the United States since it undermined the impact of the sanctions. The headgear had two functions. One is to keep Russian oil flowing into the global market. This is because Russia accounts for 10% of world supplies, and a total cutoff would send prices skyrocketing. Second, to diminish Russian export revenues by lowering output and forcing purchasers to pay less than the international price.

The price cap, together with the penalties, was designed to achieve both goals. The former was more than the average cost of production of Russian crude oil, which is ranged between $ 25 and $40 a barrel, and so provided an incentive for Russian enterpres to contiisnue producing. The latter impeded access to vital utilities and, as a result, restricted Russian oil trading and transportation.

I’ve been wondering about the practicality of this idea since it was initially proposed. Because it is a well-known economic axiom that administrative price (and income) restrictions do not work and, in fact, generate profitable arbitrage opportunities for astute traders. I do not a believe in conspiracy theories, but I have wondered why a world-class economist like Janet Yellen would support such a concept when, as an economics professor, she would most certainly criticise it as a brutal and ineffectual weapon. I’ve considered if the originators of this concept had goals other than those declared publicly.

Two months into this cap, I’m noticing some surprising tendencies that lend some validity to my observations. First, as predicted by all experts, the cap does not function. It has far too many loopholes. For example, one simple technique to avoid the cap would be for the seller to indicate a price in the bill of lading at the port of loading that is at or below the cap price and then modify it upwards to account for freight and other expenses. Buyers pay based on the provided price. More importantly, Russia is said to have collected a shadow fleet of tankers in order to avoid western insurers.

Second, Russia’s output has decreased by 800kbd to 1 mbd, representing nearly 25% of the country’s exports. This has resulted in lower export revenues. However, seasoned merchants continue to conduct business in Russia. Several have (re)registered their operations in countries that are not subject to sanctions like the UAE and have utilised the arbitrage opportunity to purchase “cheap” and sell “high”.

Third, the reduction of Russian crude (and products) has caused the market to tighten. Prices are now holding since the winter has been milder than projected, the US has released more barrels from its strategic petroleum reserve than planned, and Chinese demand has lagged. This tendency, though, might reverse. Saudi Arabia and the United Arab Emirates are unlikely to use their spare producible capacity to fill the void left by Russian export cuts. And China is determined to resume its rapid economic expansion. If and when prices do rise, the cap’s creators may find themselves hoisted by their own petard.

Four, Saudi Arabia must be concerned that a price ceiling has taken shape and that the US may be tempted to use it against them if prices reach politically unpalatable levels. There are several reasons why the Saudis want to establish transactional connections with the United States, and why India is considered as an increasingly significant strategic market. Whatsoever , one cause might stem from this discomfort.

Five, the price ceiling has had a detrimental impact on Europe. This is because they rely too heavily on Russian crude and commodities. They have been forced to rely on the United States, the Middle East, and India to make up the shortfall, causing suppliers from these countries to redirect their supplies to the European market at a premium. In an ironic twist, Indian refiners are obtaining oil from Russia’s eastern shore, transporting it to their refineries, principally in Jamnagar, and then exporting the goods, primarily diesel, to Europe. As trading distances have risen, shipping markets have become more competitive. Tanker freight rates have surged, and stock values in shipping companies are approaching historic highs.

Finally, US petroleum firms have gained the most from Europe’s predicament, which is maybe the reason I used the word “conspiracy” before. The US government has given Chevron permission to return to its concessions in Venezuela in a show of business opportunism, but only if the crude oil they produce is sold solely in the US. Despite the fact that they still do not recognise President Nicolas Maduro, they have still done this. This choice would enable US businesses to transform heavy crude oil, which is often affordable, into lighter products with greater added values, like diesel, for export to Europe at a premium.


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