The core of her proposal is that an international price cap of between $US40 and $US60 a barrel – a level just above Russia’s break-even productions costs of between $US30 and $US40 a barrel – would be imposed on Russian oil shipments.
Those importers that could demonstrate that they had observed the cap would be able to get access to insurance coverage and financing.
The thesis underpinning the plan is that Russia would keep producing oil because it would rather receive some, albeit far lesser, revenue from oil sales than none. It would also face significant and lasting damage to its wells as other oil industry infrastructure if there were a prolonged shutdown of production.
For the buyers, the carrot would be very low oil prices. While China and India have taken advantage of existing sanctions on Russia to gorge on purchases of Russian oil at discounts of about $US30 a barrel to international prices, they could get even cheaper oil if they signed up to Yellen’s plan. The current oil price is about $US96 a barrel.
The US is relying on the self-interest of China and India and other buyers of Russia’s oil to outweigh any relationships with Russia. Russia and China, of course, signed a pact – a “friendship with no limits” – just ahead of Russia’s invasion of Ukraine. China has been listening to Yellen but has made no commitments.
Russia has, predictably, threatened to simply cut off all its oil sales if the price cap is imposed. That would send the oil price soaring dramatically – it isn’t possible to replace 10 per cent of the world’s supply – and cause shortages and spikes in already unpalatable inflation rates in the major economies.
Yellen is relying on Vladimir Putin to act rationally in Russia’s economic self-interest, just as the plan really needs China and India and others to do the same.
It could also use myriad sanctions-busting techniques to try to circumvent or at least blunt the impact of the plan.
The West buys about 70 per cent of Russia’s oil and there is a big question mark on whether there is sufficient demand elsewhere to absorb that even if the logistical issues of getting it to prospective buyers could be resolved.
The US believes that Russia, while perhaps briefly carrying out its threat to halt production, will want to produce as much as it can even at prices modestly above its break-even to maintain at least some flows of revenue to fund a war in Ukraine than has so far been largely funded by oil sales that, even with the big discounts and reduced sales, have been hugely profitable at the current prices. The higher prices have more than offset the losses of volume.
If the American assessment were to be proven correct, the flow of Russian oil into the market at prices way below the current market could have a halo effect, helping to bring prices down generally and contributing to a lowering of global inflation rates.
US Treasury Secretary Janet Yellen has been touring the world trying to convince countries, insurers, banks and shipping companies that a price cap could work to crimp Russia’s oil revenues.Credit:Bloomberg
How OPEC might respond to the creation of a buyers’ cartel isn’t clear. Russia is a key OPEC affiliate and the producers’ cartel has been reluctant to co-operate with US efforts to increase oil production to bring prices down. It begrudgingly agreed to a meager 100,000 barrels a day increase – about 0.1 per cent of the current production – after Joe Biden’s recent visit to Saudi Arabia.
It isn’t going to be happy about the prospect of a significant fall in oil prices if the Yellen plan is implemented effectively, nor will it be keen to promote a buyers’ cartel that could subsequently be used to counter its influence over the oil market .
The price cap proposal is complex and it is unclear whether, even if they wanted to, the shipping and insurance companies could ensure compliance in practice.
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Much of the recent work being done on the plan, with input from the shipping, banking and insurance companies, has been on trying to simplify the compliance regime so that it is workable and the companies can identify which charges have been sold within the cap and which haven’t.
Time is running out for Yellen to lock the complex pieces that would support the price cap regime in place. If the EU sanctions go live without some compensatory measures the oil price will take off. Even if those measures are in place, Russia’s response could still cause prices to soar.
Yellen is relying on Vladimir Putin to act rationally in Russia’s economic self-interest, just as the plan really needs China and India and others to do the same.