Russia's oil clock is ticking.  How Putin reacts will affect us all

Russia’s oil clock is ticking. How Putin reacts will affect us all

The cap is intended to limit the price of Russian oil above Russia’s cost of production, to give Russia an incentive to maintain production but at a significant discount to international prices, to reduce its oil revenues and ability to fund the war against Ukraine.

That price, likely somewhere between $40 and $60 a barrel, is expected to be announced this week, perhaps as early as Wednesday.

Europe is heavily dependent on Russia for oil and gas.Recognition:Bloomberg

The cap is backed by a ban on shipping, financing and insurance for sales of Russian oil at prices above the cap, with the UK dominating the marine insurance market – about 90 per cent of insurers are in the UK or Europe – key to enforce the cap.

Whether the cap and the threat of accompanying sanctions will be effective for supplies above the cap is debatable, especially since the main buyers of Russian oil since the invasion – China and India – are not parties to the G7 deal.

With interest rates in major economies rising this year to levels not seen in decades, the prospect of a global recession is already on the horizon. A rise in oil prices would likely both guarantee this and worsen its impact.

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The cap offers a carrot and stick to China, India and others who have been buying Russian oil since the invasion.

Russia has already reduced its oil significantly to attract buyers – China and India got discounts of $25-$30 a barrel from international prices – and the US is hoping buyers will be self-interest-driven and use the cap as leverage for an even cheaper supply.

Russia has two general responses to the actions of the G7. It can try to circumvent them by insuring and financing its supplies itself, or employing some of the sanctions-busting techniques its new ally Iran has perfected, or it could, as it has threatened, simply refuse supplies to anyone who agrees , the penalties implement price cap.

It might even just shut down production in the expectation that the subsequent price surge would hurt the West more than Russia and shatter the surprisingly unified support Ukraine has received from some of the world’s largest economies.

A significant reduction in Russian production could send oil prices dramatically higher – prices have been estimated at US$200 a barrel or more – but could be at the expense of Russia in the long term, as its wells and infrastructure are already depleted by the retreat from the West Oils are affected Investments, know-how and technology could be permanently damaged by longer production interruptions.

That should not deter Vladimir Putin, who showed by cutting off gas supplies to Europe earlier this year that he is more driven by his immediate military and geopolitical goals than concerns about Russia’s economy or its already dwindling economic future.

Whether the direr predictions of what Russia might do, and the impact that this might have on the supply and price of oil worldwide, will materialize is uncertain and depends only in part on how effective or not the price cap and mechanism is to monitor them.

Whether the direr predictions of what Russia might do, and the impact that this might have on the supply and price of oil worldwide, will materialize is uncertain and depends only in part on how effective or not the price cap and mechanism is to monitor them.

Despite OPEC+ production cuts, today’s oil price is just under $88 a barrel, more than 10 percent below when those cuts were announced and more than 30 percent below its peak of around $128 a barrel in early March immediately after the invasion.

With the US (possibly) and Europe (probably) apparently heading for a recession, or at least something that feels like a recession, and China’s already anemic growth threatened by another COVID outbreak, Beijing will have a hard time holding on from the zero-COVID policies that have been a major factor in this slowdown in growth, demand for oil is likely to weaken on its own.

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Even without the price cap and embargoes, this would mitigate the impact of reduced Russian supply, at least to some extent, in the short term.

In the longer term, Russia’s pariah status in much of the world and/or any new rise in oil and gas prices will provide incentives for increased oil and gas production or the more rapid development of alternative energy sources elsewhere.

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