The Russian oil debacle

The looming Russian oil price “cap” has all the hallmarks of a historic debacle in the making. For months, the United States and the G-7 have haggled over a complex plan to constrain the money that the Kremlin makes from some of its oil exports. With a looming deadline to loosen oil sanctions just days away, policymakers should dump the plan — as it will do little to hasten an end to the war in Ukraine.

The problem is money. Despite Russian President Vladimir Putin’s brutal war against Ukraine and subsequent Western sanctions on his regime, Russia is swimming in petrol dollars. By the end of the year, the Russian Economy Ministry estimates that the country will have made a record $338 billion from its energy exports. This money supports the Russian economy, buoys its current account, and – less directly – helps to finance Putin’s war against Ukraine.

Presently, the global oil market has precious few barrels to spare. Together with America’s existing embargo on Russian crude, when the European Union’s oil embargo comes into full force on Dec. 5, policymakers fear that the move will constrain global petroleum supplies and push prices upward. Western leaders want to slash the Kremlin’s oil revenue — but also minimize any political blowback from potentially high energy prices and the inflationary pressures that might materialize as a result.

Over the summer, the Biden administration and other allies conceived of the Russian price cap as an elegant solution to a complex problem of supply and demand. The initial plan: allow international buyers of Russian petroleum to avoid the hammer of Western sanctions if their purchases met three requirements. First, the price that they paid needed to be at-or-below an artificial price cap. Second, the petroleum in question must leave Russia by sea — a major avenue for Russian oil shipments. Third, the oil should not arrive on U.S. and European shores (or other countries that banned energy from Russia).

The most obvious flaw in this scheme was Russian participation. What if the Kremlin refused to abide by the arrangement, as Russia recently hinted? A second snag was the price cap itself. If it was too high, Moscow would generate outsized petrol profits to fund its war against Ukraine. Technocrats from participating G-7 countries were tasked with determining a “capped” price for Russian crude and, at least in theory, updating it to follow changing market conditions.

Inside the European Union, however, this process created a diplomatic trench war. Poland initially blocked the EU’s proposed price, saying that a cap of $65 per barrel was too high. The EU countered with a price of $60 per barrel. However, this too is very lucrative for the Kremlin, since the cost of producing a barrel of Russian crude is between $20-$40 (depending on the well). The EU’s plan will still leave piles of money on the table for Putin to spend on his war.

Finally, there is a historic precedent. A previous international price-fixing scheme failed — spectacularly. In the 1990s, the UN’s disastrous Oil for Food Program inadvertently created a corrupt patronage system for artificially cheap barrels of Iraqi crude.

Assuming that EU and G-7 leaders can sort out their current price puzzle and fix Russian crude below what the international market would prefer to pay, who will pick winners and losers in the subsequent scramble for cheap Kremlin oil: Putin and his energy cronies? Will corrupt kickback “fees” be required to purchase these newly discounted barrels of crude — as was the case in the UN’s Oil for Food Program? And if Moscow goes along with this scheme, the gold rush for potentially low-cost Russian barrels may inadvertently increase the Kremlin’s power as a kingmaker and rainmaker of petroleum fortunes.

The Russian oil “cap” would not be necessary if the Biden White House had been making it easier to open the spigots of American oil from the start. The president’s pledge of “no more drilling” in America continues to undercut his economic and foreign policy against Russia.

While current crude prices are encouraging some U.S. drillers to pump a little more in the oil patch, the benefits of America’s swing capacity may not be felt until mid-2023 and beyond. In the meantime, Western economies will continue to rely upon the capricious decisions of the Saudi-led OPEC cartel to increase crude production. This is what American energy weakness looks like.

If the Russian oil price cap fails to materialize or work as officials intend, the United States and its allies should drop the scheme and keep to their previous, more aggressive sanctions policy. Washington should likewise prioritize efforts to fully open the taps of U.S. domestic energy production while holding together the coalition of countries that signed up for America’s sanctions regime on Russia in the first place.

We should deny Russia the “sinews of war” – the petrol dollars that it needs to sustain its invasion of Ukraine – instead of haggling like merchants in a bazaar over exemptions to a strong sanctions policy.

Peter Doran is an adjunct senior fellow at the Foundation for Defense of Democracies and the author of “Breaking Rockefeller” on the rise of Russian oil.