In addition, at least for now, hard currency revenue is of limited value for Russia, as illustrated by the plummeting dollar and euro exchange rates on the Moscow exchange. But Russia is a strategic player with a somewhat exotic value function, adept at negative-sum games. That indeed might be a rational approach in a single-turn game. It is based, however, on an assumption that Russia would prefer to see some revenue, as long as it covers the marginal cost of production and allows for some profit, rather than to leave the oil in the ground and see no money at all. On paper, the plan to establish a large cartel that would keep Russian oil flowing at a low price is a magic bullet. Less developed countries are already complaining about sky-high energy prices damaging their economies, and it would be difficult to make major energy importers such as India and China join the embargo if, on the one hand, the high price of non-Russian crude would hurt them, and on the other hand, there is the lure of an ample supply of discounted Russian crude. Worse still, partial exclusion is driving prices so much higher that Russia would earn more money by selling less oil, which would defeat the purpose of the plan. It seems that Russia comprises too large a share of the supply of the already tight oil market for its volumes to be replaced. Warnings to this effect have been issued forth from various quarters, including public comments by oil industry executives and communications between G7 leaders at the recent summit. The Western coalition is rapidly coming to the conclusion that the world does not have sufficient spare oil production capacity to replace Russian oil, even taking into account the traditional stalwarts of the last resort like the Persian Gulf states. The rationale behind the proposed price cap, to be implemented through a buyers’ cartel using a mixture of enticement and coercion, is quite clear. Sometimes these wild fluctuations are caused by a sudden influx or reduction in supply, like in 1986, when Saudi Arabia tripled its production in the space of a few months, or by sharp reductions in demand, like in the aftermath of the 2008 financial crisis or during the COVID shutdowns in the spring of 2020.Īt other times, the driving factor is a sudden realization that one of the parties has market power-like after the relatively short-lived Arab oil embargo in 1973-or that, on the contrary, it does not, as it transpired in the fall of 2014, when the world suddenly discovered that the United States was no longer the main importer of crude but an exporter, and a growing one at that. These aspects make it extremely hard to establish a fair value price, and lead to price volatility from $20–30 to $120–130 per barrel. Oil is an unusual commodity: its price is much higher than the average short-term production cost and much lower than the average utility value to the consumer plus, it has very low short-term price elasticity both on the production and consumption side. If implemented, a price cap on Russia oil will likely achieve little more than providing more food for thought for those theorists. Oil markets and the OPEC cartel have been a favorite subject of game theorists since the 1973 oil crisis prompted by a Saudi Arabia–led embargo. The G7’s recent proposal to impose a price cap on Russian oil may look good on paper, but would be difficult to enforce in practice, and is unlikely to achieve its aim of limiting Russia’s ability to finance its war against Ukraine.
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