Europe as global oil cartel? Why price cap won’t work

Recently the European Commission, the umbrella political organization for the European Union nations, issued its latest set of sanctions on Russia.

The most important of the measures was the announcement that the EU was establishing a price cap for purchases of Russian crude oil in global markets.  In so doing, the EU in effect plans to become a cartel controlling the price of global oil.

Saudi Arabia and even OPEC in the past failed as a cartel to control the price of global crude by controlling its supply. Yet the EU believes it can become a cartel and control the price of oil even globally even without influence over global supply.

Under the plan, which still requires the approval of all EU economies, the EU will not buy Russian oil at global prices set by market supply and demand. Instead, it will buy Russian oil only at a price that is capped below that of the global market. Reportedly the participants in the Commission discussed a price per barrel of crude capped around $55-$60 a barrel. EU economies will purchase Russian crude only if it is sold to them at or below their ‘cap’.

The plan, if approved, will go into effect only this December 2022.

The idea of the west setting a price cap on Russian oil as a form of sanction originated with Janet Yellen, Secretary of the US Treasury, some months ago.  It was an economically absurd proposition then, and remains no less so today.  The price cap may not prove effective, but it does illustrate the ineffectiveness of sanctions to date on Russian oil and energy products (i.e. natural gas, uranium ore for Europe commercial nuclear facilities, etc.).

Global oil is traded (bought and sold) in the global market solely in US dollars. So too are other critical industrial commodities and many agricultural commodities.  The main focus of US sanctions, including the price cap idea, is to deny the target country—in this case Russia—access to revenue in dollars from the sale of its oil.  Theoretically, the loss of dollars from lower priced oil sales means Russia won’t be able to purchase as much needed imports critical for its economy in general and its war effort in particular.  The lack of dollars in turn further means, again theoretically, Russia would have to print more of its own currency, the Ruble, to make up for lack of dollars in its own economy. That might lead to inflation as excess money supply is created for the domestic Russian economy. In turn excess money supply creation in Russia might lead to devaluation to domestic inflation and devaluation of the Ruble.

US initial sanctions on Russian oil and energy to date have largely failed. Russia’s export revenue from sale of oil has actually risen since sanctions and war began last February. Russia has sold more oil to China, India, and at least half of the world economies that have been ignoring US/EU announced sanctions altogether.

The EU ‘price cap’ idea is supposedly going to what oil sanctions up to now, which have been full of loopholes and exemptions, have failed to do—i.e. reduce Russian revenue from oil sales and its accumulation of dollars from those sales.

It is important to note that the EU itself has all but ignored sanctions on Russian oil to date. Russia has continued to ship oil to Europe.  And the EU hasn’t even bothered to enforce sanctions on Russian natural gas imports or uranium ore shipments.  What reduction in oil and natural gas shipments to Europe that has occurred, has been mostly due to political actions not sanctions. Last spring the Nordstream2 pipeline was quickly closed and more recently  sabotaged. So too was the Nordstream1 pipeline. Prior to sabotage, Nord1 gas flow to Europe was reduced in stages by Russia to about only 30% of capacity.  It wasn’t sanctions but decision by Russia that reduced the gas exports.  There are two remaining large gas pipelines from Russia to Europe still functioning. One crosses the Ukraine and another transverses Turkey and the Aegean Sea into the Balkans. Europe has not tried to reduce gas flow from these with sanctions, although it is likely politics will result in their reduction and shutdown as well eventually.

But to the extent Russian natural gas flow to Europe has been reduced, the causes have been political and have had nothing to do with sanctions.  So sanctions on Russian energy exports to Europe have hardly been implemented, let alone been effective.  The EU price cap idea is supposed to finally result in sanctions on Russian oil sales and revenue.

Sanctions on exports to Europe and US of Russian industrial commodities have also been rife with exemptions, loopholes and work arounds. In the US, for example, Russian nickel and palladium exports needed for catalytic converters in US autos and in steel production have been significantly exempted. The US some time ago implemented sanctions on Russian oil imports to the US. The amounts of Russian oil imports were quite small. In any event, the US—unlike Europe—has a glut of excess oil and natural gas.

Russia has been earning significant export revenues therefore from the sale of its oil, natural gas, as well as many industrial commodities, ever since the US/EU sanctions regime was first imposed last January 2022. The ‘price cap’ is but the latest desperate attempt by the US and EU to make the sanctions on Russian oil to Europe ‘work’. But it won’t work. 

The price cap is not going to take effect until December (if at all even then since all the EU nations must agree). So why should Russia even bother selling any oil to Europe in the interim. In business contract matters, if one party notifies the other it is breaking its contract and is no longer going to buy from the seller, that seller can simply cancel its contracts early and not wait until December.  Russia will likely therefore cut off its oil exports to Europe sooner rather than later, and just redirect the oil elsewhere to China, India or rest of the world. No need for sanctions of any kind in other words.

But the price cap sanctions idea involves not just the EU buying Russian oil. The price cap is really the US/EU foray into what’s called ‘secondary sanctions’. That is, sanctions on other economies around the world. Up to now, the US has been careful about enforcing sanctions or penalties on other countries that refuse to go along with sanctions to date—and there are many such examples of economies that have been refusing to participate in sanctions.  

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