CREA: Why Russia has strong incentives to keep supplying oil with a $30 price cap

2023-03-16 | Expert publications, Sanctions, Energy

By Meri Pukarinen, Europe-Russia policy officer at the Centre for Research on Energy and Clean Air. Russia continues its atrocities in Ukraine, including targeting civilians in shellings, and damaging energy infrastructure. At the same time, the first evidence of the effect of the crude oil import ban and price cap, after their introduction on December 5 2022, suggests that the policy is robust and effective. The measures are costing Russia an estimated EUR 160 mln/day. As the price cap coalition is due to review the price cap in March, we outline why Russia has strong incentives to keep supplying oil at a price cap level much closer to their production costs. Lowering the price cap level could significantly reduce Russian Federal Government revenues used to fund the war.

The EU is a key player in the transportation but also the insurance of Russian fossil fuels. EU owned vessels transported the highest proportion of Russian crude oil in both 2022 & and 2023 year to date up to mid-February (43% and 45% respectively). This demonstrates the strong leverage that the EU has through the oil price cap policy to achieve its aims in lowering Russia’s fossil fuel export earnings used to fund the war.

Due to the flexible design of Russia’s tax regime for oil exports, which is designed to extract maximum tax revenue while maintaining production, it is likely that lowering the price cap would still entice Russia to export close to similar volumes of oil whilst significantly lowering government revenues from oil exports.

Russia has recently announced a production cut of 0.5 mln barrels/day starting in March, about 5% of its production, blaming the oil price cap and broader sanctions for its decision. While prices have reacted with an increase following the decision, analysts have pointed to the limited impact of the move on a generally weak global oil demand while others have pointed at a possible lack of demand for Russian oil and oil products leading to the cut.

The key thing to note is that the small output cut is designed to increase revenue by propping up prices. This is a rational revenue-maximizing move in a situation where the crude oil price cap is so high that Russian oil has been selling at prices far below the cap.  Far from encouraging more output, the current excessively high price cap has given Russia the opportunity and the incentive to continue to manipulate the oil market with supply cuts.

Ahead of the announced production cut, Russia’s oil export volumes have increased after the EU import bans and price caps, showing that Russian producers reacted to lower prices by increasing, not withholding supply. This demonstrates that the lowest price levels reached in recent months are still far above marginal production costs.

Read the 3 page brief of the study here.

Read the full publication here.