EXPLAINER: What is the effect of the Russian oil price cap, the ban?

FRANKFURT, Germany (AP) – Western governments aim to cap the price of Russia’s oil exports in a bid to cap fossil fuel gains who support Moscow’s budget, its military and the invasion of Ukraine.

The limit will take effect on December 5, the same day the European Union imposes a boycott on most Russian oil — its crude which is shipped by sea. The EU was still negotiating what the maximum price should be.

Twin measures could have uncertain effect on oil price as concerns over supply loss due to boycott compete with fears about lower demand from a slowing global economy.

Here are the basic facts about the price cap, the EU embargo, and what they could mean for consumers and the global economy:

WHAT IS THE PRICE CAP AND HOW DOES IT WORK?

US Treasury Secretary Janet Yellen has proposed the limit with other Group of 7 allies as a way to limit Russia’s gains by keeping Russian oil flowing to the global economy. The goal is to hurt Moscow’s finances by avoiding a sharp rise in oil prices if Russian oil is suddenly taken off the global market.

Insurance companies and other businesses needed to ship oil would only be able to deal with Russian crude if the price of oil is at or below the cap. Most insurers are based in the EU or UK and may be required to participate in the cap. Without insurance, tanker owners may be reluctant to take on Russian oil and face obstacles in its delivery.

HOW WOULD OIL KEEP COMING TO THE GLOBAL ECONOMY?

Universal enforcement of the insurance ban, imposed by the EU and the UK in previous rounds of sanctions, could take so much Russian crude off the market that oil prices would rise, Western economies would suffer, and Russia would see increased earnings from whatever oil it could ship in defiance of the embargo.

Russia, the world’s second largest oil producer, has already diverted much of its supply to India, China and other Asian countries at discounted prices after Western customers avoided it even before the EU ban.

One purpose of the limit is to provide a legal framework “to allow for the flow of Russian oil and at the same time reduce windfall revenues for Russia,” said Claudio Galimberti, senior vice president of analysis at Rystad Energy.

“It is essential for global crude markets that Russian oil still finds markets to be sold after the EU ban is in place,” he added. “Without that, global oil prices would skyrocket.”

WHAT EFFECT WOULD THE DIFFERENT CAP LEVELS HAVE?

A ceiling of $65 to $70 a barrel could allow Russia to continue selling oil and keep its gains at current levels. Russian oil is trading at around $63 a barrel, a sizable discount to the international benchmark Brent.

A lower limit, around $50 a barrel, would make it difficult for Russia to balance its state budgetwith Moscow believed to require $60 to $70 a barrel to do so, its so-called “fiscal break-even”.

However, that $50 cap would still be higher than Russia’s cost of production of $30 to $40 a barrel, giving Moscow an incentive to keep selling oil simply to avoid having to plug wells that can be difficult to restart.

WHAT IF RUSSIA AND OTHER COUNTRIES DO NOT AGREE?

The Russian has said it will not respect a limit and will stop deliveries to countries that do. A lower bound of around $50 could be more likely to provoke such a response, or Russia could cut off the last of its remaining natural gas supplies to Europe.

China and India may disagree with the limit, while China may form its own insurance companies to replace those banned by the US, UK and Europe.

Galimberti says China and India are already enjoying discounted oil and may not want to alienate Russia.

“China and India get Russian crude at a huge discount to Brent, so they don’t necessarily need a price cap to continue enjoying a discount,” he said. “By respecting the limit set by the G-7, they risk alienating Russia. As a result, we believe compliance with the price cap would not be high.”

Russia may also resort to schemes like transferring oil from ship to ship to disguise its origins and mixing its oil with other types to get around the ban.

So it remains to be seen what effect the cork would have.

WHAT ABOUT THE EU EMBARGO?

The biggest impact of the EU embargo may not come on December 5, when Europe finds new suppliers and Russian barrels are diverted, but on February 5, when the further European ban on oil-based refinery products, like diesel – enter into force.

Europe will have to turn to alternative supplies from the US, the Middle East and India. “There will be a deficit, and this will translate into very high prices,” Galimberti said.

Europe still has many cars that run on diesel. Fuel is also used for trucking to deliver a wide variety of goods to consumers and to run farm machinery, so those higher costs will be spread across the economy.

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