G7 Price Cap Allows Higher Revenues In Exchange For Lower Retaliation Risk

Goldman Sachs note that “reports today suggest that the G7 is considering a price cap on Russian oil of ~$65-70/bbl, substantially higher than the $40-60/bbl range discussed earlier this year, which was meant to merely cover the cost of production. However, this was an incomplete analysis, as it did not consider Russia's influence on global prices.”

• “A higher cap can keep prices lower in the end. This is a classic 'Stackelberg game', where the G7 must anticipate Russia's response to their price cap decision. We find a price cap of $70+ may be sufficient to preclude Russian retaliation.”
• “However, the announcement increases the risk of retaliation from other global exporters, for whom the price cap may set a concerning precedent.”
• “It is important that this cap fluctuates with crude benchmarks, as incentives of the game vary with global prices, balances, and discounts. This can result in the phenomenon of a backwards-bending supply curve, as supply is actually reduced in response to higher prices. To avoid this, we believe the price cap would need to be raised to ~$80-85+/bbl next year, given our $110/bbl 2023 Brent forecast.”
• “We do not expect a production impact of the price cap beyond the 0.6 mb/d sequential fall in Russian supply due to the (separate) EU oil embargo, as we do not think it is enforceable.”