Oil is Today’s Rhubarb

Officials from the U.S. and E.U. have been engaged in frenzied negotiations to agree on a “price cap” for Russian oil.  As readers will certainly be aware, sanctions deployed against Vladimir Putin following his invasion of Ukraine have failed to deter or affect his military activities to any significant degree.  Biden’s early braggadocio that the ruble would be reduced to “rubble” has been rebutted by the Russian currency’s persistent strength against the dollar – the highest in seven years – not least because sanctions have failed to dent Russia’s oil export earnings, not only sustaining the strength of its currency but helping to pay the bills for the Ukraine war.

Only economists could have dreamed this up.

Responding to the pipeline-sized hole in their economic blockade, U.S. sanctioneers schemed to cut Putin’s money-flow while simultaneously preserving a flow of Russian oil onto the world market by allowing the Russians to sell oil, but only at a small profit. The mechanism for achieving this goal would be the marine insurance market, dominated by brokers in London, whereby only oil tankers carrying oil at or under the “capped” price could get insurance.  Birthed inside the U.S. Treasury Department, the plan’s impracticality and evident ignorance of oil market realities are telling indications that it was conceived by economists.

Sooner the keys to their daughter’s bedroom…

Outsiders, which would seem to include those UST economists along with the media, seemingly assume that there is a set, publicly available, price for crude oil, like the number on your local gas pump.  Such is not the case. The “price” quoted in the papers does not reflect what buyers are actually paying They are the notional prices in the futures market a month from now, which in turn is set, so an oil industry veteran informs me, “by speculators reading the newspapers” and do not reflect what buyers actually fork over. For example, he cited how back in the early days of the covid-prompted lockdowns, oil was briefly “priced” at less than zero. “But no one actually bought oil at that amount.”  As my helpful informant explained, actual transactions are traditionally masked in secrecy.  Traders, as he pithily put it are “more likely give you the keys to their daughter’s bedroom than tell you their book.”

The  Russians have made it clear that they will not allow outsiders to regulate the price of their oil to their disadvantage, and would refuse to sell under any such regime, thereby potentially driving global prices skyward, thus hugely boosting Putin’s take from exports to the Indians (who promptly refine and sell it back to Europe) and the Chinese, neither of whom have any intention of observing U.S./EU price controls. 

Solution: Set the cap too high to matter

Therefore, to ward off unpleasant inflationary outcomes, western negotiators came up with a brilliant solution: impose a cap that looked good in a headline but that didn’t actually affect the Russians, thereby satisfying honor all round. The “cap” has now been at $60 a barrel. But oil industry sources indicate that “Urals crude” headed for western markets is currently being sold at around $55 a barrel, below the level of the proposed limit. Meanwhile oil from Russian fields headed east to Indian or Chinese buyers is going for around $75 in volumes that are sure to increase when Xi Jinping abandons his failing covid lockdowns and the Chinese economy takes off again. The absurdity of the cap arrangement as agreed reached last week is shown by the fact that it also includes a provision that the ceiling be regularly reviewed to ensure it is “at least 5 per cent” below average  market prices for Russian oil “ which, my oil industry friend observes “means it will be below the average of both East and West bound shipped oil, i.e. above the current price of West bound oil!”

“So long as there is Rhubarb, there can be no enemies under the heavens.”

So much for the latest effort to use sanctions. A glance at the actual record of this instrument could have foretold the result and saved everyone a lot of trouble.  The Chinese got the lesson long ago. Embroiled in a late 18th century dispute with Tzarist Russia, the Qing emperor was informed by experts that China’s global monopoly of rhubarb gave him a sure-fire weapon, since westerners absolutely depended on it to relieve chronic constipation.  Accordingly, he imposed an embargo on exports to Russia. An efficient  sanctions bureaucracy took steps to choke off attempts at evasion viz Japan and the Ryukyu islands. Since the original dispute was over largely empty and relatively unimportant territories in the far east, the Russians ultimately acceded to the Chinese demands. Buoyed with misplaced confidence, the Chinese relied on it to ward off the ravaging (but constipated) British fifty years later in the first of the opium wars.

As a Chinese historian of the episode summarized the consequences, disastrous for the Middle Kingdom: “…the  semblance of victory …greatly increased China’s sense of self-importance, and created the myth that ‘so long as there is rhubarb, there can be no enemies under the heavens’, which was to endure for several decades…Up until the time of the Opium Wars the country was pervaded by a sense of optimism, and only the outbreak of hostilities finally brought some realization of what was actually afoot.”

How long will it take for reality to dawn on today’s sanctioneers?