Working Paper: NBER ID: w31347
Authors: Simon Johnson; Lukasz Rachel; Catherine Wolfram
Abstract: In December 2022, following Russia’s invasion of Ukraine, a G7-led coalition of countries imposed a $60 per barrel price cap on the sales of Russian oil that use western services. This paper provides a theoretical and quantitative analysis of this new tool. We build a tractable equilibrium model in which the financially constrained exporter of a non-renewable resource optimally exerts market power, and the price of the resource varies stochastically. An important insight from this framework is that the supply curve is inelastic and can even be downward sloping, rationalizing the patterns we observe in the data. Contrary to the fears that an introduction of the price cap will cause a damaging oil supply shock, the exporter may have strong incentives to increase extraction following the introduction of a binding price cap. In fact, when the producer is large and has market power, a price cap that applies to all or most sales significantly limits the degree to which market power is used in equilibrium and stabilizes world oil prices. But if the cap is poorly enforced, or if the sanctioned state has access to a non-compliant “shadow” fleet, the cap is less effective at stabilizing world prices.
Keywords: price cap; nonrenewable resources; oil markets; Russian oil; sanctions
JEL Codes: F51; L13; L71; Q41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| binding price cap on Russian oil sales (P22) | increase in producer's extraction levels (L71) |
| binding price cap (D41) | increase in producer's extraction levels (L71) |
| binding price cap on Russian oil sales (P22) | stabilization of world oil prices (E63) |
| binding price cap (D41) | diminish incentives to exercise market power (D43) |
| imperfectly enforced price cap (D43) | incentives to shut in production (J65) |