A Theory of Price Caps on Non-Renewable Resources
What is the optimal response of an exhaustible resource producer to sanctions in the form of a price cap? This paper develops a dynamic framework incorporating stochastic prices, financial frictions, and market power to study this novel tool of statecraft. A binding price cap can incentivize increased extraction, stabilizing prices in the global market. But the cap’s effectiveness diminishes when the policy is leaky or is weakly enforced, as seen with the G7 price cap on Russian oil. Such imperfections introduce a trade-off between market stability and the welfare of the sanctioned producer. We provide a systematic approach to setting an optimal cap level in these circumstances.
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