Can the G7 proposal for a cap on Russian oil prices work?

As military battles continue in the Ukraine war, the parallel skirmish over energy continues to escalate, with the West announcing plans for price caps to try and stem Russia’s soaring oil revenues directly financing its expansionist ambitions.

The Group of Seven (G7), a group of the world’s richest Western nations, said at a recent summit in Bavaria that it is exploring the feasibility of capping Russian oil prices, thereby preventing Moscow from profiting from jumps in market prices due to the invasion of Ukraine.

The group includes most of Russia’s most vocal adversaries, such as the United States, Germany and Britain, and said in a communique that it would try and stop the export of Russian oil not purchased at or below a certain price. While the details of such a dramatic proposal would still need to be sketched out, the political effects of the statement was heard loud and clear by a dismissive and sceptical Kremlin.

A price cap could work through a system to reduce or ban insurance or financing for Russian oil shipments above a certain amount.

In simple terms, if a tanker agrees to take an oil shipment from Russia at higher than the G7-set rate per barrel, it will not be able to obtain the insurance and financial services essential for such a transaction to be successful.

But one thing is clear, for such a move to work, the G7 would need to get countries beyond its membership involved – especially large consumers of Russian crude such as China, India and Turkey – and it would need to find alternate producers to fill the power void.

“It’s going to be challenging, it seems enforceable among Western countries, but internationally it needs others to take part, and that includes India and China,” Timothy Ash, an economist and associate fellow at London’s Chatham House think-tank, told Al Jazeera.

“One aspect about sanctions or such measures is the unintended consequences it has on global markets,” he said. Like all markets to some extent, there are the effects of demand and supply. Since the West consumes huge amounts of oil, technically it should have some say over the pricing.

“But aside from manipulation, the global economy may well experience such a slowdown from the war in Ukraine that demand effectively comes down on its own. Bizarrely, stagflation could end up being the next weapon against Russian energy,” he added.

The European Council president, Charles Michel, told reporters in Bavaria that G7 leaders would discuss a technical mechanism that had the effect of an oil price cap through services related to oil and export insurance.

In response, Moscow has said that any price-cap plans would lead to scarcity on global oil markets and rocketing prices for European consumers.

“This is another attempt to interfere in market mechanisms, which can only lead to market imbalance,” Russia’s Deputy Prime Minister, Alexander Novak, said in a televised address last week.

‘Threat and reward’

So, is such a gambit workable – and even desirable, considering its potential consequences? And exactly how would it unfold?

“It would basically stop financial institutions, especially ship insurers, from carrying Russian oil unless the oil was priced below an agreed price,” said Benedict McAleenan, a managing partner at Helmsley Energy and senior fellow at the Policy Exchange think-tank in London.

“In theory, it’s quite an elegant solution because it uses a ‘threat and reward’ approach. The reward is the chance to buy even cheaper Russian oil. The threat is the prospect of sanctions and not being able to trade with major economies like the US and EU.”

And with such left-field solutions, comes the question of whether any precedent exists for such a scenario? “The Iranian oil sanctions,” said McAleenan, “which work pretty well at limiting the Iranian economy whilst allowing oil exports.” The oil-for-food embargo in 1995 against Saddam Hussain’s Iraq is another example, even if it was beset with logistical and corruption problems.

But McAleenan said for this scheme to succeed, there would have to be a customers’ alliance. “It would effectively be a ‘monopsony’ – a dominant buyer or buying system that can decide prices in the market, ” he said. The idea mirrors the more common concept of a monopoly or a dominant seller such as the intergovernmental Organisation of Petroleum Exporting Countries (OPEC).

“Monopsonies exist in many markets such as nationalised health systems and they can be very effective at lowering prices. But there can be all sorts of unintended consequences, such as boosting black markets and loopholes, as well as market inefficiencies. Also, what if the price cap system suddenly collapses? You’ll see global price shocks,” McAleenan warned.

Discussion of economic factors is one thing, but in dealing with a nation like Russia with as unpredictable a leader as Vadimir Putin, the repercussions could go beyond markets and pricing. How will it now affect political and diplomatic channels?

“The relationship between Russia and the west cannot get much worse”, Natasha Lindstaedt, Professor of Government and International Relations at the University of Essex, told Al Jazeera.

“Russia has shown its brazen tactics before of refusing to export gas to Europe. So it’s safe to assume that Russia will just stop exporting to the West if the G7 tries to implement this, or at least limit the supply.

“Moscow knows that it has mass revenues coming in from the sale of other energy products to China and India and elsewhere. Putin is confident that it can survive and reduce the exporting of its products to Europe.”

A new supply system?

With oil being simultaneously a talisman of free-market capitalism yet also a sector that is protected and controlled by a very powerful global cartel, analysts are dubious if alternate suppliers can suddenly emerge for Western Europe.

Ash said: “I think there are overtures happening behind the scenes. The natural alternate sources would be Saudi Arabia and UAE for Europe, but a whole new supply system takes a lot of time – and there is just no getting around the fact much of Europe is dependent on Russia.

“And Russia knows what the alternatives are, whether it’s creating new gas terminals, shipping oil from other producers or switching to LNG, and it’s trying to head them off. Putin is pumping just enough gas to allow Europe to function but also ensuring it cannot stockpile.”

Perhaps Putin’s scariest attribute is his patience, seemingly willing to play a long and brutal game – which could mean come winter, his wrath could be taken out on a colder Europe needing heat and fuel, and consumers facing absurd energy prices, even if gas comes under a price-cap scheme.

“I’m afraid it seems likely prices will rise”, said Ash. “Unless we see some resolution on Ukraine. The UK has to a certain extent its own energy, France has nuclear, Italy has some alternate sources, but is it enough?

“On the gas issue, one needs to look at the end of the pipelines – which in Europe is Spain, southern Germany, Czech Republic, Slovakia, Austria – all these countries will need to make dramatic decisions over their stance on Ukraine if Russia shuts down the supply.”

Lindstaedt added: “This is why Volodymyr Zelenskyy declared that the war needs to be over by January. There is concern that the winter is going to create a huge demand for energy and Russia will be at a greater advantage.”

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