G7’S Overambitious Plan To Punish Russian Oil And Alter The Future Of Oil Markets

On June 28^th, leaders of the G7 announced that they agreed to explore the possibility of imposing a price cap on Russian oil to reduce Moscow’s energy revenues. While many view this as political exigency or a futile return to price controls, the truth is far more complex — with reverberations beyond the war in Ukraine or current energy woes.

The G7 is attempting to coordinate a group of consumer countries to create a market where consumers rather than producers have leverage, a monopsony оf sorts. This stands in stark contrast to the OPEC+ which includes the historic OPEC plus Russia and its neighbors. This is a group of producers created in 2016 that coordinate and enjoy near-monopolistic powers. The attempted transformation of the G7 into an anti-OPEC monopsony would be one of the most significant geo-economic developments since the new millennium.

This initiative comes after embargoes on Russian oil drove up global crude prices for five months. Although oil stabilized from $70 a year ago to just above $100 a barrel on Wednesday, prices are still high. Concerns remain that rising crude prices have largely offset Russian losses from sanctions. The G7 is eager to address this issue. The proposed mechanism for their monopsony would reduce or ban insurance and financing for Russian oil shipments above a set price. For example, if a tanker agrees to take a shipment from Russia at a higher rate than the G7 set price per barrel, it will not be able to obtain the insurance and financial services necessary for the transaction or continued operations.

Despite the announcement to explore price caps, it is still unclear whether the plan will go forward. After US President Joe Biden presented the idea at the summit to the enthusiasm of EU leaders, an official statement from the European Council expressed interest but required more details as to the specifics of the policy. The EU collectively remains Russia’s largest customer despite its plan to phase out imports later this year, and the negotiations that led to the agreement were tense, with land-locked Hungary insisting on exemptions.

Further complicating matters, individual G7 states have their own perspectives on the best way of implementing the mechanism. France has advocated for capping oil prices worldwide instead of only targeting Russian oil— implying immediate coordination with or confrontation against OPEC while exploring alternative suppliers like Iran and Venezuela.

Italy proposed an additional exploration of Russian gas price caps to curb inflation in the bloc. Interests within the G7 and the EU will further diverge in the winter months when European resiliency will be tested. Paris and Rome are making a typical mistake of midsize powers overreaching for goals that are too ambitious. G-7 needs to walk before they run.

Coordination will not just be difficult in the EU or G7. The largest consumers of Russian oil, China and India, have benefited immensely from receiving discounted crude from Russia while prices rise. The likelihood of either of these consumer countries changing course is rather low, considering Beijing’s anti-Western posture. India is a particular concern for the West.

And even beyond the two Asian elephants in the room, the likelihood that actors in the global south will sacrifice their own developmental imperatives for the sake of the G7’s defense of Ukraine, European security, and standing up to the Russian aggression appears uncertain. Playing economic warfare is both an art and a science. Washington and its allies would need to do more to expand the oil consumer alliance to make Moscow sweat.

Beyond the complications of creating any price cap, it is also unclear what incentives or enforcement mechanisms the G7 envisions for it. In a world of shell companies and offshoring, even limited bans on financing are challenging. Before the summit, European leaders struggled to reach a consensus on moving against Russian energy due to fears that Moscow could decrease its oil and natural gas supplies and drive prices further up. It would be naïve to assume Russia will not retaliate by choosing not to sell at prices mandated by the cap or intentionally drive-up prices by decreasing production. The Kremlin has already shown its willingness to withhold natural gas supplies in its quest to undermine the sanctions levied against it.

If the G7 succeeds in creating a monopsony, a litany of problems must be confronted. Enforcement and punishment mechanisms will inevitably be lacking. OPEC will certainly not be happy, and even if OPEC is defeated in any confrontation, as it was after the 1973 oil embargo, any western victory will be pyrrhic. Monopsonies also create economic uncertainty and inefficiencies that will upset market calculations on everything from externalities to compliance. A monopsony could inadvertently revive black market oil trading with significant state support.

Despite the dangers and uncertainties, there is a great prize to be won by the G7 should they succeed. The international energy regime would be totally reordered. The G7 would be able to freeze the energy-based foreign policy ambitions of upstart authoritarians. There would also be a potent new tool that could help solve many compliance-related problems of international environmental treaties. The G7 and EU collectively enforcing regulations on prices may do for energy production what trade unions did for workers’ rights. But none of these promises are inevitably or even likely. The G7 will only succeed if they can find some way to untangle the Gordian knot of competing interests from an array of actors, though it currently lacks any sword to speak of.

With assistance from Aiganym Nurakhanova and Wesley A. Hill