BUSINESS TIMES
It’s far from clear that the G7’s plan to cap the price of Russian oil would work
Wed, Sep 07, 2022
WHEN historians recall the recent decision by Western governments to try to cap the price of Russian oil on global markets, they might describe it as a smart and creative plan that helped reduce the funding for President Vladimir Putin’s war, a diplomatic achievement that helped Ukraine halt the Russian invasion. And to attain that goal with minimal costs for the economies that import oil from Russia was just brilliant!
Or perhaps the historians would describe the plan devised by policymakers in Washington and rolled out by the Group of 7 wealthy nations last week (Sep 2) as misguided and silly, and explain that it had no chance of succeeding, and demonstrated that when it comes to military wars, employing economic power may not be enough to win victories.
In fact, it’s time to admit that the US-led alliance’s efforts to try to crush Russia’s US$1.8 trillion economy with a set of massive economic sanctions, including the freezing of Russia’s currency reserves and embargoing that country’s oil imports, haven’t been quite effective.
That is certainly the case if the intended strategic goal behind the sanctions was to cripple Russia’s productive and technological might and force President Putin to end his aggression in Ukraine.
But while Russians may have experienced some economic pain from the sanctions, the country’s GDP has contracted by less than expected while global energy prices continued to allow Russia, which produces more than 10 per cent of global oil supplies, to maintain a healthy current account surplus.
If anything, that the Western-imposed embargoes haven’t been enforced by other large economies like China and India, allows President Putin not only to neutralise the impact of the economic sanctions but also to exploit his country’s chokehold over gas supplies to ignite an energy crisis in Western Europe and perhaps trigger a recession there.
From that perspective, the idea of capping the price of Russian oil embraced by the finance ministers of Canada, France, Germany, Italy, Japan, the United Kingdom and the United States, and championed for a long time by US Treasury Secretary Janet Yellen, should be seen as an attempt to square the circle.
It supposedly would force down Russia’s energy revenues without having the side effect of causing a rise in global oil prices and in the process benefiting the Russian economy. Or, as the G7 put it, the goal was to “amplify the reach of existing sanctions”.
“This price cap is one of the most powerful tools we have to fight inflation and protect businesses in the United States and globally from future price spikes causes by global disruptions,” explained Yellen.
Hence, Russian oil would continue to flow, including to economies that have not joined the Western embargo, while limiting the upward pressure on global oil prices but without increasing Russian revenues from its oil exports, and thus constraining Moscow’s ability to fund its war against Ukraine.
In practical terms, the G7 decision means that the world’s richest economies would move to ban the insurance and financing of shipments of Russia oil and petroleum products unless they are sold under a set price cap. In fact, if the plan works, even the economies of the European Union (EU) could continue purchasing Russian energy supplies and avert an energy crisis.
But why would the financial institutions that insure and finance the shipments of Russian oil, and other governments, go along with the plan? Because the US and its allies continue to be the dominant force in the global economy, and 90 per cent of global shipping traffic pass through these countries.
That provides the West with a leverage over the insurance companies as well as over economies like China and India that continue to purchase Russian energy. Or at least that’s the general idea.
But neither India nor China has indicated a willingness to participate in the scheme, and Russia has warned it would retaliate against any country that takes part in it.
Western policymakers are operating under the assumption that all the major players involved in their plan are what economists and political scientists describe as “rational actors” who can be relied on to make informed, calculated decisions that maximise value and perceived benefits to the state.
Under this rational-actor model, the political leader is seen as an “economic man”, not unlike your ideal business executive who acts rationally, with perfect knowledge, and who seeks to maximise ‘personal’ utility or satisfaction - for himself and/or his organisation.
Based on these assumptions, the leaders of China and India have a clear interest in adhering to the G-7 plan which would not only allow them continued access to Russian energy supplies; they will actually pay less for these purchases and explain to President Putin that the Western companies made them do that.
Even if other governments deny that they are joining the G7 plan, in the real world, buyers of Russian oil around the world can be expected to demand discounts on their purchase contracts with Russia because of the price cap, suggesting that the Russians would be losing some of their leverage in the global energy markets, as they need to adjust to the new reality under which they would be able, after all, to sell their oil albeit at lower prices.
A rational actor may come to the conclusion that, indeed, if the choice is between selling your oil at lower prices or not selling it at all, the first option makes more economic sense.
But then President Putin has demonstrated that he isn’t an “economic man”. If he was, he wouldn’t have invaded Ukraine in the first place. He regards the control of Ukraine to be a core Russian national interest, and he is supposedly willing to pay the high economic costs.
Hence President Putin could threaten to retaliate against the G-7 decision by cutting energy supplies to their countries off entirely, which could prove to be a devastating economic blow to Western Europe and could force governments there to reassess their strategy of economic war against Russia. Under such a scenario, energy prices would rise and accelerate inflationary pressures in the US and elsewhere.
Moreover, since it would be difficult to monitor compliance, China and India and other countries could try to evade the G7 scheme by making side deals with Russia. China would certainly reject the plan which, if it succeeds, could serve as a model for imposing economic sanctions on China in retaliation for a possible invasion of Taiwan.
In a way, Western governments may have to reassess the notion that their economic power by itself could help them win their geo-strategic conflicts with either Russia or China; at the end of the day, it is hard (or military) power that determines the outcomes of wars.