Global energy price cap: market manipulation whose time has come?

“United against megalomania” was how one German newspaper succinctly put it.

Sanctions on Russian gold exports, the enlargement of the Nato intervention force to six times its current strength, an air missile defence system for Ukraine, and a broad commitment that the Group of Seven will be with Ukraine for as long as it takes.

None of these, secured at this week’s G7 summit held high in the Bavarian Alps in weather that ranged from glorious sunshine to shattering thunderstorms, is a paltry achievement.

But there was one idea that stood out, both because it is new, divided the G7 and told a bigger story about the dilemma the west faces as it tries to damage Vladimir Putin’s war economy.

It is the proposal of a global price cap on energy. The idea has a simple attraction as it deals with two problems. It would bring energy prices back under some form of control, quelling a consumer backlash about inflation. At the same time, it would slow the flow of western funds to Putin’s war machine, which is largely dependent on gas and oil revenues supplied by western purchases.

Jake Sullivan, the US national security adviser, explained at one briefing that the west was facing a dilemma. It had through its own measures cut the amount of Russian energy it was purchasing, but due to the rise in the price of oil, the revenues reaching Putin had not correspondingly declined. Russia is, according to business intelligence company Rystad Energy, due to secure at least $180bn (£147m). That is 45% higher than in 2021 and 181% higher than in 2020.

The solution is at one level disarmingly simple – to refuse to pay as much as Putin and the market demand. Such an idea, so antithetical to free-market principles, might seem like a Marxist magic bullet but it comes with the backing of Mario Draghi, the former president of the European Central Bank, and Janet Yellen, the head of the US Treasury. And it is the brainchild of Washington academics.

Advocates are, however, touting slightly different but not necessarily conflicting versions of the idea. Yellen principally wants to impose a cap on the price of seaborne oil, which will disproportionately affect Russia. Draghi thinks it is possible to go further by putting a cap on piped Russian gas. In some ways, his idea has greater potential since European consumption is not due to trail off as quickly.

Francesco Giavazzi, the economic adviser to the Italian prime minister, explained Draghi’s plan to the Guardian. He said: “Russia’s gas pipelines essentially go in two directions: to Europe and – for the moment with much smaller capacity – to China. A gas producer can slow the flow of gas, but it cannot stop it. Ultimately, if there is no flow, one will have to start burning gas in the air – which means burning dollars in the air. Putin could do it, but it would be very expensive for Russia, also politically.”

Draghi, who tends to get a hearing at summits on economic issues, explained: “We must reduce the amount of money going to Russia and get rid of one of the main causes of inflation.”

The oil cap would in theory work through one lever – insurance.

Nearly 95% of the world’s oil tanker fleet is covered by the International Group of Protection & Indemnity Clubs in the heart of the City of London, and some firms based in continental Europe. European nations already agreed to end insurance for Russian oil shipments. Western governments could try to impose a price cap by telling buyers their insurance is available, but only as long as they agree not to pay more than a certain price for the oil onboard. In the papers that have been circulating at the G7, no figure is mentioned.

It was clearly a battle at the G7 for the US to get Germany to engage with this idea, and they ended up with a classic summit compromise to allow technical experts to go away and study the idea.

There are multiple drawbacks to the oil plan. First, it is possible the insurers will say they are being deprived of legitimate business for no valid reason. Second, the EU might have to reopen painfully agreed existing oil sanctions packages to endorse the idea. That would require unanimity, and Hungary might again block progress in favour of cheaper oil. The EU is also due to phase out oil purchases by the end of the year.

Third, Putin might say, if he is being required to sell the oil at marginal costs, that he will simply not sell. He has shown with gas he is prepared to forgo some revenue by slowing or turning off the taps to intimidate gas-dependent countries such as Germany and Moldova. It might not be an economically rational response by Putin, but the Kremlin is not currently seen as a paragon of reason.

Finally, and most importantly, is the question of whether oil-importing countries such as India that are less engaged in the war be willing to go along with the scheme. At one level they would have no choice if they had no shipping insurance. But India might also be positively disposed to the idea of getting an expensive commodity at a cheaper price. The pricing would be a matter of fine-tuning.

Oil-producing countries such as Saudi Arabia might also not welcome this piece of novel market manipulation fearing that if this worked it sets a precedent that puts oil-consuming nations in the driving seat.

Mark Mozur, a market analyst for S&P Global Commodity Insights, says “the battle has already been lost, for this year at least” as Russia has reported high revenues. “Russia’s brazen behaviour in reducing gas flows to Europe should be seen in this context: it can do just fine without the additional income.”

What seemed intriguing ideas in the meeting rooms high in the Alps may yet emerge to have been world leaders clutching at straws. On the other hand, the belief that oil markets are free is drivel. They are riddled with cartels, and perhaps it is time for the consumers to have one as well.