Successful G7 Oil Price Caps = OPEC Rival Consumption-Based Price Setting Cartel

indianpunchline |  The Biden Administration tempted Fate by underestimating the importance of oil in modern economic and political terms and ignoring that oil will remain the dominant energy source across the world for the foreseeable future, powering everything from cars and domestic heating to huge industry titans and manufacturing plants. 

A smooth transition to green energy over time is largely dependent on the continued availability of plentiful, cheap fossil fuel. But the Biden Administration ignored that those who have oil reserves wield a huge amount of power over our oil-centred energy systems, and those who buy oil are on the contrary, cripplingly dependent on the market and the diplomatic relations which drive it. 

The Western powers are far too naive to think that an energy superpower like Russia can be simply “erased” from the ecosystem. In an “energy war” with Russia, they are doomed to end up as losers.  

Historically, Western nations understood the imperative to maintain good diplomatic relations with oil-producing countries. But Biden threw caution into the wind by insulting Saudi Arabia calling it a “Pariah” state. Any improvement in the US-Saudi relations is not to be expected under Biden’s watch. The Saudis distrust American intentions. 

The congruence of interests on the part of the OPEC to keep the prices high is essentially because they need the extra income for their expenditure budget and to maintain a healthy investment level in the oil industry. The International Monetary Fund in April projected Saudi Arabia’s breakeven oil price — the oil price at which it would balance its budget — at $79.20 a barrel. 

The Saudi government does not disclose its assumed breakeven oil price. But a Reuters report suggested that a preferred price level would be around $90 to $100 a barrel for Brent crude — at which level, it won’t have a huge impact on the global economy. Of course, over $100 will be a windfall. 

Meanwhile, a “systemic” crisis is brewing. It is only natural that the OPEC views with scepticism the recent moves by the US and the EU to push back Russia’s oil exports. The West rationalises these moves as aimed at drastically reducing Russia’s income from oil exports (which translates as its resilience to fight the war in Ukraine.) The latest G7 move to put a cap on the prices at which Russia can sell its oil is taking matters to an extreme. 

The OPEC regards it as a paradigm shift, as it implicitly challenges the cartel’s assumed prerogative to ensure that global oil supply matches demand, where one of the key measures of supply-demand balance is price. Arguably, the West is de facto setting up a rival cartel of oil-consuming countries to regulate the oil market. 

No doubt, the West’s move is precedent-setting — namely, to prescribe for geopolitical reasons the price at which an oil-producing country is entitled to export its oil. If it is Russia today, it can as well be Saudi Arabia or Iraq tomorrow. The G7 decision, if it gets implemented, will erode OPEC’s key role regulating the global oil market.