The European Commission’s plan to target Russian oil in its latest sanctions package aims to ramp up the pressure on Moscow.
Oil is a major source of hard currency for Russia, and since the introduction of financial sanctions, it has become even more vital for the country’s economy, as well as a crucial source of funding for its war on Ukraine.
Crucially, however, the proposed phase-in of an embargo on Russian oil could prove counterproductive — at least in the short term — and there is a better option.
Undoubtedly, one of the immediate consequences of the announcement of a phased-in embargo will be an increase in prices; and as Russian oil sales to the European Union will continue for several months to come, this could very well increase Russia’s profits, providing a short-term boost to its government budget as the war is raging.
Also, while the gradual phase-in would give Europe time to develop alternative oil supplies, it would allow Russia the time to secure new export opportunities as well. And even though measures to limit Russia’s access to shipping are an important part of the EU package, they may not be sufficient to deter alternative customers for Russian oil in an energy-hungry world.
Finally, a price spike following the embargo announcement will be a drag on the global recovery after the pandemic — which is why United States Treasury Secretary Janet Yellen called for the EU to exercise caution in banning Russian oil.
Even at this late hour, the EU should consider taking a different path — that of an immediate punitive tariff on all Russian exports of crude oil, oil products and possibly natural gas.
A tariff would be a flexible tool to increase or reduce the pressure on Russia, depending on the situation in Ukraine.
It would immediately reduce Russian revenues, while still giving Moscow an incentive to sell to Western buyers. As oil and gas would continue to flow, global prices may well fall, reducing Russian profits further. Finally, it would also give Russia less reason to quickly build new infrastructure to export fossil fuels to third countries.
The reason the tariff option has been rejected so far is because of two misconceptions among European policymakers: First, that it would increase prices for consumers more than other alternatives, and second, that Russian President Vladimir Putin would not accept it, choosing to stop oil and gas flows immediately instead.
However, the price effects of a tariff depend on the ability of sellers and buyers to find alternatives. The harder it is for Russia to develop new export routes, and the easier it is for the EU to find alternative oil supplies and reduce domestic demand, the greater Russia’s willingness to pay the tariff will be.
As infrastructure bottlenecks currently prevent any substantial redirection to Asia, Russian oil and gas exports to Europe are in fact quite inelastic in the short to medium term. The EU therefore has a real chance to ensure tariffs are mostly paid by Russia rather than being passed on to EU consumers.
With a bold energy strategy, Europe could credibly threaten to cut Russia’s oil and gas revenue, while minimizing the domestic economic consequences of a tariff. And to improve its position, the EU should aim to reduce the oil and gas demand across the bloc, while increasing the use of all available alternative energy resources.
Of course, reducing demand for oil and gas will involve stopping subsidies and encouraging citizens to consume less. Such measures are politically difficult, but they are now urgent.
In fact, government responses to energy price increases have mostly been counterproductive, increasing the EU’s dependency on Russia rather than reducing it. Direct energy-price subsidies and tax cuts have propped up oil and gas consumption. Initially designed to provide a quick fix to what was supposed to be a temporary problem, these measures have now ballooned and become structural.
European governments need to acknowledge that higher energy prices are not the problem but are, in fact, part of the solution, and that cutting the demand for oil and gas is crucial for increasing our energy resilience.
Europe needs to replenish its gas storages before next winter to avoid Putin’s energy blackmail, and each cubic meter of gas that isn’t consumed now counts. Governments should have the courage to tell their citizens that Europe is in the midst of what possibly represents the greatest energy crisis in its history.
According to the International Energy Agency, simple actions such as turning down the thermostat or turning up the air conditioning by just 1°C, working from home when possible, or reducing cruising speed on motorways by 10 kilometers per hour could save enough oil to fill 120 super tankers and enough natural gas to heat 20 million homes.
Compared to difficult and expensive supply-side options like finding substantial additional volumes of LNG, demand-side options like these could be a significant and quick win.
And as for triggering Putin’s retaliation with a tariff, this may well happen — the recent shut-off of supplies to Poland and Bulgaria show that this possibility should not be dismissed. However, the proposed phase-in of an oil embargo would only increase the likelihood of such a supply stop even further — and is clearly Europe’s worse option.