Commentary on Political Economy

Thursday, 10 March 2022


Oil revenues are Moscow’s single most important funding stream for the Ukraine war 


 Last week I explained why EU countries should completely stop buying Russian gas now. We will not see quite such a decision when EU leaders meet in Versailles today and tomorrow — not least because the German chancellor, Olaf Scholz, has explicitly ruled it out. But the European Commission has issued a proposal that would cut Russian gas imports to a third by the end of this year. That is progress. Scholz’s argument is flawed. “All our steps are designed to hit Russia hard, and be sustainable over the long term,” he said. But sustainability is a problem for actions that become more and more costly over time. Ending gas imports does the opposite. The hardest moment would come within a few months, when stored gas could be depleted (as I pointed out last week, the EU overall has enough gas stored to cover about two months’ worth of Russian imports). Even that would coincide with the summer season when demand plummets. From then on, things would only get easier the more time there was to adapt and find substitutes. Scholz’s reasoning is a bit like saying it is not “sustainable” to rip the plaster off in one go. Besides, as opposition politician Norbert Röttgen has asked him, what if Russia decides to cut off gas supplies? In addition, Scholz made his argument not just for natural gas but for energy imports generally, including oil. That matters, because an oil embargo is now on the cards. The US announced one on Tuesday. The UK immediately followed suit, but is unhelpfully and incomprehensibly delaying its ban until the end of the year. The rest of Europe, however, is so far doing nothing on oil imports. An oil embargo would be a much bigger deal for the EU than for the US. A quarter of the bloc’s oil imports come from Russia (the US only sources 7 per cent of its imports there). But the arguments I offered for a European cold turkey on gas apply even more strongly to oil. One important difference between the two hydrocarbons is that oil does not involve the same physical entanglement as gas. Most gas is transported in pipelines. Oil, in contrast, is “fungibly” traded on a liquid world market — that is to say, a barrel of oil is (roughly) a barrel of oil no matter where it comes from, and can be shipped from anywhere to anywhere. (Some gas is traded like this in liquefied form.) That means, on the one hand, that an effective embargo will reduce the global oil supply and drive up prices for everyone. But it also means that nobody would be physically unable to procure oil — which is theoretically possible for gas — even if the price may be very high. Another important difference is how much more Moscow earns from oil than from gas. Russia normally exports close to 8mn barrels of oil every day, which at today’s prices mean daily revenues above $1bn. This dwarfs the (admittedly significant) earnings from natural gas. According to the IMF, Russia exported about $200bn worth of oil in each of the past two years before the pandemic. Gas exports were worth only a quarter of that. In other words, whatever economic damage could be inflicted on Russia through blocking it from selling natural gas (largely by Europe), four times that damage could be inflicted through a global oil embargo. Big as they are, even these numbers do not fully capture the importance of oil. Oil is not simply an important part of Russia’s exports. Natural resource rents are also largely captured by the state: Russia uses state-controlled companies for hydrocarbon exports and has a progressive resource tax regime at home. That means oil revenues have an even more outsize role in Moscow’s government budgets than in the economy overall. Still, according to the IMF, oil revenues accounted for more than 20 per cent of general government revenue in recent years, and 40 to 50 per cent of federal government revenue. These shares will have grown with today’s high hydrocarbon prices. To get a sense of how an oil embargo would impair Russian president Vladimir Putin’s room for manoeuvre, consider a government losing a quarter to half of its revenue overnight, while having to both pay for an expensive war and protect a population from an economic collapse already under way (while that economic collapse itself undermines non-oil revenues). That reflection should make it immediately clear that buying Russian oil finances aggression and war crimes in Ukraine. If there were a choice between a gas and an oil embargo, the latter would be more effective. Doing both would be better still. But precisely because oil is traded globally and fungibly, an embargo only works if Russia cannot easily just sell its oil somewhere else. That requires two things. One is that all friends of Ukraine’s freedom should join the embargo to paralyse the Kremlin’s ability to wage war. The UK should stop dragging its feet and the EU should follow suit. That would be the best possible outcome from Versailles. The other is that, to encourage this, the US (and others) should add secondary financial sanctions to enforce the energy embargo. Such sanctions would target banks, corporations and commodity traders that fund, buy and trade oil even if they are not American, on penalty of losing access to the US financial system. The possibility of a more extensive embargo on Russia’s oil exports is one reason oil prices have soared to some of their highest ever levels. That means talk is not cheap: considering an oil embargo but not imposing one — or leaving it ineffective — boosts Putin’s finances because he can sell as much but charge more than before. Europe’s hesitation on oil is worse than standing on the sidelines; it actively benefits the aggressor. Other readables In a powerful piece for the FT, the economic adviser to the Ukrainian president warns that Putin’s war on Ukraine could cause a global famine by disrupting the sowing season. The head of the World Food Programme has talked of “hell on earth”. Not a moment too soon, the west is imposing sanctions on Russian oligarchs. In a books essay for last Saturday’s Weekend FT, I reviewed three new books on how the west facilitated oligarchs’ looting of their native countries. After Ukraine applied for EU membership (followed by Moldova and Georgia) a debate is taking place about whether to grant the official status of candidate for admission. An open letter from the think-tank Ceps points out that existing agreements with the bloc have already begun the arduous preparations to qualify for membership. More generally, there is too much debate on what to do with Ukraine without taking into account what Ukrainians say. So do read the Kyiv Declaration where civil society leaders set out what they want for Ukraine right now. 

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