What to do with Russian oil and gas

The European Union should apply import tariffs, instead of imposing an embargo.

The Russian war on Ukraine has already reduced growth and increased inflation in the European Union and worldwide. Current growth forecasts remain too positive and 1970s-style ‘stagflation’ can be expected in the EU.

According to different studies, an embargo on Russian gas imports would lead to recession in Germany, with a reduction in gross domestic product this year of anything from 0.3 to 6 per cent, compared with prewar growth forecasts for 2022 of 3-4 per cent. Other EU countries such as Austria, even more dependent, could be even more affected.

An embargo would have very negative consequences for affected industries while strongly raising energy prices in the EU and on world markets. The EU should instead introduce import tariffs on Russian oil and gas—of €50 per barrel and per megawatt-hour respectively—and their products.

Extreme shifts

In oil and gas markets supply and demand respond slowly to price signals, with little reaction in the short term but all the more in the long run. This leads to extreme price shifts after demand falls, as evidenced in the pandemic, and after it rises, as when economies opened up again. The Arab oil embargo in 1973 showed the effect of supply shocks to be even more marked.

If, due to an EU embargo, Russian exports were not available on the market, prices would increase dramatically. This would damage the EU yet help Russia—which could sell oil and gas, at higher prices, to the rest of the world. By contrast, an EU tariff on Russian oil and gas imports would lower Russian incomes from these sources impressively.

Prices are currently at least €100 per barrel of oil globally and around €100 per MWh for gas in Europe (one-month future, wholesale). Because the oil market is global, Russia would have to discount the tariff in its oil exports to the EU, since the world market price would not rise as there would be no supply shock. Removal of the uncertainty around a potential embargo might even lower the world market price somewhat.

In the more regional EU gas market, Russia could try to raise prices to pass on some of the tariff, but these are already elevated. Most gas is anyway delivered on long-term contracts and competition from cheaper liquid natural gas will erode Russia’s market power over time.

Inadequate transport

Russia would still try to sell its oil and gas to other countries. It would however find this difficult, partly because most would not be willing buyers but also because of inadequate transport capacity. There are simply not enough pipelines and ships to transport Russian oil and gas to China and India.

The EU should seek, together with the United States, to persuade other countries to implement such tariffs. Russia already has to sell its oil at a steep discount of 20-30 per cent. Even the politically-supportive China and India, which as big oil and gas importers are suffering economically from the inflation exacerbated by the Russian war, might be convinced to introduce tariffs or demand bigger discounts when it comes to Russian imports.

An EU import tariff would be compatible with the World Treaty Organization, as the security-safeguard clause could be used. Russia also has export tariffs on oil and gas.

‘Strategic autonomy’

Income from an EU import tariff could support Ukraine and Ukrainian refugees, create a strategic EU oil and gas reserve, and be invested in energy infrastructure, energy savings and CO₂-free energy production. This would not only strengthen defence, where EU countries already spend four times as much as Russia, though not very efficiently—but also ‘strategic autonomy’ in energy.

In the short term we should lower our energy consumption, especially fossil fuels. The International Energy Agency has proposed very good ten-point programmes on gas and oil, such as lowering speed limits by 10 kilometres per hour.

This would help reduce energy prices, as these react strongly to falling demand, as we have seen in the pandemic. In the long term we should aim to stabilise prices, as their volatility is extremely harmful for our economies.

A buffer could be provided by a system of social support of lump-sum payments for individuals or households where prices rise above €90 a barrel and above €80 per MWh for gas. Deficit financing is appropriate in this context.

If prices fell a carbon tax could sustain them at €80 a barrel and €70 per MWh, with the revenue paying back the debt caused by the social-support arrangement. Beyond that, such a price-sensitive tax could again support energy-saving investments by households and firms, the transition from oil and gas to electricity and renewable electricity generation.

This would incentivise investment in alternative energy, as the prices of competing fossil fuels could not fall too low. The transformation of our energy system, essential for our climate goals, would be supported while economically damaging boom-and-bust cycles on energy prices would be smoothed.