KYIV – Blocking the Russian central bank’s foreign-exchange reserves was a brilliant move. Disconnecting some Russian banks from the SWIFT financial messaging system was helpful. And pursuing the offshore wealth of Putin’s cronies is appropriate. But none of these sanctions have stopped the Russian invasion of Ukraine for one reason, and none of them will.
The reason is simple: Russia continues to export oil and gas. Indeed, the war has boosted the price for these products, benefiting the most important sector of the Russian economy. So, a week after it began, Western energy consumption is still financing Russia’s invasion of Ukraine, and the Russian elite is doing better than ever. There is no way around it: The only way to stop Russian President Vladimir Putin’s aggression is to impose a comprehensive boycott on all Russian energy products.
Energy comprises the bulk of Russia’s exports, primarily in two forms: gas to Western Europe, via pipelines and paid for on long-term contracts, and oil to world markets, sold mostly on spot markets.
According to figures from the International Energy Agency,
“Revenues from oil and gas-related taxes and export tariffs accounted for 45% of Russia’s federal budget in January 2022. Considering current market prices, the export value of Russian piped gas to the EU alone amounts to $400 million per day. Total export revenues for crude oil and refined products currently amount to around $700 million per day.”
So far, there have been some small disruptions to Russian oil exports, but no impact on gas exports, according to the IEA. With Brent oil prices up from around $90 per barrel to around $110 per barrel since the invasion started (and up from $80 at the end of 2021), Russia has plenty of cash coming in. If there is a discount on Urals crude, it is smaller than the increase in oil prices – so Russian oil exporters are still ahead, financially.
Over the past month, the daily value of Russian oil exports has increased by around $100 million per day (calculated from the IEA estimate of daily Russian exports, multiplied by our estimate of the increase in the effective price for Urals crude). The Russian current-account surplus was about $19 billion in January 2022, or about 50% higher than is typical for January (in most years, the monthly surplus is $9-12 billion).
There is a view in policymaking circles in the United States that the current policy of financial sanctions is degrading Russian oil capacity in a way that serves US strategic interests. But by putting more cash into the pockets of oil producers, the US and its allies are having the opposite effect. There is no alternative to sanctions that immediately reduce the volume of Russian oil and gas exports.
A comprehensive boycott of Russian energy can start with the US imposing full sanctions, including secondary sanctions, on all Russian oil and gas exports. The world oil price will rise, but if the sanctions are fully enforced, none of that windfall will go to Russian producers. In this scenario, the IEA estimates that oil production around the world will be boosted very quickly – Russia exports five million barrels per day; additional world supply can add at least three million bpd. Energy conservation measures can and should also be introduced where appropriate.
Of course, the European Union would need to follow suit. But, to put it bluntly, this is only a matter of time. The EU can either stop buying Russian gas now, to halt the invasion, or it can wait a month, until thousands more people have died – and the horrific photos of civilian casualties flood every channel. At some point soon, Europe will no longer be able to stomach the fact that it is paying for Putin’s atrocities in Ukraine.
The IEA has a sensible plan for how to wean Europe off Russian gas, and a team at Bruegel has published important proposals and have addressed how to get through the next few months without Russian gas. Every European policymaker needs to confront the issue head-on.
To be sure, Europeans will have to make difficult decisions, not least how to finance the immediate transition away from Russian gas. But imagine the decisions that must now be made in Ukraine, to keep people alive and to prevent the greatest humanitarian disaster Europe has seen since World War II.
Nor will the impact be limited to Europe. For example, very soon Ukrainian agriculture will collapse: No one can plow or plant seeds while being attacked by Russian forces. This will push up global food prices, because Ukraine is the world’s fifth-largest exporter of wheat, implying a major impact on budgets and poverty in low-income countries.
Some Europeans will need help to pay their heating bills, and they may face other economic costs because of what Putin is doing. But compare this with millions of Ukrainians already struggling to find food, safe drinking water, and essential medicine – and to avoid being shot or blown up. Hundreds of thousands of Ukrainian children are already traumatized for life, and their suffering will only get worse unless Putin is stopped immediately.
The outpouring of support for Ukraine and Ukrainians has been amazing. More than one million refugees have been welcomed by individuals and governments throughout the EU, and the US, the United Kingdom, and other countries are providing many forms of assistance. We are grateful for all of it.
But it is time to face the harsh reality that Putin and his cronies have gone berserk. The world can either boycott Russian energy fully today, to stop the invasion immediately, or it can continue to watch Russian forces commit one outrage after another – every day moving closer to the territory of EU countries.
No one in the world should buy Russian energy. The stigma should be worse than for blood diamonds. The world is arming and encouraging a violent, uncontrollable monster. It must stop.
Simon Johnson contributed to the writing of this commentary.
CAMBRIDGE – As I write, Russia’s army has entered Ukraine’s capital, Kyiv. It is clear now that the threat of sanctions did not dissuade Russian President Vladimir Putin from launching his invasion. But making good on the threat can still play two other roles: Sanctions can limit Russia’s capacity to project power by weakening its economy, and they can create a precedent that might influence Putin’s future behavior vis-à-vis other countries such as Georgia, Moldova, and the Baltic states.
One reason why the threat of sanctions might not have prevented war is that Russia did not regard them as credible. If imposing a sanction is costly, the political will to do so may be weak or evaporate over time. For example, Western consumers are already upset at the high energy costs. An embargo on Russian oil will reduce the global energy supply and send prices even higher, potentially triggering a backlash against the policy.
That may be why Western countries have not imposed it, opting instead for financial sanctions that have, so far, been underwhelming. After all, arguably the most significant sanction to date – the suspension of the Nord Stream 2 pipeline that would have delivered Russian natural gas directly to Germany – will strain Europe’s already tight natural gas market.
Sanctions are more effective and credible if they impose large costs on the intended target but entail small costs or even benefits for those imposing them. Finding such sanctions is easier said than done, as the Nord Stream 2 project shows. So, what instruments does the West have in its arsenal?
One that has received surprisingly little attention is punitive taxes on Russian oil and gas. At first sight, imposing a tax on a good must increase its price, making energy even more expensive for Western consumers. Right? Wrong!
At issue is something called tax incidence analysis, which is taught in basic microeconomics courses. A tax on a good, such as Russian oil, will affect both supply and demand, changing the good’s price. How much the price changes, and who bears the cost of the tax, depends on how sensitive both supply and demand are to the tax, or what economists call elasticity. The more elastic the demand, the more the producer bears the cost of the tax because consumers have more options. The more inelastic the supply, the more the producer – again – bears the tax, because it has fewer options.
Fortunately, this is precisely the situation the West now confronts. Demand for Russian oil is highly elastic, because consumers do not really care if the oil they use comes from Russia, the Gulf, or somewhere else. They are unwilling to pay more for Russian oil if other oil with similar properties is available. Hence, the price of Russian oil after tax is pinned down by the market price of all other oil.
At the same time, the supply of Russian oil is very inelastic, meaning that large changes in the price to the producer do not induce changes in supply. Here, the numbers are staggering. According to the Russian energy group Rosneft’s financial statements for 2021, the firm’s upstream operating costs are $2.70 per barrel. Likewise, Rystad Energy, a business-intelligence company, estimates the total variable cost of production of Russian oil (excluding taxes and capital costs) at $5.67 per barrel.
Put differently, even if the oil price fell to $6 per barrel (it’s above $100 now), it would still be in Rosneft’s interest to keep pumping: Supply is truly inelastic in the short run. Obviously, under those conditions, it would not be profitable to invest in maintaining or expanding production capacity, and oil output would gradually decline – as it always does because of depletion and loss of reservoir pressure. But this will take time, and by then, others may move in to take over Russia’s market share.
In other words, given very high demand elasticity and very low short-term supply elasticity, a tax on Russian oil would be paid essentially by Russia. Instead of being costly for the world, imposing such a tax would actually be profitable. A punitive global tax on Russian oil – at a rate of, say, 90%, or $90 per barrel – could extract and transfer to the world some $300 billion per year from Putin’s war chest, or about 20% of Russia’s 2021 GDP. And it would be infinitely more convenient than an embargo on Russian oil, which would enrich other producers and impoverish consumers.
This logic also applies to Nord Stream 2. A tax equal to 90% of the European Union’s natural gas price, which is currently around €90 ($101) per megawatt-hour, would keep Russian gas in the market but expropriate the rent.
But how feasible would a 90% world tax on Russian oil be? In 2019, 55% of Russia’s exports of mineral fuels (including oil, natural gas, and coal) went to the EU, while a further 13% went to Japan, South Korea, Singapore, and Turkey. China got only 18%. If all these countries except China agreed to tax Russian oil at 90%, Russia would try to sell all its oil to China. But this would put China in a strong negotiating position. In such a scenario, it would be in China’s interest to impose the tax, because such an instrument would extract the rent that it would otherwise have to pay to Russia.
In short, a punitive tax on Russian oil would both significantly weaken Russia and benefit consuming countries, making it more credible and sustainable than an embargo. The idea deserves considerably more attention that it has received.