Co-authored by Anastassia Fedyk, Haas School of Business, UC Berkeley; Yuriy Gorodnichenko, UC Berkeley; Tania Babina, Columbia University; and Tetyana Balyuk, Emory University. Reposted from the Berkeley Blog.
The European Union (EU) countries have paid over 13 billion dollars for Russian oil, gas, and coal since Russia invaded Ukraine on February 24, 2022. Meanwhile, Ukraine is heroically defending not only its own freedom, but also the freedom of the EU and other democracies around the world. The dissonance between the sacrifices made by Ukrainians and the lack of sacrifices made by the EU countries can’t be sharper.
Ukraine gives everything it has to battle Russia, while the rest of Europe is rather silent in one crucial respect: Russian energy. It is crystal clear that the EU has the key to force Putin to stop this war and prevent the world from sliding into the law of the jungle. With no energy revenues, the Russian economy will experience a blow that no dictator can afford.
So, why not do it now, when the time is so vital for Ukraine’s survival and for the safety of other countries? German Chancellor Olaf Scholz and other EU leaders suggest that stopping imports of Russian energy can push their economies into a recession. Prominent Western European economists disagree. Furthermore, the policy does not have to be cast in “all or nothing” terms, and the free world has a number of levers to economically destroy Putin’s war machine.
For example, EU countries use natural gas for heating and generating electricity. But electricity can come from a variety of sources, thus enabling the EU to substitute electricity generated by power plants burning gas with electricity generated elsewhere, including Europe’s existing nuclear power plants and renewable energy options such as geothermal and green hydrogen. Natural gas can also come from places other than Russia. Overall, while Europe’s current dependence on Russian oil is unsettling, the situation is not as dire as it might seem at first glance. Over nearly a decade of low energy prices, Western companies such as Chevron have focused on making substantial efficiency gains. Now that crude oil prices are hitting $115/Bbl, producers that traditionally have higher costs, such as those in the United States, are poised to expand supply.
In the short term, the EU can impose a 90% punitive tax on Russian energy as suggested by Ricardo Hausmann. He argues that because the supply of energy is inelastic, the incidence of this tax will fall on Russia. Russia’s reliance on pipelines to transport gas limits its ability to materially redirect flows of natural gas from Europe to other destinations. In addition, Russia has limited gas storage capacities and existing ones are almost full. What will Russia do if it cannot sell or store the natural gas it produces? The EU has a number of precedents of slapping punitive tariffs even on better-behaving countries. Choosing between no revenue and some revenue, Russia will have little choice. A similar point applies to oil.
If the EU can cut its consumption of Russian energy significantly—say by 80%, which does not require cutting all consumption of Russian energy and corresponds to cutting EU’s overall energy use by only 32% for gas and 24% for oil—Putin’s regime will lose cash flows that are critical for him in the current conditions. Dependence on Russian energy is not a necessary condition for Europe. Before the 1990s, the attempts by the USSR to expand energy supplies to Europe were largely resisted—with administrations from JFK to Ronald Reagan understanding the danger of potential dependence on Soviet energy—and only a small fraction of European energy imports came from Russia. Weaning Europe back off of Russian energy is possible and will be less costly to Europe than to Russia.
There is no doubt that Putin will try to sell Russian oil to other countries that are less concerned with the morals of the Russian war in Ukraine. The wide spread between Urals (a blend of Russian oil) and Brent (a benchmark blend of North Sea oil) already suggests that there are limits to such diversions, but there is more to come. A snowballing financial crisis has already put Russia on the brink of default. The Russian government threatens to nationalize foreign-owned assets of a torrent of firms exiting Russia. Russian airlines refuse to return leased aircraft. These events mean that creditors will be chasing Russian assets all over the world. Russian tankers will be arrested as soon as they enter a port of a country that recognizes international law. In a similar spirit, non-Russian tankers will be arrested when they carry Russian oil.
In addition, energy trades are often done in major currencies such as the US dollar and the euro. This makes purchases of Russian oil or gas vulnerable to financial sanctions. Indeed, banks using dollars or euros to clear transactions with Russian oil may face huge penalties. For example, Deutsche Bank was fined $258 million for helping Iran to bypass US sanctions. Russian energy will be so toxic that few financial institutions will dare to service it.
The hesitation of the EU to impose tough, meaningful sanctions on Russian energy prolongs the war. And every day of delays and bickering leads to new deaths and unspeakable suffering in Ukraine. If Ukrainians find the courage to fight in the most difficult conditions, EU leaders must find the courage to do the right thing and crush the economic ability of Russia to wage its war in Ukraine. Such courage now will only make Europe stronger in the long term.