The European oil embargo is not enough
Vladimir Putin needs petrodollars, and he needs them now. Many expected the Russian president to issue a formal declaration of war against Ukraine, a move that would allow the full mobilization of Russian reserve forces. But although Putin wants to send more soldiers to Ukraine, he cannot afford to do so. Will the oil embargo recently announced by the European Union force it to put an end to the invasion?
Already, the Kremlin has softened its propaganda. It is no longer a question of taking Kyiv. Putin’s only goal now, apparently, is to occupy the eastern region of Donbass. But even there, Putin’s victory is not guaranteed, as this is where Ukraine has launched its so-called joint forces operation, which includes its best-trained military units – increasingly armed with advanced Western military equipment.
Russia, meanwhile, has lost much of its modern military equipment and Western sanctions have prevented it from replenishing its stockpiles. With few options, Russia is now unboxing Soviet-era tanks.
The only way for Putin to compensate for the lack of equipment is to send more soldiers. But drafting new conscripts is an unpopular idea, so Putin resorted to paying people to fight for Russia – and not nothing either. Recruits would now receive between $3,000 and $5,000 a month. But the recent decision to scrap the age limit for army recruits suggests that even the prospect of earning an order of magnitude higher than the average salary in Russia’s middle region is not attracting enough fighters.
Budget data recently released by the Russian Finance Ministry suggests that Putin can ill afford to cover the rising costs of war. The data confirms, first, that the war has been expensive, with military spending rising nearly 130% last month to 630 billion rubles ($10.2 billion), or 6% of annual GDP pro rata.
The data also shows that Russia recorded a budget deficit of more than 260 billion rubles in April, or 2.5% of GDP pro rata to annual figures. With global oil prices skyrocketing, Russia has been selling its oil at a huge discount – accepting $70 a barrel for Urals crude in recent weeks, 30% below market price – while Russia overall production is expected to fall by 10% this year. Meanwhile, nonhydrocarbon revenue has fallen, leaving oil and gas taxes to account for more than 60% of tax revenue, compared to less than 40% a year ago.
Putin’s reliance on petrodollars means that by announcing an embargo on around 90% of Russian oil imports within the next 6-8 months, the European Union is hitting Russia where it hurts. Putin is now almost certain to face a major budget crisis within a year, which will make it difficult to continue his war in Ukraine, let alone invade another country.
The problem is that the embargo will help Putin in the short term. The mere announcement of it has already caused a spike in oil prices. This is why Europe should supplement its oil embargo with immediate additional measures. Two options stand out.
The first – which Ricardo Hausmann proposed immediately after the invasion, and which others have shown could be implemented quickly – is a high tariff on Russian oil imports. This approach makes perfect economic sense. Every euro spent on Russian oil helps Putin fund his violent campaign in Ukraine. This is a “blood externality” and should be priced accordingly. Part of the amount paid by buyers of Russian hydrocarbons should be transferred to Ukraine as reparations or stored in special escrow accounts until reparations are officially granted.
But at a time when European households are facing soaring energy costs, there is little political appetite for an oil tax. With this in mind, Italian Prime Minister Mario Draghi has proposed an alternative solution: a price cap. Under this proposal – which the European Council has instructed the Commission to assess – Western countries would pay a lower price for Russian oil and gas and impose secondary sanctions on third parties who pay Russia more.
A price cap could be put in place immediately – say, at $70 a barrel – and lowered by about $10 each month as the war continues. Yes, Putin could refuse to sell oil at this price. But, given that it’s already desperate enough to sell to China and India at deep discounts, and that current energy prices far exceed production costs, that seems unlikely.
Instead, Russia would likely continue to supply oil and gas to Western buyers at the capped price, while buyers like China and India, under threat of sanctions, would have no reason to pay more. This would relieve consumers of high energy prices and lead to a sharp drop in Russia’s income.
Some might argue that price caps distort incentives – in this case, the incentive to adopt renewables. But this argument only applies to a competitive market. In today’s oil and gas market, prices far exceed marginal costs, and the global oil cartel Opec+ (which includes Russia) only recently agreed to increase production in July and August. The Russian gas supplier Gazprom probably manipulated prices in Europe even before the war. Such monopolistic behavior justifies price caps.
Another common argument against a price cap is that it can stimulate a black market. It’s a real risk. Already, European energy companies have begun to combine Russian petroleum products with others – a “Latvian blend” – so they can take advantage of lower prices, while claiming not to support Putin’s war machine. But these companies are not currently breaking any laws. If a price cap was put in place, they would be. Given the public outrage over the war, the West’s commitment to secondary sanctions, and the rise of citizen investigations based on open-source intelligence, it would be very difficult, if not impossible, to s get away with such a violation of the rules.
The EU oil embargo will hurt Putin, but not soon enough. Europe must immediately impose a price cap on Russian oil and gas. – Project union
• Sergei Guriev, former chief economist of the European Bank for Reconstruction and Development, is professor of economics at Sciences Po.