The embargo on Russian hydrocarbons

While the Russian army is bombing Ukraine and massacring civilians, the EU keeps transferring half a billion to a billion euros to Russia daily, paying for oil and gas supplies.

Ceasing purchases of Russian hydrocarbons is the quickest way to strip Putin of the capacity to finance a war in Europe. This decision will also bring the best economic effect.

Europe’s indirect losses from Russia’s aggression against Ukraine are higher than direct ones from an embargo on Russian oil and gas. The EU can afford to impose this embargo immediately.

Damage to European countries from a complete ban on energy imports from Russia will be estimated at a mere 0.2-0.3% of the gross national profit. This means every adult European will lose an average of 100 euros.

The cost of the German embargo on Russian energy ranges between 0.5 and 3% of GDP, or approximately EUR 120-1200 per capita, equivalent to a moderate recession and below the economic fallout from COVID.

The German government has sufficient financial resources to support German consumers by subsidizing higher energy costs from alternative sources and offsetting the negative impact on production and the labour market, as was the case amid the COVID-19 recession.

Russia accounts for just 3% of German imports, while the ongoing war in Europe disrupts production chains and processes (so far mostly) in Eastern Europe, which account for a significant share of European trade.

By imposing an embargo immediately, the EU economies will be able to quickly adapt and finally get rid of dependence on Russian fossil fuels, which will remove Europe’s vulnerability to Putin’s economic blackmail. An analysis by Bruegel Center (Brussels) suggests that next winter, Europe will be able to do without Russian gas and face only temporary issues as Russian oil and gas supplies are fully banned.

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Rejection of the embargo entails much more costs. Putin’s war in Ukraine is, first of all, a human tragedy – and also an economic disaster for Europe.

Prolonged Russian aggression against Ukraine will lead to much higher economic costs than the imposed energy embargo imposed on Russia. Europe faces the greatest refugee crisis since World War 2. The number of refugees has already exceeded 4 million and growing.

At current oil prices, Russia will resolve its fiscal and balance of payments problems. Oil and gas revenues are the backbones of Russia’s budget. In 2021, amid significantly lower oil prices, direct taxes on hydrocarbons accounted for 40% of the Russian budget, with significant indirect revenues from corporate income tax, personal income tax, and VAT.

The absence of a formal European embargo offers Putin a light at the end of the tunnel. As he hopes for a medium-term solution to his oil revenue problem, he has an incentive to continue the war. The Russian budget is balanced at $44 per barrel. If oil and gas revenues keep flowing, Russia will enjoy a budget surplus.

The foreign money that Putin receives from Russian natural resources is now and will continue to be used to pursue the war in Europe.

Oil and gas revenues will be used to hire mercenaries from third countries and purchase key components for Russian military systems that are not produced domestically. In addition, Putin will try to use these proceeds to sow chaos and division in Europe to improve his negotiating position.

Without revenues from the export of natural resources, the Russian budget will see a deficit. Putin will either have to cut military allowances or resort to printing more money. Inflation is already very high (2% per week), while the export embargo will accelerate it significantly.

Depletion of forex earnings, coupled with higher inflation, will undermine Putin’s ability to maintain the purchasing power of salaries in his security sector, as well as those of lawmakers and propaganda pundits – all of whom are key pillars of his repressive regime. This will make further foreign military aggression unsustainable.

Complete reorientation of exports to China and elsewhere is deemed impossible given the constraints of transport infrastructure and the size of the European market, which accounts for half of Russia’s oil exports and three-quarters of Russia’s gas exports.

The embargo is an economic imperative that will deprive Putin of financial resources to continue the war. Any other policy option would be far more costly and dangerous.

The embargo on Russian energy resources will be the final statement of the unity of the Western nations. The embargo must remain in place until Russia provides credible guarantees that further aggression against Ukraine or other countries is a no-go.