Europe must put more pressure on Russian oil exports

The writer is a senior research scholar at the Center on Global Energy Policy, Columbia University

In 1951, six European countries started to co-ordinate national economic policies to develop the European Coal and Steel Community, a common market for energy and industry. The EU grew out of this effort, as did its principle of unanimous decision-making.

Seven decades later, a piece of graffiti in the entrance hall of the House of European History in Brussels proclaims: “It started with coal and steel, it may end with oil.” The artist, unwittingly, may be right. In the wake of the invasion of Ukraine, the EU is struggling to dismantle parts of its integrated energy infrastructure in support of sanctions against Russia; and a credible European oil embargo requires a substantial step back from the principle of unanimous decision-making.

Oil, natural gas and coal exports, in that order, still generate the bulk of Russia’s revenues. Europe is the primary market for Russian oil and gas. So if the western alliance is serious about sanctions as a policy weapon, it needs to address these exports.

The problem is that energy sanctions may backfire, by leading to fuel price increases which hurt the sanctioning economies. So far, only Australia, Canada and the US — each of them net energy exporters — have announced and implemented an embargo against Russian oil imports.

There is no denying that the initial rounds of non-energy sanctions have affected Russian energy exports as well. The disruption of financial transactions, lack of clarity on the regulatory outlook and, if oil traders are to be believed, moral suasion have cut deep into Russian oil trade. As a result, Russian oil is still trading at a discount of 30 per cent, and a sizeable backlog is currently looking for a home.

But without further escalation, this success will fade. Oil is fungible and markets will quickly adapt to the new rules. Without an expanding embargo, oil flows will adjust, price differentials will be competed away and producer revenues restored.

Even more important, without sustained pressure on export volumes, one of the prime targets of the embargo will elude the west: the long-term physical damage that such a move may inflict on Russia’s production capacity.

Can Europe deliver?

The standard mechanisms by which rising oil prices translate into lower economic activity — through inflation and interest rates, or by increasing input costs directly — need close monitoring, including by central banks, at this stage of the economic cycle.

However, the capacity of the G7 countries to absorb an oil price shock is higher than that of India, China or other non-OECD economies. The EU and the US have come out of the pandemic with strong economic momentum; their oil intensity and their terms of trade exposure are relatively modest. In addition, if properly adjusted for inflation and efficiency gains, today’s real oil prices are far from exorbitant.

Moreover, a number of safety valves are available to balance price rises before they occur, and can be deployed independently from the eventual global supply response to high prices.

First, the strategic petroleum reserve in the US and Europe alone holds 1.5bn barrels of crude and oil products. This is equivalent to almost a year of Russian exports to Europe. Sometimes mocked as a stop-gap measure (given that eventually it will have to be replenished), it is in fact a powerful instrument.

Second, resolving the political impasse motivating sanctions against Iran and Venezuela would add about 1mn barrels per day, with prospects for more, once production facilities have been restored. Similarly, bringing peace to Libya (0.3mn b/d) and Nigeria (up to 0.7mn b/d) will have small but immediate rewards.

Third, core Opec members are holding a cushion of more than 3mn b/d of spare capacity, explicitly for emergencies. How and when it can be activated is a political decision but it is there. Finally, pivoting US energy policy from a tendency to restrict shale oil growth for climate policy reasons to maximising domestic production could add another 2-3mn b/d over the next 18 months.

It would not be wise for Europe to replace Russian imports in one fell swoop. In addition to the frail global supply and demand balance, spatial bottlenecks and global product mismatches will take time to resolve. But oil is available to start curtailing Russian supplies immediately; and there is certainly enough below ground to replace them, eventually. It is not efficient, but the process can — and should — be set in motion.