It is time to curb imports of Russia’s gas

Martin Wolf: This would help to make life as difficult as possible for Vladimir Putin

The reports of massacres of civilians in Bucha, close to Kyiv, cannot, alas, be a surprise. In response, Emmanuel Macron argued that: “What happened in Bucha demands a new round of sanctions and very clear measures, so we will co-ordinate with our European partners, especially with Germany.” He added that “on oil and coal, we must be able to move forward. We should certainly advance on sanctions ... We can’t accept this.” But sanctions on Russian oil and coal are insufficient. It is necessary to embargo imports of Russia’s gas, too.

According to the US Energy Information Agency, in 2021, 74 per cent of Russia’s exports of natural gas went to European members of the OECD. That would amount to 5 per cent of Russia’s export earnings. The difference between these exports and those of oil and coal is that it is easier for Russia to shift their destination than it is of gas, whose transport depends on inflexible infrastructure.

Adding gas to the list of embargoed products would therefore increase the pain on Russia. The objections to this idea are that some European countries are particularly dependent on Russian gas and so the costs of cutting imports substantially for them would be huge.

Among the most vulnerable countries are Germany and Italy. Germany, for example, depends on Russia for a third of its energy consumption. Moreover, Germany received 58 per cent of its gas from Russia in 2020, while Italy received 40 per cent. These countries are also heavily reliant on gas: Germany’s consumption is more than double that of France, whose nuclear generation capacity is large. An embargo on gas supplies would, it seems, devastate the economy of Germany and similarly vulnerable countries.

Recent economic research suggests, however, that this fear – though understandable – is exaggerated. A paper on Germany by economists headed (alphabetically) by Rüdiger Bachmann of Notre Dame university notes that the focus should indeed be on gas, since oil and coal are supplied in global markets. If necessary, as the paper notes, “Sufficient world market capacity exists from other oil- and coal-exporting countries to make up the shortfall.” Russia could also shift its exports elsewhere, though it might have to do so at a discount.

Sanctions

So what about sanctions on gas? In the short run, the loss of Russian gas could not be made up by imports from elsewhere. The paper assumes that the result of an embargo on Russian energy would be a cut of 30 per cent in gas deliveries, which is about 8 per cent of total German energy consumption. The key points in the analysis are that substitutability of gas in consumption and production is lower in the short run than the long run and higher in some uses than others. With very low short-run substitution elasticities (a pessimistic assumption), an 8 per cent decline in consumption of oil, gas and coal leads to a 1.4 per cent decline in gross domestic product – a cost of €500-€700 a year for each German citizen. With a 30 per cent fall in gas usage, the economic losses rise to 2.2 per cent of GDP (2.3 per cent of gross national expenditure) or €1,000 per year per citizen. If one allows for possible second-round macroeconomic effects, this impact might reach 3 per cent of GDP.

Alternative estimates exist. A survey by Clemens Fuest of the Ifo institute in Munich presented at last weekend's Ambrosetti economic and finance forum, shows that estimates of the decline in GDP vary between a tiny 0.2 per cent and 6 per cent. As he states, "We don't really know". But we do know that if an embargo became necessary, it would be best to do it now: as the paper cited above explains, the justification "is the seasonality of gas demand. A cut-off from Russian gas over the summer months could be substituted from Norwegian and other sources, keeping industrial supply going." Such an early move would also "trigger the substitution and reallocation dynamics that are central to reducing economic costs".

Above all, a comprehensive embargo on Russian energy imports into Europe would be a statement of collective will in defence of the values on which postwar Europe was founded against its fiercest enemy. It is Germany’s duty to lead. Yes, it would bear significant costs. But the reasons it is so vulnerable are, after all, what the economist Hans-Werner Sinn rightly calls “Germany’s Energy Fiasco”, with its closure of nuclear energy and excessive reliance on Russia. Moreover, even on the worst assumptions, these costs would be modest compared with the ones suffered by those hit by the euro zone crisis.

Helping

Of course, Germany and other vulnerable countries must be helped. The gas available should be treated as a European resource, so far as is practical. It would be a magnificent gesture if the UK were to join in. It will also be necessary to adopt fiscal policies that cushion the blow on vulnerable people. Beyond that, it is essential to build an infrastructure that delivers maximum flexibility.

The long-run goal should be for Europe to be able to import from anywhere, while Russia remains reliant on European markets. The short-run goal should be to make life as difficult as possible for Putin. A superior alternative would be the suggestion of Harvard's Ricardo Hausmann of a penal tax on Russian imports by most buyers, worldwide. Alas, that is not going to happen.

It is possible that Putin’s demand for payment in roubles will end up cutting off supplies, anyway. But this should not be necessary. Rightly or wrongly, Nato decided not to defend Ukraine militarily. The least Europeans can do is to use all other tools at their disposal. They must bear and share the costs of cutting off Russian energy imports. They must create an energy policy that will maximise flexibility and resilience. It is time to act. – Copyright The Financial Times Limited 2022