To price-cap or to embargo, that is the question

Having your cake and eating it, too, is, I’ve heard, a difficult thing to do. The same appears to be the case with having your oil and using it, too.

The European Union has been struggling to convince all member states that they need to stop buying Russian oil because Ukraine. It quickly became clear this is easier said than done because, what a shocking surprise, Europe may be Russia’s biggest oil export market but Russia is, in turn, Europe’s biggest oil supplier.

Despite the crystal clarity of this fact, the EU appears to be trying to hurt Russia in the oil without hurting itself in the economies. These attempts have grown truly grotesque lately and now the U.S. Treasury Secretary has joined the party so it’s even greater fun for all of us.

An embargo, to be phased-in gradually with a view to limiting the pain for importers, was the original idea. It has been the topic of discussions for weeks now but opposition remains strong from Hungary and, surprisingly, Bulgaria. And while Bulgaria would be easy to convince to join the choir, Hungary is standing its ground.

Alternatives, therefore, have come to the table, or rather, one alternative: a price cap. Italy’s PM Mario Draghi, a man who used to be at the helm of the European Central Bank, floated an idea following a meeting with President Biden for a cap on import oil prices, saying “Prices don’t have any relationship with supply and demand”.

To say that this remark, coming from a banker, is confusing, is to put it extra-mildly. It suggests the world is awash in oil but sellers are not selling it because they want prices to go higher. This is, in fact, not the case, although it would be quite accurate to say that prices have a relationship with not just supply and demand. They also have a relationship with things like sanctions. But this is not the most important part.

The most important part is Draghi’s apparent conviction that once importers put their foot down and say “We won’t buy your oil at your prices” producers will bow and say “Please set a price you would be willing to pay, then.”

The belief fueling this conviction is probably a belief that large oil producers rely exclusively on their oil revenues to run their economies. This certainly seems to be the predominant belief in the EU and the U.S. when it comes to Russia. Unfortunately for those sharing it, it is not true.

The reason this is unfortunate is that it is this belief that has guided the actions of the European Union so far — the belief that Russia needs to sell Europe its oil and gas more than Europe needs to buy it. Based on the difficulties the EU has faced in getting all members on board with an embargo and the fact it had agreed to exemptions for highly dependent importers, this is not the case.

But there is something even more telling than the exemptions for the oil embargo. While the EU continuously talks about preparations to get rid of all Russian hydrocarbons in just five short years, more and more European energy companies are opening ruble accounts at Gazprombank.

Remember how loudly the EC yelled that accepting Gazprom’s new payment conditions would constitute a breach of EU sanctions on Russia? Remember all the warnings EC President Ursula von der Leyen rained on gas buyers in the EU? Now all the big buyers are paying in euros, these euros are being converted into rubles, and gas continues flowing. Bulgaria and Poland threw themselves under the bus for nothing.

The reason the gas payment situation ended this way was because the EU thought Russia will take everything the EU throws at it lying down. Of course, it didn’t. And yet the EU continues to believe it can dictate the terms in what is effectively a trade war with its biggest energy supplier because… it’s used to dictating the terms. So is the U.S.

Treasury Secretary Janet Yellen this week visited Europe to discuss Russia-quitting measures with the EC’s von der Leyen. She told media that tariffs and an embargo "are two things that could be combined." She also said, and this was really amusing, "We're not trying to tell them what's in their best interest, but you know, we discussed some of the things that are under consideration."

It’s a plain fact that if anyone knows anything about sanctions, that’s U.S. politicians, including the former Fed chair. But if anyone really knows anything about sanctions, it is that they may hurt a country’s economy but they somehow never seem to accomplish the goals they were set out to accomplish. I mean, I’m not telling the EU to be careful who it takes sanction advice from but, you know, I’m discussing some of the things that are under consideration.

Tariffs, as far as I understand them, are surcharges for a product or commodity that is imported in a bid to stimulate consumption of its local analogues (or to curb the market influence of the exporter). In the case of Russian oil, a potential EU tariff would aim to encourage purchases from other foreign suppliers because the EU has no oil industry to speak of.

An embargo, on the other hand, is a suspension of imports regardless of the price. Whether phased in or sudden and complete, the embargo has nothing to do with prices. A combination of tariffs and a gradual embargo, then, would look like this: higher prices for Russian oil and a strong verbal — and possibly financial — EU encouragement for member states to wind down imports as soon as possible.

It certainly sounds like something that could work. But only with the assumption that Russia will not retaliate because it really has no one else to sell its crude. Also, with the assumption that other oil producers would be eager to step in and fill the gap.

How realistic such assumptions are was recently demonstrated by Russia with the suspended gas supplies to Poland and Bulgaria. I believe it would’ve been smart to see that move as a warning shot but what do I know. Saudi Arabia’s and the UAE’s clearly stated refusal to boost production above current quotas was another demonstration of the nature of the EU’s assumptions.

Meanwhile, the EU, the busy bee that it is, is working on its plan to completely stop importing Russian oil and gas, and coal by 2027. Last week, that plan was supposed to cost 195 billion euro. This week, the price tag is already 210 billion euro. But what’s 15 billion euro between friends. As to where the money would come from, here’s a paragraph from the Reuters report:

Taken together, Brussels expects them to require 210 billion euros in extra investments - which the EU plans to support by freeing up more money for the energy transition from its COVID-19 recovery fund, and which would ultimately reduce the billions of euros Europe spends on fossil fuel imports each year.

How this ultimate reduction will happen exactly remains unclear but hopefully we will see a detailed version of the actual proposal before too long.

The point of sanctions is to hurt their target and either prevent it from doing something (Iran) or force it to stop something it is doing (Venezuela). As these two cases show, sanctions don’t work very well. And the economies of Iran and Venezuela are much weaker than Russia’s, which should have theoretically made them more malleable. Only it didn’t. If anything, sanctions tend to cement the status quo they are supposed to try and change.

But there is something else that the EU appears to have either forgotten or simply refuses to think about. The point of sanctions is to hurt their target only, not the one dispensing them. And even if some collateral damage is on the cards because of some mutual dependence or other, sanction action should not hurt those dispensing it more severely than its target.

Sadly, what is happening currently in Europe is evidence that “should be” is not the same as “is”. Or as someone on Twitter said the other day, Europe is shooting itself in the feet and trying to run.