Smart sanctions and how to diminish Europe’s dependency on Russian gas

The ongoing suffering of the civilian population in Ukraine has led to calls for the EU, or individual Member States, to stop imports of Russian gas. The economic consequences of such a step would be very severe in the short run. But there is another way, more gradual, which would minimise economic disruptions. The EU should simply impose a special import tariff on Russian gas.

Such a move would of course be against World Trade Organisation rules. But under these special circumstances it can be justified with the exemption under WTO article XXI for national security. Moreover, Russia has long imposed an export tax of 30 percent on gas. The EU can claim that its import tariff merely compensates for this distortion.

A tariff could be implemented almost overnight. Given that it would be done at the EU level, it would provide a tangible sign that Member States can act together.

Advantages for Europe

The political advantages of a tax on imports of gas from Russia are also clear. First, it would counter, at least partly, the argument that by importing gas from Russia EU actors are financing Russia’s war of aggression. Those who still buy Russian gas would then also be helping finance opposition to this aggression. The tariff would provide them with a strong price signal to diversify over time. Those who have alternatives will do so immediately. The demand for Russian gas in Europe will fall, slowly at first, but at an accelerating rate.

The revenues from this tariff could be substantial. At present high global natural gas prices, a 30 percent tariff on the value of Russian gas could easily reach €30-50 billion (on an annual basis, based on the assumption that the overall cost of imports of gas from Russia would jump to 100-160 billion from €30 billion in 2019). This would allow the EU to assist vulnerable groups being hit by higher gas prices, support the Ukrainian government and help Member States defray the costs of caring for the millions of refugees expected to arrive. If, as now unfortunately seems likely, 3 to 5 million Ukrainians must seek shelter in the EU, the overall cost could reach €15–25 billion (at €5,000 per refugee for housing and living expenses).

A further advantage of this approach is that it would provide a strong long-term incentive for the private sector to seek other supplies. And these supplies would be forthcoming. If the EU makes it clear that the tariff is going to stay as long as Russia’s aggression against Ukraine continues, other potential suppliers of gas around the world will take notice and start investing in finding new sources or better exploiting existing ones.

Hard for Russia to evade

There is little Russia can do to avoid this tax on its exports to the EU because it cannot simply sell its gas somewhere else. With 140 billion cubic metres (bcm) of imports in 2021, the EU accounts for about 70 percent of overall Russian pipeline gas exports.  Specifically, in 2021 Russia’s total exports of gas amounted to about 240 bcm, 40 billion of which is shipped in the form of LNG (which cannot be increased quickly). Of the remaining 200 bcm about 30 went to its client state Belarus. This leaves 170, of which about 140 go to the EU.

The other customers are unlikely to be able to compensate fully for the EU market. China already takes substantial amounts of Russian gas and will not want to become dependent on Russia for its energy. As the biggest buyer, the EU has considerable ‘monopsony power’.

Economic and strategic considerations

The economics is clear: a small tax on Russian gas imports would be advantageous for the EU. A high tax on Russian imports (beyond the 30% already applied by Russia) would probably be beyond the economically optimal tax, but the economic costs for the EU should be minor because the higher cost paid by consumers would be tariff revenue which would stay in the EU. The price for gas might anyway increase by less than 30 percent because there are some alternative supplies. Moreover, the imposition of this tariff might calm markets as it shows a way out without a complete blockage.

It might well be the case that Russia reacts to an import tariff by increasing its own export tariff. But Russia’s export tariff is of little importance. It determines only the domestic price level for gas. The lower that level the more gas will be wasted inside Russia. Russia’s domestic price for gas is fixed in rubles and has already dropped relative to the world market price. The Russian export tariff has thus de facto already increased.

The more general argument for a European import tariff on Russian gas is that it is needed to put a price on Europe’s collective energy security. Gazprom cannot be considered a private-sector supplier. It represents the interests of the Russian government. The present situation of a Russian monopolistic supplier facing Europe’s uncoordinated private-sector demand is untenable. Currently, private-sector entities compete for Russian gas. The import tax would put a price on two external effects of this which importers have so far ignored. The first is the (pecuniary) externality is that each individual importer drives up the price, thus worsening the terms of trade of Europe. The second externality is that each individual importer increases the collective dependency of Europe on Russian gas.

A further advantage of introducing import tariffs is that within a short time, the reaction of prices and LNG flows would give policy makers much needed information about how difficult it would be decouple the European gas network completely from Russia. Moreover, the tax could be modulated over time, depending on the political situation.

Why not oil as well?

The same approach could be applied to Russia’s oil exports. Oil if much more easily transportable than gas. The tariff on Russian oil imports should thus be much smaller. Given the reputational risk and other difficulties in transacting in Russian gas there is already a substantial discount on Russian crude. Media reports indicate that some Western companies are buying Russian cargo at a discount of over 20 percent. One should not leave these profits to private-sector intermediaries. A modest import tariff would thus be appropriate. But even at a rate of 10 percent, such a tariff implemented by both all Western allies could raise substantial revenues, which could be used to compensate vulnerable groups.

It is clear that a tax on gas imports from Russia will not deter Putin. He has now put himself into a situation in which it is very difficult for him to back down. However, a system of tariffs on Russian energy exports should further increase the cost for him and it would provide the least costly way to quickly reduce Europe’s dependence on Russian gas.

 

Daniel Gros is a member of the Board and Distinguished Fellow at the Centre for European Policy Studies (CEPS) in Brussels. He is at the EUI as a Robert Schuman Fellow and working on a book project on central bank digital currencies.