The European Commission announced the price for the mooted gas price cap yesterday (although a final decision is due today) at €275/MWh (€2,974 per 1,000 cubic metres). That is extraordinarily high. Moreover, a rider is that not only does this level have to be crossed to trigger the caps, but it has to be crossed and stay over that level for two consecutive weeks. And that has never happened. Even in the worst of the spikes this year those conditions have never been met. It’s like repairing your house and instead of bringing the ceilings down to create an attic all you have done is build a roof above the existing roof outside the house.
The Wall Street Journal also reported that the oil price cap will be $60-70. (A decision is due tomorrow.) This one appears to be a little more reasonable, as the current price of oil is $83 per barrel today, but given Russia is selling its oil with a 20-30% discount, the actual price of its contracts is… about $60. So no real impact there either.
Indeed, the Duma passed the 2022-25 budget yesterday with an oil price assumption of $70 for this year falling to $65 in 2025, so this cap could cut into Russia’s revenues – if it is made to work, still a big “if” – only a little bit.
Of course, Russia has said many times that anyone that tries to impose the caps on it will simply get cut off.
We have written a lot about the consequences of Russia refusing to export oil and gas to Western customers that tried to use the caps – in short, a worsening of the energy crisis – but today I wanted to look at why these sanctions are non-sanctions. Why is the EC imposing sanctions that will make no difference in the near term? The key question to ask is: who ultimately pays the cost of the sanctions? First of all we should note that the two cap sanctions were supposed to hobble the Kremlin and slash its revenue. That clearly is not going to happen. The Kremlin’s revenue will be totally unaffected by the gas cap, and probably will only be marginally hit by the oil sanctions – if Russia plays along, which it won’t.
Some people like Professor Sergei Guriev of Science Po and Robin Brooks of Institute of International Finance (IIF) have called for an extreme oil price cap of say $30 per barrel that would crater the Russian budget and almost certainly cause a financial crisis pretty quickly (again, assuming there is no oil export leakage, of which, as we have reported, there is a lot).
The reason the EC has flinched is pretty obvious: there is no way to replace the 60bn cubic metres of gas Russia sent this year – half the normal levels – so the EC cannot run the risk of cutting off Russian gas deliveries for at least two years, when massive investment into alternative energy supplies such as renewables could make that possible.
Oil is a little easier, hence the slightly more realistic price cap, as it is possible to import oil from places like the Middle East, but that too is going to be tough. It’s not for nothing that OPEC+ reportedly said it has reversed a decision earlier this month to cut production by 2mn barrels per day (bpd) (the amount Russia sends to Europe) and will increase production by 500,000 bpd instead, that will go some way to mitigating the missing Russian oil. It seems OPEC+ has fully anticipated Russia carrying out its threat to cut off anyone that tries to impose a cap and is getting ready to boost its output. Tellingly, the OPEC+ decision on the production increase is due to be made at its next meeting on December 4 – the day before the EC oil embargo comes into force – when all the details of the oil price cap should be known.
It all looks a little ridiculous, but the politics of it are clear: the West has to be seen to be doing something and it has made so much noise about hitting Russia’s oil and gas exports that the cap mechanism is really the only option.
The point is that actually just banning Russia’s oil and gas exports, which is what should happen, is not an option. Well it is, but then instead of cratering Russia’s economy, the EU would crater its own economy. And thanks to the oil export leakage – as part of the negotiations on the ninth package of sanctions, Greek shipping has again just been given new exemptions – Russia’s economy will fare much better than the EU’s for the short to medium term. Russia has already put its economy on a war footing. The EU has not.
The obvious takeout is that the West has over-estimated its ability to hurt Russia. It is simply too big, too deeply integrated in the global economy, and commands too much market power in many essential inputs. The US is in a much stronger position, as it is largely self-sufficient in many things, including food, metal, energy and chemicals, but the EU is not. The EU imports too many key raw materials and too much energy from Russia to be able to cut itself off overnight.
All of this is fairly obvious to the sober observer, but the difficulties surrounding the sanctions run deeper than that.
This is not the first time that the West has imposed symbolic sanctions on Russia that have no real effect other than to make a good headline.
Following Russian President Vladimir Putin’s annexation of Crimea in 2014 the EU lashed out with “harsh” sanctions, but actually these came down to little more than seizing the assets and issuing travel bans to individuals directly involved in the annexation – i.e. things that made no difference at all.
As time wore on the list of sanctions was expanded to include people “close to Putin” and oligarch lists were issued, but again this makes no real difference to the Russian economy, but was good for more headlines.
Things finally started to get serious when sanctions were placed on Russian primary debt issues. But here too the sanctions were merely symbolic, as while international investors could not bid for the primary issue of, say, a Russian sovereign Eurobond, they were still free to buy it on the secondary market literally seconds after it was issued. Local Russian finance ministry OFZ treasury bills, where the bulk of the foreign money is held and the main funding tool for the Russian government, were not touched and indeed for most of the intervening years bond traders have been heavily overweight OFZs as they pay such high yields in a zero-yield world… thanks to the sanctions.
In short, pretty much all of the sanctions imposed before February were largely symbolic. It has only been since the war in Ukraine started that real sanctions have begun to appear, but even then the EU has continued to pull its punches to avoid the boomerang effects.
The root of this failure to impose real sanctions on Russia is the almost complete refusal by the EU to hurt its industry – and again, as the US is so unengaged with Russia’s economy it is willing to go much further.
The debate over including Russian exports of coal as part of the fifth package of sanctions issued in April – the first sanctions to target energy – is a prime example, as those proved to be extremely difficult. In the end some exemptions were made and the deadline set for August 10, but as soon as they came into force the EU quietly backtracked and softened them under pressure from some of its members. The coal sanctions were simply unworkable.
It is this refusal to impose any sanctions that seriously affect Europe’s industry that is the EU’s Achilles’ heel, and Putin is well aware of this, as it is written plainly in Russia’s export statistics – they barely changed after each round of sanctions was released. Plus Putin had already sacrificed Russia’s growth potential by building up his Fiscal Fortress since 2012 and felt the $600bn cash pile could adequately cushion Russia from the inevitable shocks new, harsher sanctions would bring.
Knowing this is probably partly why Putin felt confident enough to actually cross the Ukrainian border: he expected the hue and cry that would inevitably follow but could be fairly sure that the EU at least would continue to depend on Russia for a large share of its inputs and sanctions would remain largely symbolic. For example, after the “harshest ever” sanctions were imposed after it downed the Ryanair flight in 2020 and arrested blogger Roman Protasevich, Belarus’ trade turnover with the EU actually doubled that year.
Things changed after February 24 when some real pain was inflicted. Ironically it was the self-sanctioning by oil traders and multinational retailers that caused more damage than the official sanctions. The only really effective sanctions imposed on Russia by the West have been the bans on the export of technology and high quality machinery, which will have devastating consequences – but only in the long term.
The SWIFT sanctions that were imposed only days after Russia’s invasion of Ukraine in February on banks and the freezing of $300bn of Central Bank of Russia (CBR) reserves came out of left field and really hurt. But CBR Governor Elvia Nabiullina sprang into action and narrowly averted a financial crisis, and the gold and cash the CBR still has proved to be enough to cushion the blow. Putin had calculated correctly that his Fiscal Fortress could withstand the worst the West had to offer. Ironically, if the oil and gas embargo had been immediately imposed in the first weeks of the war then that would have almost certainly pushed the Russian economy over the top and caused a large-scale financial crisis, but the West was not prepared to forgo its inputs and energy supplies even for the few weeks it would have taken to trigger that calamity at that time. Now it's too late. Russia has successfully rerouted much of its oil to Asia, to its friends in India and China, amongst others.
While sanctions that hit the EU’s own industry have proved to be an anathema to Brussels, the financial response to Russia’s war is another kettle of fish. That is because the West’s main response has been to tax its own population to pay for the cost of the proxy war with the Kremlin.
Compare the amounts of money spent on supporting Ukraine and on dealing with the economic fallout caused by the polycrisis that is a result of this showdown.
Despite the “stand with Ukraine” rhetoric, the West has sent a mere $28bn of actual cash to Kyiv this year to support the government and fund the budget deficit. And the decision to provide serious amounts of money – previously the IMF’s stand-by arrangement was for a total of $3.5bn over 18 months – was only made in September when Ukraine was about to go bust.
Next year the US and EU have collectively committed to a total of $38bn, which will be just enough to cover the anticipated budget deficit.
These two sums pale into insignificance compared with the $40bn military and macro-support package the US has spent so far, and US President Joe Biden has just asked Congress for an additional $38bn – but almost none of this is cash going to Kyiv; it's being spent on weapons and other programmes to support the Ukrainian campaign.
The amount of EU spending is even bigger. Germany recently announced a controversial €200bn support and relief package to mitigate the effects of the cost-of-living and energy crises impact on Germany. Likewise, Italy has already spent €53bn and expects to commit a total of €100bn by the end of this year. All in all, according to my estimates, the EU will have spent around €1 trillion by the end of this year and the IMF said earlier the cost of the war on the West could rise to as much as $4 trillion.
Bottom line is, the West will send a total of $64bn to Ukraine in cash by the end of next year, but just Europe will probably spend around €2 trillion on relieving its own economies by next Christmas. Why is the West so generous with itself and so miserly with Kyiv? And the US and EU are already bickering about who should carry the heavier load of supplying macro-support to Kyiv, with some senators saying that as the US is paying for most of the weapons, the EU should provide more of the budget support funds.
The difference is that the financial support doesn’t go to Ukraine but is recycled back into domestic economies. Almost all of the money used to buy the US-made weapons being sent to the front line in Ukraine is being spent on US weapons manufacturers and comes from the budget. The upshot is this spending gives the US economy a boost and is ultimately paid for by the US taxpayer. The same is true for the EU spending: none of Germany’s €200bn will go to Ukraine but is cycled back into the German economy and is ultimately paid for by the taxpayer.
The Western governments are happy to liberally spend on their own economies, as this is in effect a tax that is easy to justify given the overwhelming public support for the Ukrainian cause. But at the same time, the West is extremely reluctant to impose real sanctions on Russia that strike at industry, which is the source of these countries' wealth.
This must also be part of Putin’s calculation. He must be banking that as the war increasingly hits the average EU citizen in the pocket, support for Ukraine will wane. And as bne IntelliNews reported, the first signs of Ukraine fatigue are already visible, which is fuelling the calls for a start of negotiations. But the West’s capacity to fund this sort of massive spending is huge and it can keep it up for a long time. European Commission President Ursula von der Leyen recently repeated her earlier remarks that the EC will support Ukraine for “as long as necessary”.
Now the race is on: who can withstand more pain? Russia will keep striking at the West’s soft spot: hurt European industry as much as possible, hoping that he can continue to dodge the effective sanctions as much as possible. The West will continue to buy its way out of trouble, but at the same time try to inflict as little pain on its industry as possible. The question now is who will cry “uncle” first.
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