By David ThorntonWhen you think about the economic impact of Russia’s invasion of Ukraine, the obvious subjects are Ukraine and Russia. Ukraine’s economy is being ravaged by fighting while the Russian economy is being destroyed by sanctions. However, the $80 trillion question is what the impact will be on the world beyond the two combatants.
Oil is the basis for the question. Shutting off the Russian economy from the rest of the world probably wouldn’t dent many bottom lines except that Russia has the eighth largest oil reserves in the world and is the fifth-largest producer. Russia currently produces more oil than Saudi Arabia.
One of the big debates of recent days has been whether Russian oil and natural gas should be subject to the sanctions that are beginning to devastate Putin’s economy. On the surface, it seems hypocritical to exempt Russian oil from sanctions while shutting off other sorts of trade ranging from financial transactions to aircraft parts.
There are at least two problems with shutting off Russian oil. First, not much of Russia’s “black gold” (“Russian tea?”) goes to the US, but a lot goes to our European allies. Russia’s biggest oil customer by far is China, followed by the Netherlands and Germany. South Korea and Japan are also large consumers of Russian oil along with other European countries.
This presents a couple of problems. It would likely be difficult to enforce sanctions between two authoritarian countries, neither of which would want to cooperate. My guess is that even if Russian oil was the subject of a worldwide boycott, they would still have a market in China. The Chinese would probably get the oil at a discount because so few buyers would be competing for it.
On the other hand, it would be easy to shut off the flow of oil to Russia’s European customers, but the consequences of doing so have to be considered. March is still cold in much of Europe and the oil is needed for heat as well for running factories and transportation. If the Russian oil spigot is turned off too quickly, before replacement sources can be found, European countries may find their own economies slowing in addition to that of Russia. If Europe falls into a recession, economic difficulties could fracture the anti-Russia alliance.
Only about 3.5 percent of oil imported into the US comes from Russia, but that oil would have to be replaced as well. That small percentage is still a lot of oil, an average of about 20 billion barrels per month in 2021. As more countries compete for the non-Russian oil on the market, prices will be driven up.
Even if the US was totally energy independent, oil and gas prices would still go up here because of the way markets work. If American producers could sell their oil domestically for $50 per barrel or abroad for $130 barrel (as they have already hit briefly), a lot of American oil would be exported. Domestic prices would have to rise to compensate.
Over time, if the crisis lasts that long, oil producers will increase production. The government doesn’t have to tell them to do this. The producers will make that decision on their own as oil prices rise. Basic economics and capitalism tell us that as prices rise, more producers will get into the market to make profits.
It takes time to ramp up production, however. Lead time is required for permitting, drilling, building wells, and assembling the infrastructure to move and refine oil in order to bring it to market. It will likely take months before producers can start bringing new wells online.
Having said that, there’s an erroneous belief that Joe Biden has cut oil production in the US. That is not true, and the president doesn’t have nearly as much control over oil production, a private industry, as many people on both sides seem to think.
The good news is that oil companies already started increasing production last year as we began to exit the pandemic. US oil production dropped off a cliff when demand cratered in 2020 due to the pandemic. Oil producers shuttered wells rather than contribute to a glut with prices already at historic lows. As the pandemic waned, production began to increase and has continued to rise under Joe Biden. In fact, even before the war started, the Energy Information Administration forecasted that US oil production would reach record levels by 2023.
Inflation and supply problems had driven up gas prices, even before the invasion of Ukraine, but gas prices are still below record highs. By the end of 2019, before the pandemic killed demand, the average gas price was above $2.80 per gallon. In January 2022, the average was $3.41. By the end of February, the national average was $3.70 and rising. I fully expect gas to average higher than $4 per gallon when the next report comes out.
Prices were up before the invasion, but a large percentage of the current price can be blamed on Vladimir Putin. In my area, prices have climbed about $1 per gallon since Russian soldiers stepped across the Ukrainian border. There is an undeniable link between the Ukraine war and the recent price spike.
The question is how high oil and gas prices will go and how long they will stay elevated because the world economy runs on oil. Uncertainty and rising prices make people and businesses pull back and stop spending unnecessarily. People on tight budgets cannot absorb an extra $20 to fill their tank without cutting elsewhere. If enough people stop spending, we could see an economic downturn.
So the Biden Administration and our European allies have tough choices to make. How do they isolate Russia and turn the screws on Putin while not shooting themselves in the foot? My guess is that the flow of Russian oil will eventually be shut off, but it will take some time to bring all the players on board.
But it may not be as long as you think. Oil companies can read the writing on the wall and are already starting to divest themselves of Russian business. BP, ExxonMobil, and Shell have already announced that they are exiting partnerships with Russian oil companies. The West just doesn’t want to do business with Russia and consumers don’t want Russian products, whether it is vodka or oil (or whatever else they might produce aside from cybercrime).
The matter is made more complicated by domestic politics, however. Republicans seem determined to blame Biden no matter what he does. A Sunday tweet by Senator Marsha Blackburn (R-Tenn.) is a good example. Blackburn called attention to the gas price in 2020 at the depths of the pandemic, drawing a contrast to current prices. But on Fox News just a few hours earlier Blackburn had called oil “Russia’s currency” and said that the US and allies need to “shut down” the Russian oil trade. Never mind that this would drive up prices even further. Or maybe that’s exactly what Blackburn has in mind.
If the Republicans really wanted Biden to sanction Russian oil, they’d make it easy for him by saying that the two parties were coming together to fight Putin on behalf of Ukraine. They could explain that rising gas prices due to Russian oil sanctions were a difficult sacrifice that we all need to make for the greater good.
But no. What we see is the GOP blaming Biden for high gas prices while simultaneously pushing for policies that would drive oil higher. That seems a bit dishonest to me.
Further complicating matters is the fact two other major oil producers are under sanctions as well. Donald Trump placed sanctions on Iranian and Venezuelan oil, which ironically aided Russian oil producers. But if Biden removed these sanctions on the grounds that Russia was a bigger current threat, Republicans would undoubtedly attack him for being soft on terror and pro-socialist.
Why is it that God placed so much oil in so many politically unstable and hostile places? At least we have Canada, although even if Biden had not canceled the Keystone pipeline, it would not have been open for business until next year. Republicans might also want to sanction Canadian oil in retaliation for the breakup of the trucker protest. Who knows?
There are other producers who are not being sanctioned, but the Saudis just refused to increase production. Remember what I said about presidential power being limited when it comes to oil production? Perhaps slow-walking arms sales to the desert kingdom would change Saudi minds.
The Biden Administration could do things to help relieve pressure. Permitting for new leases could be expedited and pipelines from Canada approved, but those are long-term solutions. In the short term, we could waive the federal gas tax and maybe even allow Iran and Venezuela to replace some of Russia’s oil. Keeping these sanctions lifted could be contingent on good behavior.
The bottom line is that oil is a finite resource. Only so much can be produced in a day (about 101 million barrels per day, by the way.) The world needs oil to run and there are only certain places where we can get it.
I’m old enough to remember the Arab oil embargo of the 1970s, if barely. In retaliation for American support of Israel in the 1973 Yom Kippur War, Arab oil-producing countries stopped selling oil to the United States. As a result, there were high prices (for the time), shortages, and rationing. Cutting off Russian oil could conceivably cause similar problems, but these would be self-inflicted.
In the long term, we should also be looking for more ways to break our addiction to oil. High prices will help to incentivize such moves. Alternative energies are more attractive when oil prices are elevated. In that way, Vladimir Putin’s aggression in Ukraine may contain the seeds of Russia’s ultimate economic decline as it drives the world away from its main export.
For now, though, we have to deal with the world as it is, not the way we wish it was. We have to accept our current levels of production and consumption. For now, we have to make hard choices.
The West wants to help Ukraine, but it also wants to avoid slipping into another economic downturn. A recession could erode support for the Ukrainians and end up hurting their war effort as well.
The Ukraine war is currently a war of attrition. It is a race to see whether Ukraine’s ability to resist will outlast the Russian economy’s ability to support the invasion army. Our interlinked global economy makes for strange bedfellows, but allied governments would be wise to tread cautiously as they move to isolate Russia. The consequences of each move has to be carefully – but quickly – considered.
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