Why is Russia Choking Off Gas Supplies and How Should the West Respond?

Why is Russia Chocking Off Natural Gas Supplies?

If an Embargo of Russian Gas is a Good Idea, Why is Russia Cutting Off Supplies?

In earlier posts I have pressed for an embargo on Russian natural gas exports. I still think this makes sense, but I can also see the wisdom of a buyers’ cartel that would cap the price that Europe would pay for Russian gas (also explained here). What gave me pause in these thoughts was Putin’s decision (and I am assuming it was his idea) to reduce Russian gas exports through the Nord Stream pipeline. Why would he voluntarily forego this revenue? Does he really think it hurts the West more than it hurts him? Does he just think that Western leaders, particularly German leaders, are so weak-willed that even a small amount of pain will cause them to collapse like a house of cards? Is he just acting like a spoiled child, threatening to hold his breath until his parents give in?

The Role of Contracts

One clue as to what is behind the choking off of gas supplies is the excuse offered: technical problems with the generators that push the gas through the pipeline. The company responsible for maintaining the compressors says that it is unaware of any problems. Why offer this excuse? Presumably the gas flowing through the Nord Stream pipeline is sold under a long-term contract with a fixed price (or some complicated formula that limits the extent of fluctuation in the price). What this means is that even though natural gas prices in Europe are exceptionally high, Russia is receiving a price for the gas that is substantially lower.

Isn’t Russia Contractually Obligated to Supply the Gas?

There is, probably, an out in the contract, for technical problems or “acts of god” that make it difficult to supply the gas. My guess is that Putin is using this ruse to limit Europe’s ability to stockpile gas for this coming winter.

What Should the West Do?

If there are contracts that govern the sale of gas through Nord Stream and other pipelines, the West ought to seize the opportunity created by Russia’s abrogation of its responsibilities under those contracts. The West should “renegotiate” the terms of purchase under those contracts at a lower fixed price determined by a Western buyers’ cartel. By the way, there is no reason why this arrangement should not survive the end of Russia’s war against Ukraine. It is important to remember that this is at least the second time that Russia has, probably, violated the terms of its contracts. The first was when they insisted on payment in rubles.

Would this Work?

I am assuming a lot of facts in this argument and would welcome others, who know the details of the Nord Stream agreement, to weigh in. However, if I am right, a buyers’ cartel for gas delivered by pipeline from Russia to Western Europe could accomplish two important objectives. One, it would deny Putin an important source of funds for carrying out his unprovoked war against Ukraine. Two, it would mitigate the harm to Western Europe from continuing to impose sanctions on Russia.

What Would Putin Do?

In response, Putin could do any of the following. First, he could realize that, in the long run, his situation is hopeless and withdraw his forces from all of Ukraine and cease all hostile acts against Ukraine. (I know this isn’t likely, but one can only hope that at some point Putin will come to his senses.) Or second, he could double down on the spoiled child model and refuse to sell gas at the cartel price, in which case we have a de facto embargo. Or third, he could accept that, once again, he has overplayed his hand and accept what he is offered for his gas.

Rand Paul and Ukraine Aid

Rand Paul Delays Aid to Ukrain

While Ukrainians fight and die to defend freedom from tyranny, Rand Paul struts upon the stage. Rand Paul, single handedly, is delaying military aid to Ukraine so that he may grab some media attention. This prima donna reminds me of the “America First Committee” who resisted U.S. assistance to Britain as Britain was being attacked by Nazi Germany in 1940. He uses the same short-sighted arguments.

Rand Paul is, like a broken clock, occasionally right, but in this case he could not be more wrong-headed about America’s self interest. Unless you think that it is in America’s interest to allow Putin to reestablish the Soviet Union/Russian empire. Is it in our interest to have a despotic empire stretching from the Arctic Ocean to the Black Sea and from the Pacific Ocean to Germany and France? Is it in our interest to have Putin using the resources of that vast empire to control and dominate those states not within its direct control? If you doubt this scenario, look no further than the degree to which Russian gas exports have intimidated Germany and France in the current conflict. It takes very little imagination to foresee pro-Russian puppet states established in Germany and France through economic dominance and interference in their elections.

Make no mistake the Ukrainians are fighting our fight, just as Britain was fighting our fight in 1940. The very least we can do for Ukraine is to arm them for the fight.

And lest we forget, the U.S. and the U.K. were co-signatories in 1994, along with Russia, in the agreement for Ukraine to hand over its nuclear weapons in return for a guarantee of Ukraine’s territorial integrity. If we fail to support Ukraine the obvious message to other countries is that you are on your own. Do we really think it is in our interest to have every country with its own nuclear arsenal? Is it in our interest for every country to believe that America’s word is no more valuable than Neville Chamberlain’s piece of paper?

Tariff (or Price Cap) on Russian Oil and Gas Exports as an Alternative to Boycott

A tanker on the high sea

The Economist published an excellent article yesterday about a way to begin gradually cutting off oil and gas revenues to Russia. Since an outright embargo on Russian oil and gas exports appears unlikely, much the same thing could be accomplished by a tariff.

In the limit, a very high tariff would be the same thing as an embargo. A lower tariff allows Europe to wean itself more gradually from Russian oil and gas and provides an economic incentive for markets to seek out other alternatives. It still allows some Russian oil and gas to enter Europe for very high value uses, but it places the social costs of subsidizing Russia’s war against Ukraine on those who want the benefit of using Russian oil and gas. Alternatively, if Russia wants to maintain its current level of oil and gas exports, Russia would have to absorb the cost of the tariff by lowering its prices. Either way Russia gets a smaller revenue stream.

As a side benefit, European countries get a new stream of revenues they can use to offset the impact of high energy costs on their economies. They can use these revenues to lower other taxes or rebate them on a per capita basis to their citizens. As long as they don’t use the revenues to subsidize oil and gas consumption, the European economies will adjust efficiently to reduced supplies of energy from Russia. Ideally countries that impose the tariff could use all or some of the proceeds to arm Ukraine.

Limitations

The good news about a tariff on Russian energy exports is also the bad news. It is gradual. Because it is gradual, it gives Russia more time to adapt.

A tariff also suffers from some of the same limitations as a boycott. Russia can send oil to India and India can export oil to Germany. Unless the tariff is also placed on energy exports from countries that do not, themselves, impose the tariff on Russian energy exports, Russia can, at some expense, evade the tariff. This is less true of Russian natural gas exports, since these generally flow through pipeline systems that cannot be easily redirected. Therefore, to the extent that it can be done, the tariff should apply to Russian energy exports and energy exports from countries that do not impose the tariff on Russia. One side benefit of this approach is that it can induce countries that are currently neutral to embrace the anti-Russian tariff, to protect themselves from having their own exports be subject to the tariff. This gets complicated, but it is certainly worth considering. Perhaps starting with a tariff on Russian gas exports would be a good beginning.

A Price Cap as an Alternative to a Tariff

A tariff on Russian oil and gas exports is a way for Europe to take advantage of the fact that it has a degree of monopsony power over Russia with respect to Europe’s purchases of oil and natural gas. This power is more significant with respect to oil and gas imports via pipelines, since these products cannot easily be redirected to other markets.

A price cap could accomplish the same thing. However, in the case of a price cap the difference in value between the cap and the market price is captured by the importer rather than the importing government. In cases where the government is the importer this is irrelevant. The value of the price cap approach over a tariff is largely cosmetic because it allows the importing government to claim (falsely) that it is not responsible for higher prices. In general, we favor the tariff over the price cap approach as more transparent, but for governments that find the tariff politically unpalatable a price cap is a workable alternative.

Was Biden Wrong to Say Putin Must Go?

Joe Biden often speaks from the heart. Whether it was good strategically to make the statement he made, I will leave to others to ponder. But can anyone not saturated with Russian state propaganda and totally isolated from the truth, doubt that the world would be better off without Putin in power?

The choice is ultimately up to the Russians. But here is their choice. They can remain a pariah state, isolated from the western economies, financial markets, and technology or they could rid themselves of Putin. They can embrace their status along with him as war criminals or they can rid themselves of Putin. They can continue to risk the escalation of the conflict he created for his own ego or they could rid themselves of Putin. They can continue to suffer the needless deaths of their own soldiers in a pointless war or they can rid themselves of Putin. They can continue to live in a ruthless autocracy where they are in fear of their lives and freedom for speaking the truth or they can rid themselves of Putin.

No, the Russians do not have to rid themselves of this unhinged autocrat with his head firmly planted . . . in the nineteenth century. But they do have some choices to make.