While the European Union continues to debate to what extent Russian oil imports should be penalised, a much more complicated question is how to deal with imports of Russian gas.
Russia's oil sales to Europe are a small share of world supply. If Europe stopped buying Russian oil, there would be a limited knock-on effect of higher world oil prices. In the short term, because of transport problems, Russia would find it difficult to supply alternative markets, even though countries such as India and China would be prepared to buy from them. If Russia is forced to switch markets, they will lose revenue because of the extra cost of transporting the oil to alternative destinations.
For gas, things are more complicated, as Russia currently supplies about 40 per cent of Europe’s needs. Replacing this with supplies from elsewhere would be very challenging as there is not enough capacity in liquefied natural gas (LNG) installations to replace the supplies being delivered by pipeline from Russia.
Germany would be very hard hit by the loss of Russian gas, on which so much of its industry depends. Studies have estimated the potential reduction in output as ranging from 1 per cent to a massive 10 per cent of GDP.
If German gas supplies from Russia dried up, either by Russian action or because of sanctions, German firms would bid to buy gas from elsewhere in the European market. Because the loss of gas supply would be catastrophic for their economy, they would be willing to pay an exceptional price to secure the supplies they need. The outcome would be a dramatic rise in gas prices throughout Europe.
Uncertain outlook
This would affect us in Ireland, and likewise Britain, though neither island buys Russian gas at present. This is because our suppliers from the North Sea or Corrib gas fields would be willing to sell elsewhere in Europe at the exceptional price. Similarly, the cost of the UK's LNG supply would also rise. Thus all of Europe would face the pain.
If our gas utilities have already contracted to buy the gas we need at a fixed price for the next year, that factor could delay the full impact of the rise in prices for consumers. However, as there is little information available on whether prices have been future-proofed for a period, the price outlook remains uncertain.
To guard against major disruption to gas supplies next winter, Europe needs to build up gas in storage over the coming months. While Germany has large gas storage capacity, Ireland has none.
However, there would be huge financial risks for private companies in buying and storing gas this summer. Prices are very high, but if the Ukrainian war ended this autumn, the price could collapse. Individual governments or the EU itself would be better able to carry the risk, so they should undertake any advance gas storage.
Renting storage capacity
It might be in Ireland’s interest for the Government to rent and fill gas storage capacity in Germany, as a hedge against the price going even higher next winter.
While there are many calls for sanctions to close off Russian gas sales, there is a clear reluctance to do this because of the cost. However, a number of economic researchers have proposed an alternative strategy – to impose a very large tariff on Russian gas imports.
The analyses suggests that, while this would see a further major price hike for hard-pressed consumers, a significant part of the tariff would be paid by Russia in the form of a lower price for their gas. Governments would earn significant revenues from such tariffs, which they could recycle into compensating consumers, for example through lump sum payments. That would leave consumers with a choice as to whether to buy gas at sky high prices or reduce their energy usage and spend the cash transfer elsewhere.
While there is an economic logic to this proposal – it transfers revenues from Russia to European governments, and on to their consumers – it would be a hard sell to voters. If gas prices are doubling while their Governments are raising tariffs, consumers may find it hard to see that they would benefit overall from the tariff “dividend”.
If gas supplies continue to flow from Russia, it would be hard to convince voters that Russia is actually losing out through EU tariffs and it could be an easy target for populist politicians. But if governments have the courage to adopt this strategy, it could be one way of imposing significant economic pain on Russia, and limiting the cost to EU consumers.
