A recession in the major economies in the only surefire way to lower Russia’s petroleum income, a point that Western leaders have attempted to conceal from domestic voters.
U.S. and E.U. leaders will not intentionally plunge their economy into a recession to increase economic pressure on Russia; hardship is not an acceptable election strategy.
Nevertheless, if their economies enter a recession, which appears likely or even probable at the moment, the risk of imposing severe sanctions on Russia’s oil shipments later this year and in 2023 will increase dramatically.
Russia was the world’s second-largest oil producer in 2021, producing 536 million tons, trailing the United States’ 711 million tons but surpassing Saudi Arabia’s 515 million tons.
So far, restrictions on Russia’s petroleum exports have increased prices for consuming nations while increasing Russia’s earnings because prices have risen faster than volumes.
According to B.P., Russia accounted for approximately 13% of global output, which placed it behind the United States (17%) but ahead of Saudi Arabia (12%). (Statistical review of world energy, July 2022).
Saudi Arabia, the other Gulf monarchies, and U.S. shale firms appear to be approaching their current production limits, with limited choices to increase output shortly. Moreover, despite the recent price increase, none of these producers seem competent and willing to compensate for any loss of crude and refined fuel exports from Russia.
In the absence of a recession, the marginal barrel on the oil market comes from Russia, and its terms of availability to international purchasers in the Middle East and Asia determine the world price. So far, sanctions on Russia’s petroleum exports have increased prices for consuming nations while enhancing Russia’s earnings, as prices have risen more quickly than quantities have decreased.
However, a recession or lengthy business cycle downturn in the major oil-consuming economies of the United States, the European Union, and China would alter the market’s capacity by creating spare capacity.
Saudi Arabia, the remainder of the Organization of the Petroleum Exporting Countries (Opec), and U.S. shale producers would all compete to meet stagnant or declining demand for oil.
Until now, sanctions have harmed consumers more than they have penalized Russia, with the European Union and the United States headed into an economic cycle slump due mainly to the high prices of energy and other commodities.
Notably, the European Union appears to have sanctioned itself near a recession as skyrocketing prices for gasoline, gas, and energy, as well as food products and manufactured goods, stifle consumer spending.
Policymakers with a knowledge of history should not have been surprised by this. Experience spanning four centuries demonstrates that energy embargoes significantly boost consumer costs in the short and medium term if alternative supplies are not immediately available to compensate for the imbalance.
Energy boycotts are an attractive policy instrument if and only if there is excess production capacity (actual or projected) that permits energy from sanctioned sources to be substituted with power from non-sanctioned sources. Similar to when the English parliament barred coal imports into London from royalist coal-producing regions during the English Civil War in 1642-1643, sanctions on Russian oil have harmed consumers.
As a result of the nationalization of the Anglo-Iranian Oil Company, multinational oil companies embargoed petroleum exports from Iran between 1951 and 1954, causing fuel shortages in Asia.
A recession or business cycle downturn would alter the situation and make it possible, at least in theory, to replace Russia’s petroleum exports with more barrels from other sources.
All producers, including Russia, would see reduced pricing due to the economic downturn and the appearance of additional spare capacity.
In a recession, Russia’s earnings would be struck doubly hard by the combination of lower prices and decreased quantities, as those of other producers would replace its barrels.
Senior U.S. and E.U. politicians are understandably reluctant to construct a purposeful recession to increase the effectiveness of sanctions.
Complicated ideas for a price ceiling on Russia’s oil exports are an attempt to circumvent this conundrum or, at the very least, to conceal the policy trade-offs.
However, if a recession happens unintentionally in the following months, this could provide additional room to tighten sanctions policies in 2022 and 2023.
The reemergence of spare capacity would make substituting Russian oil feasible, while lower prices would conceal the cost of sanctions for consumers and make them more politically acceptable to voters. With all producers experiencing a simultaneous decline in sales volumes and prices, there may be a greater desire to displace Russian barrels from rivals, so eroding the cohesiveness of the OPEC+ group.
Russia’s invasion of Ukraine, Western sanctions on Russia’s oil exports, and the global economic outlook are intimately connected.