Current demand and supply dynamics mean that a punitive tax on Russian oil would be both costly for Russia and beneficial for the rest of the world, making it more credible and sustainable than an embargo. The idea deserves a lot more attention than it has received.

CAMBRIDGE – As I write, the Russian army has entered the Ukrainian capital, Kiev. It is now clear that the threat of sanctions has not deterred Russian President Vladimir Putin from launching his invasion. But dealing with the threat can still play two other roles: sanctions can limit Russia’s ability to project power by weakening its economy, and they can set a precedent that could influence Putin’s future behavior vis-à-vis other countries like Georgia, Moldova. , and the Baltic States.

One of the reasons why the threat of sanctions might not have prevented the war is that Russia did not consider them credible. If imposing a sanction is costly, the political will to do so may be weak or evaporate over time. For example, Western consumers are already frustrated by high energy costs. A Russian oil embargo will reduce global energy supplies and drive prices even higher, potentially triggering a backlash against the policy.

This may be the reason why Western countries have not imposed it, opting instead for financial sanctions which have, so far, been disappointing. After all, arguably the most significant sanction to date – the suspension of the Nord Stream 2 gas pipeline that would have delivered Russian natural gas directly to Germany – will put a strain on the already strained European natural gas market.

Sanctions are more effective and credible if they impose large costs on the intended target but result in small costs or even benefits to those imposing them. Finding such sanctions is easier said than done, as the Nord Stream 2 project shows. So what instruments does the West have in its arsenal?

Punitive taxes on Russian oil and gas are one that has received surprisingly little attention. At first glance, taxing a good should increase its price, making energy even more expensive for Western consumers. Law? Wrong!

At stake is what is called tax incidence analysis, which is taught in basic microeconomics courses. A tax on a good, like Russian oil, will affect both supply and demand, changing the price of the good. The magnitude of the price change and who bears the cost of the tax depends on the sensitivity of supply and demand to the tax, or what economists call the elasticity. most elastic the demand, the more the producer bears the cost of the tax because consumers have more options. most inelastic the to supplythe more the producer bears – again – the tax, because he has fewer options.

Fortunately, this is precisely the situation facing the West today. The demand for Russian oil is very elastic, as consumers don’t really care whether the oil they use comes from Russia, the Gulf or elsewhere. They are not willing to pay more for Russian oil if another oil with similar properties is available. Therefore, the price of Russian oil after tax is set by the market price of all other oils.

At the same time, the supply of Russian oil is very inelastic, which means that large variations in the producer price do not induce changes in supply. The numbers here are staggering. According to Russian energy group Rosneft’s 2021 financials, the company’s upstream operating costs are $2.70 a barrel. Similarly, Rystad Energy, an economic intelligence company, estimates the total variable cost of Russian oil production (excluding taxes and investment costs) at $5.67 per barrel.

In other words, even if the price of oil fell to $6 a barrel (it’s above $100 now), it would still be in Rosneft’s interest to keep pumping: supply is really inelastic in the short term. term. Obviously, under these conditions, it would not be profitable to invest in maintaining or expanding production capacities, and oil production would gradually decline – as it always does due to depletion and loss of reservoir pressure. But that will take time, and by then others could grab the market share from Russia.

In other words, given a very high elasticity of demand and a very low elasticity of supply in the short run, a tax on Russian oil would essentially be paid for by Russia. Instead of being costly for the world, imposing such a tax would in fact be profitable. A punitive global tax on Russian oil – at a rate of, say, 90% or $90 a barrel – could extract and transfer to the world some $300 billion a year from Putin’s war chest, or around 20% of GDP. of Russia in 2021. And that would be infinitely more convenient than an embargo on Russian oil, which would enrich other producers and impoverish consumers.

This logic also applies to Nord Stream 2. A tax equal to 90% of the price of natural gas in the European Union, which is currently around €90 ($101) per megawatt hour, would keep Russian gas on the market. but would expropriate the rent.

But how feasible would a 90% global tax on Russian oil be? In 2019, 55% of Russian exports of mineral fuels (including oil, natural gas and coal) went to the EU, while another 13% went to Japan, South Korea, Singapore and to Turkey. China only got 18%. If all of these countries except China agreed to tax Russian oil at 90%, Russia would try to sell all of its oil to China. But that would put China in a strong position to negotiate. In such a scenario, it would be in China’s interest to impose the tax, as such an instrument would take away the rent it would otherwise have to pay to Russia.

In short, a punitive tax on Russian oil would significantly weaken Russia and benefit consumer countries, making it more credible and durable than an embargo. The idea deserves a lot more attention than it has received.