Updated: Mar 28
Meet an important weapon against Russia's war in Ukraine. You may ask, "How could this be? She does not look like a soldier." Our weapon against Russian aggression is our newly formed "Work From Anywhere" habit. This may be a great asset for fighting a country dependent on oil revenue. More on this follows.
Russia’s act of war with Ukraine triggered a substantive economic response from the U.S, Europe, and countries allied against this act. Allies have been quick to place an economic squeeze on Russia. The economic sanctions are very dynamic. As of the writing of this article, they are regularly changing. The final extent of the sanctions is yet to be determined. The intention is to quickly inflict economic pain on the country, particularly to impact the country’s Kremlin leadership.
In game theory, this is a simple “tit for tat” gambit. The clear message is that Russia has crossed a line. Robert Axelrod is a famous game theorist and tested 100s of game theory strategies. Dr. Axelrod’s research suggests “tit for tat,” in the appropriate context, is generally the most effective strategy. [i] Time will tell.
Regardless, this strategy will have far-reaching implications. Economists call these sorts of implications “spillovers.” Metaphorically, this is akin to squeezing a balloon. When a balloon gets squeezed at one end, it can not help but pop out at the other end. This is fertile ground for the law of unintended consequences. Such consequences may have either positive or negative outcomes. Next are a few potential spillovers and “making lemonade out of lemons” positive outcome ideas and implications.
Russian oil & spillover background: One of Russia’s most significant exports is oil. Their economy is dependent on oil revenue. Russia’s unofficial business ruling class, the oligarchs, are particularly sensitive to oil revenue. To be fair, Russia certainly exports other commodities, including natural gas. Depending on your country's exposure to Russian commodities, your spillover experience may be different. According to the U.S. Energy Information Agency or EIA, Russian oil is about 10% of world supply. By economic definition, removing the Russian oil supply will drive higher oil and gas prices. The Kremlin is depending on their trading partners‘ populations to be sensitive to higher oil prices. The following provides potential oil sanction spillover-related responses. This suggests restricting access to Russian oil is a credible alternative:
Paying higher prices at the pump (or on the runway) is directly supporting Ukraine. People should feel good about supporting the Ukrainian people as they fill up their cars. World governments should emphasize this to their populace. World leaders should be congratulated for meeting the global threat and asking all to participate in defeating the global threat.
Countries should hold their poor harmless. This could be done by providing tax credits or income tax cuts directly tied to higher oil prices. Owing to significant fixed capital costs, American oil companies and other world oil producers should benefit from higher prices via higher profit margins. Incrementally higher oil company income should be taxed (via a tax regime oil companies expect) to fund a Ukraine-supporting “hold harmless” tax credit or income tax cut. [ii] As an inferior alternative, taxes could be temporarily reduced at the pump. As discussed next, higher oil prices are necessary to fire the economics of alternative energy. [iii] Oil companies will likely embrace a program reducing the “blood money” perception of higher conflict-related profits.
Higher oil prices may encourage world oil suppliers to tap marginally more expensive oil reserves. In the short run, this may not be feasible or warranted. It takes time, investment, and regulatory approval to ramp up contingency oil reserve production. If the Russian war persists, oil companies will likely be motivated to tap these reserves. Given environmental challenges, tapping more expensive oil reserves should only be carefully considered. The Economist provides an aligned oil sanctions scenario summary. Please see the notes section. [iv]
Oil remains a massive carbon producer and source of unwanted and unsustainable planetary environmental loss. As such, countries could use higher oil prices to help accelerate the transition to lower carbon emission energy sources. The low carbon-friendly ecosystem includes wind, solar, nuclear, better batteries, electric cars, etc.
In the U.S. and in other parts of the world, there are a variety of clean energy incentive programs. (I.e., programs targeting solar panels, wind, electric vehicles, and the like). The timing of higher oil prices may be perfect. Higher oil prices should accelerate the adoption of alternative energy source substitutes. Governments may want to double down on clean energy incentives. Now is a good time to ride a wave of popular discontent for Russian war-mongering.
In the short term, the impact of Russian aggression has caused a bond market flight to safety. As such, the U.S. Ten Year Treasury bond yield has recently dropped below its previous high of over 2%. This is likely a temporary reprieve to an upward trend in bond yields. The U.S. Federal Reserve may very well continue its inflation-protecting rate increase stance, perhaps after pausing to digest Russian war implications.
Oil and gas prices will certainly increase with a reduced Russian oil supply. A potential silver lining is that owing to the pandemic, American and many countries' businesses and consumers have created an important habit. They know how to be productive and earn a living without traveling to do so. Based on the 2020 statistics from the EIA, 66% of oil is used for transportation. Our newfound habit, to be productive without leaving our houses, may come in handy as we transition to less Russian oil. From an economist's standpoint, our pandemic habits likely translate to an oil demand curve much more elastic than traditionally observed. In this case, higher elasticity means people have more options beyond oil use. Thus, digitally-enabled “Work From Anywhere” (WFA) may be a game-changing oil substitute. To help realize this substitute dividend, consumer “pump” prices should be allowed to increase.
The Russian aggression has created a quick world economic response. This response is “in progress” and will likely morph over time. Regardless of the final response, economic sanctions will clearly have spillovers. Spillovers are difficult to judge. Oil sanctions are an important option and may have the most significant spillovers. World economies are very complex and interrelated. However, we may make the most of this unfortunate situation by taking care of our lower-income and Ukraine-supporting “economic warriors.” We may also take advantage of higher oil prices to further our necessary alternative energy transition. Our new WFA habit may provide tremendous and unexpected benefits in the fight against Kremlin aggression.
[i] Robert Axelrod, Evolution of Cooperation, 2006
[ii] In case there is any doubt as to the future increase of oil company profits, the markets are “voting with their feet!”
[iii] The Economist makes a good case for why reducing taxes at the pump is a bad idea.
These tax cuts are a mistake. They will waste money and make it harder to wean the rich world off fossil fuels. There are better ways to help people cope with rising energy prices.
Leaders, Cutting fuel taxes is a bad idea, The Economist, March, 2022
[iv] There are potential scenarios to increasing the world oil supply. The following is provided by The Economist:
Rich countries could speed up the release of the 1.5bn barrels of oil they hold in reserve. Having disparaged America's shale-frackers, the Biden administration needs to prod them to drill more. The EU must promote or prolong its use of nuclear, renewable and coal-powered generation, so as to stock up on gas for the winter. It should also prepare for the worst case: gas rationing. Rich-country governments may have to protect the poor at home with handouts. Stimulus could mean higher interest rates or taxes, but that is a risk worth taking to protect the world against an aggressor.
Leaders, War and sanctions have caused commodity chaos, The Economist, March, 2022