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Embargoes: An Effective Political Weapon?

March 16, 2014 Topic: Economics

Embargoes: An Effective Political Weapon?

History suggests having lots of a commodity—like Russia—doesn't translate into easy geopolitical leverage.

At the beginning of the Civil War, the leaders of the South were, as is normal at the outset of war, confident that their superior military prowess would yield a rapid victory. But the Confederates had another reason for confidence: their possession of a near-monopoly in the market for the most important commodity of the day: cotton.

Like oil in the twentieth century, cotton was vital to the industrial economies of the nineteenth, and particularly that of Britain, the preeminent naval and military power of the day. And the Southern United States was the world’s dominant producer of cotton, accounting for 77 percent of British imports in the 1850s.

Rhetoric about ‘King Cotton’ matched the most hyperbolic claims about ‘energy superpowers’ to be heard today. In 1858, South Carolina senator James Hammond said ‘old England would topple headlong and carry the whole civilized world with her…. No, you dare not make war on cotton. No power on earth dares to make war upon it. Cotton is king.’

Southerners presumed that cutting off cotton supplies to Britain would cripple her economy, and force the British government to recognize the Confederacy, or even intervene militarily to force the North to accept secession. They expressed their belief in dramatic fashion, burning 2.5 million bales of cotton that might have been shipped overseas.

The South’s effort was a failure. Bumper crops in the pre-war years had allowed British manufacturers to build up substantial stocks, which deferred the onset of cotton shortages. By the time the shortage became acute, the Union’s naval blockade, rather than Southern policy, was the main constraint on cotton exports. Meanwhile, despite the state of war, the North bought cotton from Southern planters, some of which supplied the textile industries of New England, and some of which was exported to Europe.

In the mid-20th century, oil took the place of cotton as the commodity perceived to be essential to industrial civilization. A handful of Arab countries, most importantly Saudi Arabia, dominated global trade, and saw the potential to exercise political power as a result. Their first attempt to exercise such power came during the 1967 Six Day War with Israel, when they imposed an embargo on exports of oil to the US, and other countries that supported Israel. The embargo was a complete failure, having no significant impact on either the US economy or the course of the war, which ended in disaster for the Arab side. (It’s at least arguable that Israel’s military victory, leading to the occupation of the West Bank, has been just as much a disaster for the victors in the long run, but that’s a topic for another day).

The next embargo, imposed during the 1973 Yom Kippur War, was far more successful, at least superficially. The embargo was maintained for months, during which Americans endured gasoline rationing and long lines. Better still, the price of oil rose dramatically, enriching the states that had imposed the embargo.

On closer viewing however, this apparent success turns out to be a mirage. The increase in the oil price was part of an inflationary upsurge that had already produced dramatic increases in the price of many other commodities. The emergence of queues and rationing was not the result of the embargo, but of the Nixon administration’s decision to maintain price controls on oil and gasoline, even as the rest of its failed system of wage and price controls was abandoned. The results of the system (run by the appropriately nicknamed ‘czar’ William Simon) were the usual consequences of trying to hold back rising prices by fiat.

More importantly, from the viewpoint of the Arab countries, the embargo failed to achieve its political objectives. Three days after the embargo was imposed, Nixon offered Israel the (then massive) sum of $2 billion in aid, much of it in the form of outright grants. In the longer term, the embargo cemented the alliance between the United States and Israel, an alliance in which all the benefits flow to Israel and all the costs are borne by the United States.

 

In fact, the position of commodity exporters has been more a source of vulnerability than of strength. This vulnerability was demonstrated by the near-collapse of the Southern economy following the Union blockade on cotton exports, and has been shown many times since then.

The embargo of 1973 was the last time that exporters attempted to use oil as a political weapon. But in the ensuing decades, oil-producing countries have repeatedly been subjected to, or threatened with, sanctions on exports imposed with the aim of enforcing changes in their foreign and domestic policies. Examples include Iran, Iraq, Libya, Sudan, Syria and Venezuela. These sanctions have had mixed success, but have certainly had more effect than the 1967 and 1973 embargos.

 

Perceptions matter. Whatever the reality of the 1973 embargo, it generated a belief in the strategic centrality of oil that has hardened into dogma, notably within the US foreign-policy establishment. Even as North America has become virtually self-sufficient in oil, and a major exporter of gas and coal, nothing has changed.

When pressed to defend oil-focused foreign policy, advocates will commonly argue that control over Middle Eastern oil could still be used as a weapon against US allies, most importantly in Europe. By contrast, European discussions of ‘energy independence’ ignore the Middle East almost entirely. The focus is squarely on Russia and particularly on Russian natural gas.

With continued conflict over the Ukrainian and Crimean crises, it now seems likely that European concerns will be realized in some form or another. So, it is important to assess how powerful a weapon is Russian gas, and who will be harmed by its use.

Some things are already clear. First, there is little that the US can do, in the short term, to influence the issue. The US won’t have its first export terminal capable of supplying liquefied natural gas (LNG) to Europe until 2015 and, under current market conditions, most US gas exports will go to Asia.

On the other hand, it seems virtually certain that the crisis will result in the removal of restrictions on gas exports to the EU, despite the opposition of environmentalists and US users of gas. That will put a ceiling on EU gas prices and weaken the future bargaining position of Gazprom, the Russian gas monopoly. So, the mere possibility that exports might be cut off for political reasons is already imposing economic costs on Gazprom and its majority owner, the Russian state.

Second, Russia’s capacity to threaten Ukraine directly without entering into conflict with the EU is very limited. With winter virtually over, the seasonal peak in gas demand is over, too. Ukraine already has enough supplies to last well into summer, even without rationing. Moreover, despite the construction of new pipelines to the north, most Russian gas exports to the EU pass through Ukraine. So, Russia can’t cut off Ukrainian gas without also cutting supplies to Europe as a whole.

The key question, therefore is whether Russia can use its control over gas supplies to force the EU, or individual EU member countries such as Germany, to accede to its (as yet not fully specified) territorial and other demands with respect to Ukraine.

Those who regard energy as the essential master commodity point to the fact that Russia supplies 30 percent of European gas, with the implication that a cutoff of Russian gas would impose economic costs of a comparable order of magnitude. But gas is just one source of energy, and, in the medium term, demand for energy responds quite flexibly to prices and to public policy. A Russian gas embargo would take months to bite, as stocks run down.

During this time European customers could import more LNG from the international market. Europe has plenty of underused LNG import facilities, which ran at less than a quarter of capacity last year. That’s because the price of Russian gas is about 50 percent below the cost of LNG imports, where demand from Asia is bidding up prices. So, while a Russian embargo would raise costs for European gas users, it would be unlikely to cripple the economy.

If market responses were inadequate, European governments could institute conservation measures (or, in particularly gas-dependent areas, rationing) and switch from gas-fired electricity to other sources, including renewables, nuclear and coal. To the extent that coal was the preferred option, this would have serious long-term effects on the global climate if the switch were sustained, but such considerations tend to take a back seat in periods of crisis.