Defeating Putin: the development, implementation and impact of economic sanctions on Russia/Economic impact upon the UK

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Implementing sanctions
Defeating Putin: the development, implementation and impact of economic sanctions on Russia (2022)
House of Commons Treasury Committee
Witnesses
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In this transcription, all external links have been retained exactly as-is. Note that the links for questions 94 through 162 are dead; the live version can be found at https://committees.parliament.uk/oralevidence/9946/pdf/ (in PDF form) or at https://committees.parliament.uk/oralevidence/9946/html/ (in HTML form).

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Economic impact upon the UK
Impact of sanctions on Russian oil and gas
  1. The UK is a significant producer of both crude oil and petroleum products, and oil imports from Russia account for eight per cent of total UK oil demand. In addition, the UK imports oil from various countries including the Netherlands, Saudi Arabia, and USA.[1] However, while none of the UK’s petrol is derived from Russian oil imports, 18 per cent of the UK’s diesel demand is sourced from Russia.[2]
  2. While the UK does not use significant quantities of Russian oil and gas in aggregate, we were told that increases in global energy prices as a result of sanctions on Russian production would still be passed on to the prices the UK pays. Dr Amrita Sen, Director of Research at Energy Aspects, told us that this was because the global oil price “is set by the marginal buyer, [ ... ] whoever is the last buyer is the price of oil.”[3] She went on to explain that due to pre-existing supply constraints, combined with new concerns in the market about whether Russian oil would be sanctioned and therefore unable to reach the market, prices for oil were rising substantially:

    The fundamental point is that we were already headed to $100 oil, even prior to the Russian crisis. What [potential sanctions] have done is to bring more fear into the market about potentially losing Russia, which is one of the biggest producers of oil and gas in the world. Even if China and India continue to buy that oil—there will be some production losses. [ ... ] We just do not have the spare capacity anywhere else—OPEC in particular—to compensate for that Russian loss. That is why we saw oil prices, obviously volatile, go up to almost $140, although they have come back down to $110.[4]

    Nathan Piper, Head of Oil and Gas Research at Investec, but speaking in a personal capacity, told us that:

    If more stringent sanctions are imposed on Russia and 5 million barrels a day is truly taken out of the market, the oil price really has—not quite no ceiling, but it will rise up a lot before the demand destruction kicks in to maybe bring it back down again. For a consumer through 2022, they need to get ready for what could be continued increases in fuel prices.[5]

  3. When we asked our witnesses how much petrol and diesel might cost on station forecourts, they said petrol could rise to £2.40 per litre,[6] and diesel could reach £3 per litre.[7] We heard that the price for diesel fuel would rise higher than petrol because, unlike petrol, the UK was not self-sufficient in diesel.[8] Mr Piper told us that:

    ​

    Europe imports 50% of its diesel from Russia. We are seeing how interconnected we actually are. Diesel prices have spiked, just as oil prices have, because diesel runs the world. Diesel runs the shipping lanes, the trains, the cars—everything. Diesel is probably the one we have the most exposure to, in terms of sharp price movements.[9]

    Dr Sen agreed and told us that diesel use “tends to be more inelastic, because there is a lot of trucking”.[10]

Would the UK be affected by gas sanctions?
  1. We queried whether sanctions on Russian gas would affect the UK. Dr Sen told us that even though the UK produces significant amounts of domestic gas, it was “not isolated” and that “you are ultimately linked to what’s going on in Europe”.[11] Mr Piper told us that “while oil is a global market, gas is a regional market”[12] and that “the import price sets the gas price in Europe and in Asia”.[13]
  2. If the UK or the EU were to look to reduce their dependency on Russian gas, it is not clear where the replacement supply would be sourced from. Dr Sen told us that “Asia was not going to give its gas contracts away”.[14] Stored gas would also not be able to offer an alternative supply to Russian gas in winter because storage levels were currently very low.[15] Logistically, gas is harder to transport around the world than oil. Mr Piper said that the infrastructure to replace Russian gas in the European region did not yet exist:

    Europe does not have the LNG [Liquefied Natural Gas] import infrastructure—the terminals where you can land LNG vessels and offload the gas to fill those storage facilities. It does not have the capacity of those terminals to replace the Russian volumes.[16]

  3. Mr Piper explained that even before the Russian invasion of Ukraine gas prices were already at a historically high level:

    Fundamentally, Europe and Asia are short of gas. We do not produce enough of our own gas. Europe is 70% dependent, and the UK is 50% dependent on imports. There was less wind than expected [in 2021]. [ ... ] Coal-fired power is being closed down and because nuclear has been closed down, gas is the only back-up, so gas demand was increased as well.[17]

Impact on households
  1. Mr Piper told us that as a result of the tight supply in the European gas market, the impact on UK household gas and electricity bills would be significant: ​

    ... in June last year ... the UK gas price was 70p a therm, which seems like nothing now, but that is 50% above the 10-year average. To give you just a few points of reference, the 10-year average is 50p a therm. It was trading at 70p a therm in the summer of last year. That is really when storage should have been filled, but it was not. [ ... ] What you saw was a build in the price, all the way up to 450p a therm, before Christmas. [ ... ] From a consumer point of view, we already know the average energy bill will move up to £2000 a year from April. The key thing is that the input price is 126p a therm. The year-to-date average gas price is about 225p, so bills in October are going to go up again, and by quite a margin. What you are going to see is a doubling in people’s energy bills year on year, because the gas price sets the electricity price in the UK.[18]

  2. Despite producing significant amounts of oil and gas, the UK is not protected from the economic consequences of sanctioning Russian oil and gas production. The price paid for gas in the UK is dependent on the level of demand for gas in Europe. The price paid for oil in the UK is dependent on the global price of oil. Further sanctions on Russian oil or gas will lead to higher prices which in turn will feed through to UK households and businesses.
Macroeconomy and the cost of living
UK macroeconomic outlook
  1. We heard from our witnesses that the economic sanctions imposed on Russia to date will have an impact on the UK economy. Tom Keatinge, Director at the Centre for Financial Crime and Security Studies, Royal United Services Institute, said that he wrote in December “that we are not going to be able to put the sanctions on Russia that we are promising without creating self-harm”.[19]
  2. Neil Shearing, Group Chief Economist at Capital Economics, outlined what that cost might be, telling us that it would run through three channels: the impacts on trade, financial linkages, and commodity prices and inflation.[20] On trade he explained that:

    Our trade linkages with Russia, in a direct sense, are not particularly large— our exports of goods and services to Russia make up about 0.2% of GDP. I think you can expect those to pretty much dry up all together, at least for the foreseeable future—for the next quarter or two. That is an economic hit. Those costs might be concentrated in one or two sectors, or on one or two firms, so there might be some pain there.

    On commodity prices he noted that:

    [ ... ] far and away the most significant hit to the UK economy at the moment will come through the effect on energy prices and the cost of our imports. That is not because we import a lot from Russia, but because global prices have gone up. As a result of everything that has happened so far, ​since the start of the conflict, I would estimate that it has added about 1% to inflation versus our pre-conflict baseline. All other things being equal, that will mean another 1% hit to real incomes. Then, the pass-through to the size of the economy depends on what the Government do to take steps to mitigate that effect. If they don’t do anything, it could shave about 0.25% to 0.5% off GDP, compared with where we were before. That is not to say that the economy is going to shrink; it just won’t grow by as much as we had anticipated.

    Clearly, if it escalates to the extent that we include energy within sanctions, those effects will get much bigger. As a broad rule of thumb, I would perhaps double the size of the hit to the economy and the increase in inflation.[21]

  3. We asked Professor Jagjit Chadha, Director at the National Institute of Economic and Social Research, about the scale of the impact on the UK economy and the likelihood of an oil price shock similar to 1973, which saw the UK face high inflation and interest rates. He replied that while inflation was likely to peak at 7 to 8 per cent or higher this year, it was too early to tell whether it will reach the levels of the 1970s. He explained that there were a number of shocks in the 1970s, including oil and commodity prices as well as “the loss of the monetary anchor”. However, he noted there is now “an inflation target pursued by the independent Bank of England, which is one thing we didn’t have in the 1970s.”[22] On the outlook for growth of the UK economy, Professor Chadha added that “growth will be slower—somewhere in the region of 1% down this year and 0.5% lower next year on current forecasts.”[23]
  4. Regarding the long-term impact for UK businesses operating in Russia, given the threat by the Russian President to seize the assets of international companies exiting Russia, Mr Tony Danker, Director-General at the Confederation of British Industry, said:

    Obviously, I think that closes Russia as a market to us for a considerably longer time than anyone would have imagined. That is the implication. For Britain, which does not export or import in massive amounts to Russia, it is not a devastating hit, but it is a closed market for the medium to long term. That is the implication.[24]

UK cost of living and impact on business
  1. The potential impact of sanctions has added to concerns about the cost of living. In a recent report on living standards, the Resolution Foundation concluded that “High inflation will make falling real household incomes the defining economic feature of 2022.” The report identified “the wholesale prices of gas and oil, which increased rapidly following the re-opening of the global economy, and have increased sharply again since Russia invaded Ukraine” as the main drivers of high and rising inflation.[25] Tony Danker, ​ Director-General at the Confederation of British Industry, provided the following description of the impact of Russia’s invasion of Ukraine and subsequent economic sanctions on the cost of living in the UK:

    On consumer confidence and cost of living, right now it is particularly acute for those people on low incomes. There are still some household savings elsewhere in the economy, but people on low incomes are already suffering, and they are about to suffer more on fuel bills, food costs and so on. I think we will probably have later in the year an impact on aggregate consumption, and therefore growth. I think one would have to say, given the inflationary pressures from the energy impact, you are going to see aggregate consumption hit later in the year. That is growth challenge No. 1.[26]

    Mr Danker also added that business confidence was starting to waver. He said that on the whole there had been “high levels of optimism” from businesses about three months ago and that had been still the case until very recently, but things had changed since the start of the Russian invasion of Ukraine.[27]

  2. The cost of living impact on low income households described by Mr Danker needs to be set alongside impacts from other sources, including Government policy measures. On 31 January, prior to the Russian invasion of Ukraine we took evidence from several witnesses on the cost of living. Robert Joyce, Deputy Director, Institute for Fiscal Studies, told us then that initial ‘overnight’ effects from April 2022 of rises in energy prices and the increase in national insurance would hit all households.[28] He described the combined effects of all the measures across the year:

    Taking the year as a whole, comparing next year with last year, which is also important because there are a lot of other things going on, it is clearer that the bottom overall will be having a worse year. That is mostly because, if you compare where they are now with where they were a year ago, they have lost about £1,000 a year in Universal Credit, if they were on that.

    In combination with a slightly higher rate of inflation over the year as a whole faced by the poor, and the loss of that—albeit always temporary— increase in Universal Credit, over the year as a whole they will have seen more of a deterioration. It is less so for some of them: those who are both in work and on Universal Credit benefited from increases in Universal Credit in December.[29]

  3. During the same evidence session, Torsten Bell, Chief Executive of the Resolution Foundation, agreed with this general outline, noting that:

    The whole country is going to feel squeezed through 2022, and lower-income households are going to struggle most to deal with that. As Robert said, the ​key issue is less on the cost size and more on the income side, where you see really hard questions for the lowest-income households, because of the £20 a week removal from Universal Credit.[30]

    In a follow-up analysis on this point, the Resolution Foundation noted that:

    We have calculated that around 1.6 million families (all of which are claiming Universal Credit and in-work) will have a higher net household income (after housing costs and in real-terms) from before the pandemic to 2022–23, after taking into account: the increase in earnings; the increase in worker National Insurance contributions with the Health and Social Care levy; the increasing cost of living (including the energy price rise); the reduction in the UC taper rate from 63% to 55%; the £200 energy rebate to all households; and the £150 Council Tax rebate to all Households in bands A to D.

    To be clear, the rising cost of energy bills are included in the results, but are a part of the broader increase in prices in line with the Bank of England’s inflation forecast. We have assumed inflation effects all households equally.

    On average we expect these 1.6 million [Universal Credit] families who will be better-off to have £880 more in household income (4.9%) in 2022–23 compared to 2019–20 (after housing costs and in real-terms). However, we also calculate that around 630,000 low-earning [Universal Credit] families in-work will be worse-off by an average of £830 per year (- 4.2%), and 2.4 million out-of-work [Universal Credit] families to be worse-off by an average £560 per year (-3.3%).[31]

Recommendations to the Government
  1. Given these pressures on the cost of living, both pre-existing and stemming from the invasion and resulting sanctions, our witnesses provided the following potential recommendations to the Government. Professor Chadha recommended the following:
    • rethinking the tapering of the universal credit and considering whether the scheme ought to be extended;
    • introducing a winter grant scheme at local authority level to help households with rising energy bills;
    • providing more Government support for food banks;
    • considering delaying the National Insurance tax hike and considering an alternative such as a temporary income tax rise on higher earners; and
    • providing study grants and support for higher and further education colleges.[32]
    ​
  2. However, Dr Sen told us that “On subsidising households [ … ] The cost is anywhere between £25 billion and £50 billion to £60 billion. If we are talking about the poorer households, those kinds of subsidies will have to be given and announced”.[33]
  3. Given his concerns about business confidence described earlier, Mr Danker recommended the following:
    • The Chancellor should consider extending the tools used during the onset of the Covid-19 crisis e.g. the business interruption loan schemes, to support UK businesses in the current climate;
    • The Government should institute measures to unlock more business investment, including building skills incentives and improving business confidence;[34] and
    • In relation to energy, the Government should “double down on renewable and clean energy solutions”[35], take advantage of the UK’s success in offshore wind and unlock private sector investment in renewable energy.[36]
  4. On the cost of these proposals, Dr Sen told us that “On Tony [Danker’s] point about renewables, we think we need at least $20 billion a year in investment in renewables. Again, that can lift business confidence, and at least helps mitigate the impact on the economy”.[37]
  5. There will be a cost to the UK economy of the economic sanctions imposed on Russia. It is not possible yet to quantify that cost. But we believe that, on the information currently available, it is most definitely a cost worth bearing in order to aid Ukraine in opposing Russian aggression. However, that cost, combined with the already present pressures in the UK on the cost of living, will impact the whole country, and will be felt particularly by low income households.
  6. As the Government moves forward with its sanctions strategy, it must take further action to support UK households, in particular those on lower incomes, to manage the subsequent rise in energy and other costs.
  7. Business confidence has wavered in response to Russia’s invasion of Ukraine. The Government should consider what steps can be taken to boost business investment and growth and specifically how it can help firms which have been directly affected by the economic sanctions against Russia. The Government should also look to accelerate the UK’s transition to a more secure energy supply whilst also reaffirming their commitment to net zero and a just transition.
  1. ↑ HM Government: UK to phase out Russian oil imports, 8 March 2022
  2. ↑ HM Government: UK to phase out Russian oil imports, 8 March 2022
  3. ↑ Q95
  4. ↑ Q95
  5. ↑ Q104
  6. ↑ Q102
  7. ↑ Q104
  8. ↑ Q103
  9. ↑ Q104
  10. ↑ Q104
  11. ↑ Q97
  12. ↑ Q158
  13. ↑ Q98
  14. ↑ Q97
  15. ↑ Q97
  16. ↑ Q98
  17. ↑ Q98
  18. ↑ Q98
  19. ↑ Q15
  20. ↑ Q70
  21. ↑ Q70
  22. ↑ Q131
  23. ↑ Q132
  24. ↑ Q118
  25. ↑ A Corlett & L Try, The Living Standards Outlook 2022, Resolution Foundation, March 2022, p. 5 (Accessed 15 March 2022)
  26. ↑ Q117
  27. ↑ Q118
  28. ↑ Oral evidence taken on 31 January 2022, HC (2021–2022) 1094, Q7 [Robert Joyce]
  29. ↑ Oral evidence taken on 31 January 2022, HC (2021–2022) 1094, Q7 [Robert Joyce]
  30. ↑ Oral evidence taken on 31 January 2022, HC (2021–2022) 1094, Q7 [Torsten Bell]
  31. ↑ Correspondence from the Resolution Foundation relating to ‘The cost of living’ session, dated 8 March 2022
  32. ↑ Q136
  33. ↑ Q140
  34. ↑ Q134
  35. ↑ Q134
  36. ↑ Q139
  37. ↑ Q140
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