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One of the biggest economic worries in Europe around sanctioning Russia in response to the
invasion of Ukraine is that Russia could cut off Europe’s natural gas supplies. The EU
relies on Russia for a significant percentage its energy needs, and there are no easy substitutes
for Russian oil and gas supplies if they are disrupted. So, Russia is in a strong position,
but, they do still need to sell to Europe. Russian oil and gas export revenues made up
roughly 43% of the Kremlin’s federal budget between 2011 and 2020 – this is revenue
that they can’t afford to lose. They currently get $440m per day from gas sales to Europe
and have no easy way of rerouting this gas to other markets due to the way the pipelines
are set up. So, both Europe and Russia are extremely economically reliant on each other.
Austria and Germany in particular, rely very heavily on Russia for natural gas. Turning
off the taps for even a few days would cause havoc for these economies but doing this would
inflict much greater economic damage on Russia, as right now oil and gas exports make up almost
the entire Russian economy. Germany and Austria do have emergency plans
in place to deal with such a situation, and they are already in the "early warning phase",
the first of three steps designed to prepare the country for a supply shortage. In the
final stage, the governments would bring in gas rationing.
Earlier this week, I’m sure you heard, Vladimir Putin announced a decree, that "unfriendly"
foreign countries must start paying for natural gas supplies in roubles otherwise they’ll
be cut off. The way this new decree works, is that buyers in countries deemed hostile
to Russia (which are basically all of the countries imposing economic sanctions on them
– I guess he could probably view Ukrainians as a bit unfriendly too)… These countries
are required to open an account both in foreign currency and in roubles at Gazprombank, which
has not yet been sanctioned by the US and the EU because it facilitates the sale of
Russian oil and gas. These countries would then transfer euros or US dollars into these
accounts, Gazprombank would convert this into roubles which would then be used to make the
payments for natural gas. Though Putin’s order comes into effect for
gas exported from today onwards, the way these contracts work is that payments for the gas
being delivered right now are not due until mid-May. This means that there should not
be an immediate threat to energy supplies in Europe. A lot of analysts are predicting
that this plan is likely to be extended to include exports of oil, grain, fertilisers,
coal, metals and other key commodities too. The UK would not be directly impacted by natural
gas supply disruptions, as it imports less than 5% of its gas from Russia (and the UK
is actually already sanctioning Gazprombank), but of course, The UK would be affected by
prices rising in the global markets as the availability of natural gas falls.
This push by Russia is being seen as an attempt to boost the ruble, which was hit hard by
Western sanctions that were put in place last month. Putin says that the switch to roubles
will strengthen Russian sovereignty, and that Russia will stick to its obligations on all
contracts, if Western nations oblige. OK, so what is going on with the rouble then?
Well, back in early March the rouble lost almost half its value in less than two weeks
— after American and European sanctions kicked in. Since then though, the currency
has recovered and on Thursday it traded at 81.7 to the dollar, back to where it was before
Putin invaded Ukraine. At first this might look impressive, and that’s
because it is designed to - as keeping the exchange rate strong is part of a political
effort to make it look like the sanctions aren’t having any effect. The currency is
holding up for a variety of reasons mostly tied to the draconian capital controls imposed
by Moscow. When the sanctions were first imposed the
rouble fell sharply as many Russians were moving their money abroad, then capital controls
were quickly imposed preventing Russians from getting their money out of the country. The
central bank additionally, more than doubled interest rates to 20 per cent, incentivizing
people to hold on to their roubles. These measures stopped bank runs, and kept the Russian
banking system functional. Additionally, foreigners have been prevented from selling Russian stocks,
meaning their investment money is trapped in Russia too. Russia has forced all exporters
to convert 80% of their revenues into Roubles, which they would not naturally have done.
Right now, banks outside of Russia have essentially stopped quoting dollar-rouble exchange rates,
so when you see that the exchange rate has recovered, it has only done so because anyone
who wants to transact is prevented from doing so.
This apparent strength in the rouble is masking the damage that sanctions are doing to the
Russian economy. Analysts estimate that Russia’s economic output will drop by 15 per cent this
year, wiping out fifteen years of growth, as domestic demand collapses — this is the
contraction that is expected with Russia continuing to export oil and gas.
As of right now, more than 400 foreign companies have already withdrawn from Russia, many of
them “self-sanctioning” by quitting the country even if sanctions don’t require
them to do so. Now, before I go any further, let me quickly
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OK, so why does Russia want to be paid in Roubles, and will being paid in Roubles make
any difference? Well, the fact that Russia is still able to
sell natural gas to Europe, is the biggest hole in the western sanctions right now, and
this hole already severely undermines the overall effect. Right now, European companies
buy the gas from Russia in euros or in dollars, at which point Russia forces the exporters
to convert 80 per cent of the revenues into roubles. Under Putin’s new plan all the
money gets converted first and then the exporters get paid in roubles. The big difference here
is simply who does the currency conversion. Whether the west pays for Russian gas in euros
or in roubles, Moscow receives foreign currency, which can then be used for buying imports
or for propping up the rouble. So right now, the main reason Putin is making
these demands is political. Putin wants to look strong to the people of Russia and wants
to appear to be pushing back against western sanctions. He possibly hopes that other countries
that dislike the US or the EU might join in and keep more of their funds in currencies
of more geopolitically aligned countries. While that might be his goal, it is not obvious
what currencies could easily replace the Dollar and the Euro in the global financial system.
It would not be the Chinese Yuan due to their capital controls which mean that currency
can’t be moved freely in and out of China. Additionally, China's bond market is too illiquid
right now. If you are in the process of typing a comment saying that it will be bitcoin,
there is no need to even finish your comment, the laser eyes in your profile photo communicate
your opinion far better than anything that you could write.
Now one other reason that Putin might want to push for being paid in Roubles is he may
be worried about further sanctions being placed on Russia, similar to those on Iran. Some
supporters of Ukraine are suggesting that buyers should have to pay money into escrow
accounts from which Moscow could withdraw funds only to pay for certain essentials.
Putin’s decree may have been, in part, an attempt to insulate Russia from such a move.
OK, So, what do the existing supply contracts look like? Well under the existing contracts,
Gazprom is entitled to renegotiate the terms of these contracts every three years, and
they have dozens of different contracts with different suppliers, so a change like this
would be a long process. If there was a dispute about existing contracts, it would typically
be settled by arbitration in Stockholm, and under the terms of the contracts the gas would
be required to continue flowing while the dispute is being settled.
Now Russia could of course just decide to tear up the contracts but doing so would be
in breach of international protocols, and this is not something that Russia appears
to want to do. Russia honored their supply contracts even at the heights of the cold
war and it would appear that Russia does not wish to be seen as a pariah state like North
Korea quite yet. This is likely why they also made their bond payments last month, when
a lot of people did not expect them to. Ultimately, Russia still needs the money for the gas,
and still wants to leave the possibility of a market for its main export once a peace
deal is signed. Germany has said that it is prepared to ration
energy supplies rather than pay for gas in roubles, doing this would plunge Germany (the
EU’s largest economy) into recession but it would do much more harm to Russia overall.
Cutting off Europe would mean lost revenues for Gazprom which is majority owned by the
Russian state. It would also speed up Europe’s move away from buying Russian commodities
in the long run, adding to the country’s already-dramatic economic decline. So while
it might not be wise, in theory, Russia could cut Europe off almost immediately without
much operational difficulty. Gasfields are much easier to turn off than oilfields without
damaging them. Some gas, but not much could be rerouted to places such as central Asia
or Turkey, but Russia would probably end up initially putting a lot of gas into storage,
but they don’t have a lot of storage capacity, so they would quickly have to start shutting
down wells. There is no gas pipeline connection between
West Siberia — where Gazprom pumps gas for Europe — and China at present and building
one would take three or four years. Putin may feel he has hit back at the west
by forcing it to pay in roubles, and if push came to shove, Europe might even agree – as
in truth it makes almost no difference, but by forcibly rewriting contracts Putin will
destroy any remaining trust in Moscow as an energy supplier and Europe’s determination
to turn its back on Moscow might be here to stay.
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video description. It’s a great newsletter that I can firmly recommend. If you liked
this video, you should watch the one on the economic effects of Russia’s invasion of
Ukraine next. Have a great day and talk to you again soon. Bye.