- The plethora of sanctions that were announced by Western powers after Russia invaded Ukraine and one notable absence: energy industry sanctions.
- The reason European powers are so reluctant to sanction Russia’s oil and gas industry is that they need Russia’s natural gas far more than Russia needs their money.
- Thanks in part to high energy prices, Russia now has $630 billion in foreign exchange reserves, a sum of money that means it could survive turning off the taps to Europe.
After months of seemingly endless preparations, Biden’s and the West’s worst fears finally came true on Thursday after Russian forces launched their long-feared attack on Ukraine. Brushing off international condemnation and the first tranche of sanctions from the U.S. and its allies, Russian President Vladimir Putin declared the beginning of a “special military operation” aimed at the “demilitarization” of Ukraine. Russian forces have reportedly fired missiles at military control centers in Kyiv, with Ukrainian Foreign Minister Dmytro Kuleba saying via Twitter on Thursday that Putin had “launched a full-scale invasion,” of the country.
Some commentators are drawing parallels between Russian aggression against Ukraine to Hitler’s invasion of Poland in August 1939 in what is shaping up to be Europe’s biggest crisis since WWII. Russia’s invasion of Ukraine represents one of the continent’s worst security crises in decades and is expected to have far-reaching implications for the global economy, particularly given Russia’s unique position as Europe’s pre-eminent energy supplier.
Crude oil and gas prices are surging as Russia strikes major cities in Ukraine, hitting levels not seen since 2014. Brent futures (CO1:COM) (NYSEARCA:BNO) jumped +8% early on Thursday to trade above $105 per barrel at one point, while WTI futures (CL1:COM) (NYSEARCA:USO) rallied by a similar margin and even hit $100 per barrel at one point.
The markets have been bracing for this kind of outcome given that Russia is the world’s No. 3 exporter of oil and its No. 2 exporter of natural gas. Russia produces 10% of the world’s oil and is the biggest European natural gas supplier.
“This is a triple-hit to the global economy, with a toxic combination of higher inflation, lower economic growth, and greater uncertainty. The only silver lining is growth is strong, a buffer to any slowdown, and policymakers and investors already prepared for high inflation,” eToro strategist Ben Laidler writes.
Laidler says supply disruption risks are low, noting that Russia reliably supplied the West through the cold war. Still, he has predicted high-for-longer commodity prices, with current oil ‘risk premium’ only the latest driver to a structurally very tight market.
But not everybody is that sanguine.
“While Western governments probably will exempt energy transactions from sanctions, the blizzard of new restrictions will force many traders to be exceedingly cautious in handling Russian barrels. Gas transiting Ukraine will likely be disrupted, affecting supplies to several central and eastern European countries, and raising gas prices in Europe,” analysts at political risk consultancy Eurasia Group have told CNBC.
Turning off the gas taps
The million-dollar question here is what would happen if Russia does the unthinkable and completely turns off gas supplies to Europe.
After all, for several months, Russia has been repeatedly accused of intentionally disrupting gas supplies to leverage its role as a major energy supplier to Europe amid an escalating dispute with Ukraine. Two months ago, European natural gas prices hit record highs after a pipeline that brings Russian gas to Germany switched flows to the east. Westward gas flows through the 2,607-mile-long Yamal-Europe pipeline, one of the major routes for Russian gas to Europe, have gradually declined, a move the Kremlin says has no political implications. Western politicians contend that Russia has been using its natural gas as a weapon in the political tussle tied to Ukraine, as well as delays in the certification of another controversial pipeline, Nord Stream 2. Russia has, of course, denied any connection, with state-owned Gazprom (GZPFY) saying it has fulfilled its contractual obligations to customers.
That has not stopped many energy analysts from being deeply concerned about the risk of a full supply disruption to the EU – which receives roughly 40% of its gas via Russian pipelines, several of which run through Ukraine.
Indeed, Russia is in a better position than ever to pull off such a diabolical move.
According to David Frum of The Atlantic and author of Trumpocalypse: Restoring American Democracy (2020), Russia’s Ukraine invasion has been greatly aided by high energy prices, especially natural gas, in the ongoing energy boom. Frum notes that the price of Russian gas on spot markets surpassed $10 per million metric BTUs in June 2021 before tripling to the current $30 per million metric BTUs. The sharp rise in energy prices has helped Russia’s foreign exchange reserves hit $630 billion, or 42% of the country’s $1.5 trillion GDP.
With those massive financial resources, Russia could inflict real havoc on world energy markets if it chooses to, with the natural gas markets likely to be the hardest hit because gas is harder to substitute. In theory, Russian pipeline gas could be partly replaced by liquid natural gas from the United States, Qatar, or other suppliers; unfortunately, ramping up LNG production and shipment is very difficult to do in a hurry.
According to Kateryna Filippenko, principal analyst for Europe gas research at Wood Mackenzie, “Were all gas flows to stop today, Europe could well muddle through in the short term, given higher storage inventories and low summer demand. But in the event of prolonged disruption, gas inventory couldn’t be rebuilt through the summer. We’d be facing a catastrophic situation of gas storage being close to zero for next winter. Prices would be sky high. Industries would need to shut down. Inflation would spiral. The European energy crisis could very well trigger a global recession.“
Troy Vincent, senior market analyst at researcher DTN Markets, concurs with Filippenko’s view and has told CNBC that “there are simply no alternatives” to Russian volumes of oil and gas “that do not entail far higher prices and potentially the development of severe shortages.”
Putin is, of course, well aware of this, and could use oil and gas as an ace in Moscow’s hand in the unfolding drama.
Russian market selloff
Russian stocks have been selling off heavily, tanking by more than 40% on Thursday while the ruble hit a record low against the dollar.
The MOEX index plunged as much as 45%, while the RTS index–which is denominated in dollars–was down 37% at 7.15 a.m. ET. The crash wiped about $70 billion off the value of Russia’s biggest companies.
Russian banks and oil companies were among the hardest hit in volatile trading, with shares in Sberbank (SBRCY)–Russia’s largest lender–at one stage losing 57% of their value. Rosneft, in which BP Inc. (NYSE:BP) owns a 19.75% stake, plunged as much as 58%, before steadying a little. BP shares dropped 4% in London.
Gazprom, the giant gas company behind the Nord Stream 2 pipeline, was down 40%.
Source:Russia Has $630 Billion To Spare As It Considers Cutting European Gas Flows | OilPrice.com