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The West’s united response to Russia’s invasion of Ukraine is splintering over whether European countries are willing to take a severe economic hit and stop buying the oil that fuels the Kremlin’s war effort.
While the U.S. is moving ever closer to a crude oil ban, it looks increasingly unlikely that its European allies will agree to sanction President Vladimir Putin’s energy exports because of fears about runaway inflation and retaliation from the Russians.
Sensing a danger to this vital component of its budget, Moscow is issuing a blend of dire warnings and outright threats to its neighbors. Russian Deputy Prime Minister Alexander Novak warned Monday that any restrictions on Russian crude could send oil prices spiraling above $300 per barrel, from about $130 now.
Novak also threatened to retaliate against Western measures by cutting off the gas flow to Germany along the first Nord Stream pipeline. That would be a massive hammer-blow to German supply — out of the 93 billion cubic meters that Germany consumed in 2021, 60 bcm came via Nord Stream.
In a probable allusion to China, Novak said that Russia would simply shift its sales elsewhere if it faced Western sanctions. “If you want to cut off supplies of energy resources from Russia, go ahead, we are ready for that. We know where will reroute these volumes. The question is: Who benefits? And what is the point?”
That sort of calculus now seems to be looming large in Europe. And the Europeans are shying away from a fight if it hurts their bottom line.
While Ukrainian President Volodymyr Zelenskyy has described continued energy purchases as akin to “giving money to a terrorist,” he’s facing a potential brick wall in the EU. German Chancellor Olaf Scholz is insisting that Europe currently has no alternative to Russian supplies, Dutch Prime Minister Mark Rutte is warning of “enormous ramifications” of such a measure, and Bulgarian Prime Minister Kiril Petkov said Bulgaria might seek an exemption from EU hydrocarbon sanctions. Italy also has long-standing reservations about direct sanctions on the oil and gas sector.
While top EU officials such as Trade Commissioner Valdis Dombrovskis insist direct energy sanctions should be on the table, it would be impossible for that to happen without support from member countries, and not at the speed that Zelenskyy is asking for.
The EU relies on Russia for 27 percent of its crude imports, 47 percent of its coal and 41 percent of its gas imports, and the Continent is still haunted by the gas crises of 2006 and 2009 when it suffered from supply disruptions from Russia.
Ostracized on the market
The Kremlin has good reason to be sweating over the threat to its money flows.
One of the most extraordinary dimensions to the Ukraine crisis has been the oil market’s disconnection from Russia over the past week, even without sanctions. Even the very discussion of an embargo on Moscow’s energy shipments has triggered a de facto boycott on the market. Some 70 percent of Russian oil is struggling to find buyers, according to JP Morgan, despite a discount of more than $23 against Brent crude, the industry benchmark. That means even if Russia does manage to sell — say to an Asian buyer — it’s for a much lower price than Russian vendors would like.
Much of the market reaction is based on financial prudence about not wanting to be left holding shipments that cannot be delivered.
Insurers are currently refusing to underwrite the tankers carrying Russian crude. Traders are unclear whether the requisite letters of credit and financial notes needed to purchase the goods are impacted by the already-announced sanctions on the SWIFT payment system on certain banks and individual accounts. With single cargoes of oil representing $100 million or more, no one is ready to pay now and risk not receiving delivery in 30 days should sanctions be imposed in the interim.
It remains to be seen whether the market will relax and go back to buying Russian oil if the EU rules out any ban. For now, however, the uncertainty is winning the day.
There are also moral and reputational dimensions at work. Dock workers in Britain have refused to unload shipments from Russia and Shell announced that it would stop dealing in Russian oil and gas, after Ukrainian Foreign Minister Dmytro Kuleba accused the oil major of not caring about “Ukrainian blood.”
Still, Thierry Bros, professor at Sciences Po Paris and a member of the EU-Russia Gas Advisory Council, argued that markets were fundamentally amoral and that tighter sanctions would still need to be imposed if Western leaders really wanted to stop filling Putin’s war chest.
“The question about morals is coming to be important,” he said. “Do we finance this war? I mean, how much does Ukrainian life cost … We are getting closer and closer by the day of having extremely tough sanctions, to try to avoid funding the war in Ukraine.”
Ludovic Subran, chief economist at insurer and asset manager Allianz, said he and his team now pegged the likelihood of a ‘blackout’ scenario, in which all imports of oil and gas from Russia are brought to a halt — either by sanctions or by retaliation by the Kremlin — at 60/40. Before the invasion, they put the odds at a remote 85/15.
“I don’t think Russia will be exporting much oil and gas two weeks from now, I think the politics of that will move very fast,” said Jacob Kirkegaard, senior fellow at the Peterson Institute For International Economics and the German Marshall Fund.
Help from China, but at what price?
Even if the West decides to sanction Putin’s oil income, the rest of the world may take the chance to buy the discounted crude.
“The West needs to not just look at its own imports and do its own import ban, they need to get Eastern allies of the West such as India, Japan, South Korea to also join in and agree on banning Russian imports of crude oil at the same time to maximize the impact on Russia,” said Ajay Parmar, senior oil analyst at energy intelligence service ICIS. “If that happens then Russia’s available market to purchase their crude is just so much smaller, it would be mainly China.”
Bros from Sciences Po added: “Having only China as a customer is never a good thing … So Russia is going to be squeezed.”
Tom Marzec-Manser, head of gas analytics at ICIS, said the threats against oil have ratcheted up fears about gas sanctions as well, leading to a new record high of the EU gas benchmark at €345 per megawatt hour on Monday morning, before falling Tuesday to €209 — still 10 times higher than a year ago.
“I think in the scale of sanctions, gas would be sanctioned after oil, but the fact that we’ve moved into this world over the last three days of talking about sanctioning oil, it means we’re taking one step closer to potentially sanctioning gas,” Marzec-Manser said.
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