RUSSIAN COUNTERPUNCH

Energy crisis between Russia and the West gains momentum and increasingly looks like a football game, with teams trying to establish superiority through penalty shoot-outs. In the gas market, events are moving so fast that it is impossible to predict what the next move of each side will be. With gas spot prices soaring to record levels (above $3,500 per 1,000 cubic metres), it seemed that the worst days on the market were left in the past. But the situation has completely changed as soon as Moscow decided to use its hydrocarbon resources as a policy tool.

The stakes are too high, as the EU could end up losing Russian gas supplies without finding a suitable replacement in a short period of time. On the other hand, it will also demonstrate how far Moscow is willing to go in its intention to punish its main gas partners who stabbed Russia in the back with the knife of sanctions.

“If they don't buy, we'll stop supplies”

Amid harsh Western sanctions on Russia over its military action in Ukraine, refusing to import Russian oil and gas is the number one topic on the agenda of meetings between EU, US and NATO leaders. But apart from threats and discussions we yet to see concrete solutions. As usual, however, there is no unanimity among the EU member states on this issue. We can hear the most contradictory statements ever when Poland suggests immediate refusal of Russian hydrocarbons, while Hungary, on the contrary, is firm in its intention to keep Russian supplies running to avoid collapse in its own economy. But the question is different. In response to the Western sanctions, Russia took, in fact, an unprecedented step by demanding that ‘unfriendly countries’, about 50 of them, including all 27 EU countries, as well as the US, Japan and others, pay for gas supplies in Russian rubles. If they refuse to do so, Russian authorities threaten to cut off gas supplies. At the same time, Russia believes that European consumers will not refuse the offer and will accept the new conditions, albeit unwillingly.

Russia’s current monthly supplies to Europe reach approximately $10bn worth of gas, with total revenues from Russian gas exports in January 2022 reaching $9.75bn. According to Interfax’s calculations based on data from the Russian Federal Customs Service, Gazprom exported 7.2bn cubic metres to a group of "unfriendly" countries for $6bn. Deliveries have been made to 20 countries, including Austria, Bulgaria, Switzerland, the Czech Republic, Germany, Denmark, Estonia, Finland, France, Greece, Croatia, Hungary, Italy, Lithuania, Latvia, Macedonia, the Netherlands, Poland, Romania and Slovakia.

On March 23, Russian President Vladimir Putin announced a decision to convert payments for Russian gas supplies to "unfriendly" countries into Russian roubles. The Russian government, together with the Bank of Russia and Gazprom, were instructed to implement a set of measures to change the payment for these operations by March 31.

The idea is that buyers from "unfriendly" countries will have to purchase rubles from the Russian Central Bank in order to pay. Thus, the regulator will be able to receive the much-needed currency from those states directly.

The move was in response to the West banning its residents from transactions with Russian government agencies and the Central Bank in dollars and Euros, and freezing Russia's international reserves of about $300 billion. Putin pointed out that in such circumstances, it makes no sense for Russia to supply its goods to the US and EU in dollars, euros and other foreign currencies. In other words, the collective West has "effectively drawn a line under the reliability of its currencies and dashed the trust in them. Now everyone in the world knows that obligations in dollars and euros may not be fulfilled," Putin said.

The Kremlin later warned that if consumers from the list of "unfriendly" countries refuse to pay in roubles for Russian gas, they will simply be cut off from Russian supplies.

"It is absolutely clear that we are not going to supply gas for free. In our situation, it is hardly possible and hardly expedient to engage in all-European charity. No payment means no gas," Russian presidential spokesman Dmitry Peskov said in his interview with the US television channel PBS. He noted that Russia will "explore what can be done" when the West makes a final decision.

Peskov also said that Moscow was not interested in Europe giving up on buying gas from Russia, but that Russia is not the initiator of the ongoing process in Europe.

On the economic side, analysts believe it will not only strengthen the rouble, but also adjust the fall in Russian GDP due to sanctions.

"In order to pay in rubles for gas, European companies will buy currency from the Russian Central Bank, which means the violation of the current Western sanctions against the bank," explains economist and professor of Düsseldorf University Jens Südekum.

According to CASE Ukraine analyst Yevgeni Dubogryz, roubles can also be received in exchange for certain goods that encourage the exchange of goods between Europe and Russia. "They will have to sell goods at official (i.e. understated) exchange rate of the Russian Central Bank: now the official rate is 104 rubles per dollar, while on the black market it is 130-140 rubles," Dubogryz explains.

The Russian government believes that the switch to paying for gas in roubles with "unfriendly" countries, in addition to supporting the national currency, will also reduce risks to commodity flows.

"Our Western partners will adjust to this decision and realise that the rouble is no less reliable a currency than other reserve currencies," Russian Finance Minister Anton Siluanov believes.

"Europeans don't know what roubles look like..."

It seems the Russian counterpunch has clearly confused European leaders.

According to Reuters, French President Emmanuel Macron expressed his position on this issue personally to Putin. In particular, during a telephone conversation on March 29, the French leader said that Western consumers cannot pay Russia for gas in rubles. "France is against paying in rubles," Macron said.

German Chancellor Olaf Scholz was quick to remind that the current contracts had been defined in fixed currencies being the US dollar or Euro. Italian Prime Minister Mario Draghi called Moscow's conditions "essentially a breach of contract", while European Commission chief Ursula von der Leyen suggested that Russia was thus trying to circumvent sanctions.

Following the March 27 meeting of the G7 energy leaders, it was announced that their countries do not intend to switch to paying in roubles. "The G7 countries consider Russia's demand to pay for Russian gas supplies in rubles a clear breach of contracts and intend to urge companies not to comply with it," German Energy Minister Robert Habeck said, adding that “payments in rubles were unacceptable”.

Following the G7, the European Union also rejected Russia's demand to pay for gas in roubles. "Our position is the same as that of the G7," European Commission spokesman Eric Mamer said.

German Finance Minister Christian Lindner added that Germany should not unilaterally terminate gas contracts with Russia, but at the same time should not agree to the condition of payment in roubles.

It is clear that the West is not ready and will not agree to break the gas contracts with Russia currently, because it will not be possible to find alternative suppliers quickly. Whether Russia will stop gas supplies if it does not see its conditions met is also a question. However, it is obvious that Europe, which receives 40% of its gas supplies from Russia, will do everything to reduce this dependence, and will steadily reduce the purchase of gas and other energy carriers from Russia in order to avoid similar incidents in the future.

It is also clear that Russia will redirect its hydrocarbons eastwards—to China, India and the Asia-Pacific region, hence gradually compensating for the loss of European export volumes.

Withdrawal plan

The unprecedented situation on the European gas market has forced the European states to think seriously not only about measures to reduce dependence on imports of Russian energy resources, but also to predict the timing of their dependence from Russia.

German authorities expect to be able to halve imports of Russian oil by the summer and to stop importing coal from Russia by the autumn, Economy Minister Robert Habek said.

Berlin has set a target of reducing Russian gas imports to 24% by the summer. At the same time, Germany has already succeeded in reducing gas imports from Russia from 55% to 40% and oil from 35% to 25%.

Habek opined that much of the gas imported from Russia can be replaced, and the country plans to almost completely stop importing this energy resource from Russia by mid-2024.

Germany has also reached agreements with Qatar on the supply of liquefied natural gas, which would allow it to move away from Russian energy sources in the future. Germany is also negotiating gas supplies with Norway, Canada and the US.

Overall, the European Commission expects to stop dependence on Russian energy resources by 2027, and European Union leaders have already approved the plans.

"We wish to be completely independent of Russian fossil fuels by 2027. And we hope to reduce our demand for Russian gas by two thirds by the end of this year. This is the target we have set and it was approved by the European Council, that is, the leaders (of EU member states), last week. We are committed to do this. Details will be provided by the end of May," EC spokesman Tim McPhee said.

In addition, the US and EU authorities announced the establishment of a joint working group to reduce Europe's dependence on Russian energy resources. Its task is to ensure Ukraine's energy security and prepare the EU for the next winter period, while supporting the EU's goal to end its dependence on Russian energy. As part of the initiative, the US will seek to provide the EU market with at least additional 15 billion cubic metres of liquefied natural gas in 2022. These volumes will increase in the future.

In addition, Washington and Brussels will develop recommendations to reduce overall gas demand by accelerating the use of clean energy.

At the same time, EU leaders are planning joint purchases of the product. On March 25, EU heads of state and government agreed to allow "voluntary joint purchases of gas, liquefied natural gas and hydrogen".

The final document states that EU members and the European Commission should urgently promote common procurement due to the coming winter season. Such a model should also benefit the countries of the Western Balkans and the EU's "associated eastern partners", i.e. Ukraine, Georgia and Moldova.

The French president called common procurement "the best tool for lowering prices", hence allowing the EU, as a major buyer, negotiate a lower price. This would avoid competition between different EU states for the same volumes of gas, making supplies more expensive.

TAP at full power

Meanwhile, Azerbaijani gas deliveries to Europe via the Trans Adriatic Pipeline (TAP) have already reached 10 bcm, which is in line with the pipeline's design capacity and demonstrates the success of the Southern Gas Corridor.

The Greece-Bulgaria Interconnector (IGB) has also been connected to TAP. It is scheduled to be launched in July 2022, allowing Bulgaria to receive Azerbaijani gas directly and refuse Russian gas supplies. Once IGB is operational, the pipeline will initially provide Bulgaria with 1bcm of gas annually, with its design capacity further increased to 3bcm.

Bulgarian Deputy Prime Minister Assen Vassilev said that Bulgaria did not intend to extend the Russian gas supply contract expiring this year amid the situation in Ukraine. The country hopes for supplies from Azerbaijan, LNG and the discussed mechanism of joint gas purchases by the European Union.

"We have had talks with both Greece and Turkey about using the existing infrastructure to supply LNG and increasing supplies from Azerbaijan, with which the country has a contract," he added.

Wolfgang Urbancic of the Austrian energy regulator E-Control believes that entering into new long-term contracts with other gas suppliers, such as Azerbaijan, Norway or Algeria, will bring global gas prices down. "I am confident that the price situation will then normalise," he said.

Even before the hostilities in Ukraine, Europe showed an obvious interest in Azerbaijani gas as a good alternative. We can expect that with the further escalation of tensions between the EU and Russia, worsening of the situation on the European gas market, the need for alternative gas in Europe will only grow. At the same time, we do not want to raise this interest at the expense of wars or other conflicts in different parts of the world.