TRIAL EMBARGO

Amid the growing crisis in EU-Russian relations and after a recent recovery from Moscow's unilateral, albeit pending, decision to accept only Russian roubles in return for imported domestic natural gas, Brussels has taken an unprecedented step of imposing an embargo on Russian coal and other solid fossil fuels supplied to the EU. However, the decision was not an easy one, as it was met with the expected resistance from some European countries, which suggested a gradual withdrawal of supplies. Nevertheless, a consensus was reached and the ban can now be considered a test case for the EU's refusal to import Russian energy. On the other hand, the decision on sanctions associated with energy supplies has once again demonstrated that the EU was not yet ready to go further and ban Russian oil and gas imports.

Punishment by coal

In parallel with decision to expel Russian diplomats, European leaders spent the past week over active discussions on a new package of sanctions against Moscow over Russia's invasion of Ukraine. On 8 April, the EU Council announced a new set of restrictive measures against Russia. These include a ban on deliveries of €10bn-worth high-tech European products to Russia; imports of a number of traditional Russian goods worth €5.5bn to the EU, including timber, cement, fertilisers, etc; a complete transactions ban in the EU for four Russian banks; and banning the entry of Russian vessels into the EU seaports, excluding those carrying agricultural products, humanitarian aid and energy carriers. There is also a ban on road cargo transport by Russian and Belarusian cargo companies within the EU, including transit. Exceptions include the transportation of pharmaceutical, medical, agricultural products, and humanitarian aid. Finally, there is a ban on the imports of Russian coal.

The European Commission believes that together with the four previous sets of sanctions, the new one will increase economic pressure on Russia to undermine its ability to fund the military operation in Ukraine. "These measures are broader and sharper, and they hit the Russian economy even deeper. They are agreed with international partners," the European Commission said in a statement on the fifth sanctions package.

Embargo on coal supplies from Russia will start in August 2022. This will allow the parties to complete long-term contracts and European countries to find alternative suppliers. Moreover, the ban excludes the possibility of reselling these products through third countries.

In fact, Russia provides 54% of coal imports of the EU, which, according to the Council of Europe, reaches €8 billion.

In 2021, Russia increased supplies to Europe by 10.3%, to 50.4 million tonnes. With a total production of 438.4 million tonnes, the overall volume of Russian coal exports in 2021 was 227 million tonnes, of which 129 million tonnes went to the Asia-Pacific region.

Until mid-August, Russian companies will be able to export coal to the EU under existing contracts; spot purchases will cease immediately after the sanctions. At the same time, according to Reuters, most of the existing contracts for Russian coal supplies are short-term and will expire within 90 days, thus avoiding legal risks.

Following the US and the EU, Japan has also decided to stop importing Russian coal. "We will gradually reduce imports while looking for alternative exporters. As a result, we want to put an end to coal imports from Russia," Japanese Minister for Economy, Trade and Industry, Koichi Hagiuda, said on 8 April.

Russia accounts for about 11% of Japan’s coal imports. According to the US Energy Information Administration, Japan imports almost all the coal it consumes, making it the third largest importer after India and China.

Market reaction

Introduction of the new EU sanctions package against Russia has pushed up coal prices.

According to ICE Futures Europe, April coal futures in Newcastle, Australia, jumped to $281 per tonne on April 5 (three days before the official release of the new EU sanctions package), the biggest increase in almost two weeks. Analysts believe that prices will continue to rise as European consumers intensify their search for alternatives.

Growing electricity demand and a shortage of new coal supplies will keep prices rising, believes David Lennox, a commodity analyst at Fat Prophets in Sydney.

Representatives of Indonesia's coal industry, which is the world's leading supplier of steam coal, said the buyers from European nations, including Italy, Spain, Poland and Germany, contact them since the EU ban on Russian coal supplies. However, it is unclear whether suppliers will be able to increase exports, as they have limited spare capacity and must prioritise local demand.

Coal producers in Australia, another key exporter, said their ability to increase sales in Europe was limited.

"Lack of investment in new capacities and relatively strong demand in Asia prevents the market from filling any shortfall emerging from declining Russian exports," analysts with Australia & New Zealand Banking Group Ltd said. They said Russia accounted for about 18% of global coal exports in 2020.

European utilities and traders are likely to increase imports from South Africa, Colombia, the US and even Australia, according to a Morgan Stanley report. It notes that "reconfiguring global trade flows in such a scenario would take time and increase costs".

Russian government believes that the EU's ban on Russian coal supplies will hurt Europeans first and foremost - the products of Russian coal companies will be reoriented to alternative markets amid the EU's refusal to import from Russia.

However, according to analysts, this is not an easy task either.

The Financial Times cites an unnamed source in a major Russian producer, claiming that Russian coal miners have long promoted the idea of increasing the railway throughput capacity for eastbound transportation of coal, but the existing infrastructure remains unprepared to take on the necessary volumes.

Analysts at Renaissance Capital believe that reallocating supplies of more than 50 million tonnes of coal could be a challenge for Russia, given that the state-run Rossiyskie Zhelezniye Dorogi has downgraded its priority in favour of transporting other commodities.

Gas controversies

Meanwhile, this fifth package of EU sanctions against Russia does not include the even more anticipated embargo on Russian oil and gas, which Ukraine insists on for well-known reasons. However, EU leaders promise that this decision is only a matter of time.

"I think we will also need to take measures on oil and even gas sooner or later," European Council President Charles Michel told the European Parliament on April 6.

The Bruegel think tank in Brussels estimates that EU countries pay about €380m daily for Russian gas and about €360m for oil. Critics insist that Brussels thus indirectly participates in financing Russia's war in Ukraine.

MEPs have called for an immediate embargo on gas, oil, coal and nuclear fuel imports from Russia in response to the deaths of civilians in Bucha, Ukraine. "The European Parliament calls for an immediate and complete embargo on imports of Russian oil, coal, nuclear fuel and gas, a complete rejection of Nord Stream 1 and Nord Stream 2, and a plan to secure EU energy supplies in the short term," reads the resolution adopted at a plenary session in Strasbourg on April 7. The amendments were voted for by 413 MEPs.

The EU considers it possible to phase out oil from Russia within a year. As for gas, the EU countries have a long way to go to reach a common position on the issue. So far, harsh criticism has been voiced against Germany, Austria and Hungary as the main opponents of an immediate and complete rejection of gas supplies from Russia.

"Austria does not support an embargo on gas or oil supplies from Russia to Europe," Austrian Chancellor Karl Nehammer said. He stressed that Vienna is heavily dependent on Russian energy supplies, with the issue of gas supplies in the country being very relevant. "Therefore, we categorically reject any ideas calling for stopping imports of Russian gas or oil," the Austrian chancellor said.

Hungarian Prime Minister Viktor Orban explicitly stated that he was not going to follow the US example, as the embargo on Russian energy resources would be an unbearable burden for the country. Moreover, Budapest even agrees to Moscow's terms on payments for gas in the Russian national currency. "We have no problems with payment in roubles. If the Russians ask for it, we will pay in roubles," Orban said.

Italy relies on Azerbaijan

Italy has decided to go its own way and find an alternative to Russian gas. Thus, the country relies on Azerbaijan and Algeria. By the way, the gas cooperation issue was one of the key issues discussed during the Italian Foreign Minister Luigi di Maio's visit to Baku on April 2. 

It is known that with the completion of the Southern Gas Corridor project, Azerbaijan has become an important supplier of gas to Italy being the third largest exporter of gas to the country. In addition, Italy is the number one buyer of Azerbaijani oil.

In 2021, gas supplies from Azerbaijan to Italy reached 7bcm. But Azerbaijan promises that this year the supplies "will be even larger" reaching 9.5bcm under long-term and spot contracts, according to Azerbaijan’s Ministry of Energy.

During his meeting with the Italian minister, President of Azerbaijan Ilham Aliyev said that new opportunities were opening up between the two countries in energy cooperation. "Azerbaijan is Italy's main trade partner in the South Caucasus, as 95% of Italy's trade with the South Caucasus is with Azerbaijan. We have very good figures — almost $10 billion last year. I am sure that this year this figure will increase thanks to the growth of Azerbaijani gas supplies to Italy," Mr. Aliyev said.

On his return home and apparently satisfied with the results of his visit to Azerbaijan, Luigi Maio assured his European colleagues that the Italian authorities had no intention of blocking possible sanctions against Russian gas supplies. "Italy will not use its right of veto against the sanctions on Russian gas supplies," Mr. Maio said during meetings with his colleagues from Croatia and Slovenia.

As for Algeria, on April 12 Italy concluded an agreement with the country to increase gas purchases from Algeria by about 40%. Italian energy giant Eni has agreed with Algerian Sonatrach to gradually increase transportation through the Transmed pipeline, starting this year and reaching 9bcm of additional annual gas supplies by 2023-2024.

Decisive action

Meanwhile, dissatisfaction with Western European policies pushes Eastern European and Baltic leaders to take more decisive action against Russian energy resources.

Latvia was the first EU nation to announce on April 2 that it had refused to import Russian natural gas. The next day it was followed by the rest of the Baltic states (Lithuania and Estonia).

Also, Polish authorities announced that they planned to completely abandon imports of Russian coal as early as April or May 2022. In addition, Warsaw intends to make every effort to live without Russian oil completely by the end of 2022. "Today we are presenting the most radical plan in Europe to do away with Russian hydrocarbons - Russian oil, gas and coal. This plan is necessary to rebuild Europe," Polish Prime Minister Mateusz Morawiecki said of his country’s plans.

"We encourage everyone, Germany and other Western European states, to stop receiving these energy resources from Russia," Morawiecki added.

Incidentally, following President Vladimir Putin's discouraging decision to switch gas supply contracts to unfriendly countries from euros and dollars to roubles, the Kremlin clarified the mechanism of future settlements. Bank of Russia has already developed a new gas payment scheme, which will still make it possible for the Western countries to buy Russian gas in foreign currency. To do this, they will have to open accounts with Gazprombank, which will convert the foreign currency into roubles.

By the way, since the recent adoption of the fifth package of EU sanctions against Russia, EU foreign ministers in Brussels have already started discussing the sixth package, which, according to Lithuanian Foreign Minister Gabrielius Landsbergis, will include "a clause on oil". However, it is unknown what kind of restrictions the new package will include.

Josep Borrell, EU High Representative for Foreign Affairs and Security Policy, said it was necessary to distinguish between oil and gas. Brussels notes that in 2021, oil imports to the EU were four times more expensive than gas imports. The EU intention with new sanctions is to start with oil, which is easier to replace. In other words, the choice of victim in the new sanctions package to affect Russian energy resources is quite obvious.