Economic sanctions: after foreign exchange reserves, oil and gas?

The intensification of the conflict in Ukraine caused a new rise in energy prices, and Russia’s gas and oil exports were not subject to economic sanctions. Expanding sanctions to the energy sector will mean a sharp curtailment of energy demand through coordinated action by all developed countries. Without such action, Europe would remain defensive against Moscow and extended sanctions would soon oppose its proponents.

Economic sanctions on Russia have escalated as measures have been taken to isolate the central bank and limit access to the Swift network by Russian banks. They will reduce the ability to use the cushion of foreign exchange reserves, which will cause a decline in the rubles of the forex market and disrupt all commerce in the country.

Vulnerability of Russian economy

Gazprombank and Suburbank, through which most of the energy export settlements go, are not separated from Swift. The energy sector is largely unaffected by sanctions. However, it is Russia’s economic and financial lung and the world’s leading exporter of gas and oil (including condensate and processed petroleum products).

The other side of the coin is that the Russian economy is not very diversified. Energy products (oil and derivatives, gas, coal, electricity) account for almost two-thirds of the country’s exports and provide 40% of the federal budget. Acting directly on these receipts would have a far greater impact on a country’s economic and militant capacity.

Under the current economic and energy structure, these export-oriented retaliation measures do not work. To make matters worse, it is possible to oppose the promoter by strengthening the originally intended target.

Double-edged weapon

Indeed, European countries are Russia’s major customers and may delay or suspend their purchases in order to block some of Russia’s physical deliveries. In such cases, short-term alternatives cannot be found in the global market due to the limited transport capacity of gas and petroleum products. In that case, the price of hydrocarbons will rise over time and sanctions may be taken against its promoters.

The European Union, which imported just under 40% of gas from Russia in 2021, will be the first to be punished. Russia can compensate for the decline in western deliveries by increasing the value of hydrocarbons exported to other countries. In this kind of situation, price movements are much more pronounced than quantity movements, so you will definitely be the winner. The major uncertainty in such a scenario is the attitude of other Russian gas customers, including China, but China has limited physical capacity to increase purchases.

Westerners are afraid that this weapon will be used by Putin in the event of a stalemate in the conflict. This fear is shared by European gas market operators who are experiencing intense tensions. The weapon was already tested in 2021 and gas transport to the European Union has been curtailed since the summer. This had a double effect. Soaring gas prices in Europe and low inventories to survive the winter. As a precautionary measure, Kremlin strategists have taken care to increase the vulnerability of Western Europe, even before crossing the Ukrainian border. If he renews operations in 2022, Western Europe will face the lowest reserves next winter.

The urgency of cooperative action to curb energy demand

Can Europeans protect themselves from such risks?Bluegel Analysis Center(1) I ran the first gas simulation. The message is clear. To deal with all situations, Europe must act on supply and demand at the same time. On the supply side, the problem is to develop a series of measures to find short-term alternatives to imported gas. This is not enough because we do not have the time to make the necessary investments. To effectively hedge, you need to act on demand by simultaneously saving or distributing energy. The plan proposed by the International Energy Agency on March 3 to reduce Europe’s dependence on gas also proposes measures that affect both supply and demand.

Given the multiple interconnections between energy markets, such a strategy will bear fruit much faster if on-demand behavior is shared by all developed countries. Large importers can immediately ease their purchases through efforts to save energy (Japan, South Korea). Exporters can free up their export capacity by reducing domestic consumption (US, Canada, Australia).

Such actions could be organized in the name of climate action with the support of the International Energy Agency, which centralizes information on energy flows and recommends such actions in all its decarbonization scenarios. I have. Rather than distributing distribution cards to all consumers, it is about agreeing on short-term goals for reducing end demand in major countries and setting up monitoring mechanisms. That way, countries can mobilize or constrain citizens and businesses to maintain their freedom in ways that reduce their ultimate energy demand at the lowest cost.

Unrealistic, such energy countershock organized on the demand side? Still, if we want to weaken Russia’s economic power, it is a weapon that must be installed without delay before it goes against us.