An energy embargo on Russia would hurt Europe as much as Russia

An energy embargo on Russia would hurt Europe as much as Russia
Europe is thinking about cutting off Russian gas, but can it afford to? / wiki
By Ben Aris in Berlin April 1, 2022

The West is threatening to impose an energy embargo on Russia. The EU has a plan to cut hydrocarbon imports from Russia to zero as soon as 2025 or maybe sooner if Russia scales up its attack on Ukraine. What effect would that have on the Russian economy?

The Institute of International Finance (IIF) has forecast that Russia’s economy would decline by 15% this year and another 3% next year under the existing extreme sanctions regime, but the contraction could be even worse if Europe halted all energy imports from its large neighbour to the east.

“The current crisis will wipe out fifteen years of economic development. Nonetheless, risks are clearly to the downside, with the war in Ukraine entering its second month and no resolution of the conflict in sight. Thus, additional sanctions, including potentially an embargo on Russian oil and natural gas exports, become more likely as time passes and evidence of attacks on civilians in Ukraine emerges,” Benjamin Hilgenstock and Elina Ribakova, economists at IIF, wrote in a paper on March 30.

Russia’s exports of crude oil and petroleum products, natural gas and coal are all in the EU’s crosshairs. Together they bring in significant amounts of money to the Russian budget.

The US has already banned imports of Russian oil and the UK is slated to phase out the same imports by the end of this year. However, energy analysts interviewed by bne IntelliNews believe these bans are largely symbolic. Russia makes up a very small share of US and UK imports, and they are easily redirected elsewhere and so the ban will make no difference to Russia’s revenue stream. However, the EU is a far larger market and if it turns off the spigots that will cause Russia a real headache.

“The EU, UK and the US account for close to 55% of Russia’s oil and petroleum product exports and more than 60% of natural gas exports, both in volume terms,” Hilgenstock and Ribakova said. “We estimate that a total embargo by the three economies would lead to a loss of roughly $120bn in oil and petroleum product receipts (at a Urals price of $80 per barrel) and around $145bn in natural gas receipts (at a price of $25/mmBtu). An embargo on coal exports, which has also been discussed, would be less impactful at around $15bn.”

Following a western ban Russia would try to redirect its oil, gas and coal to other markets, such as India and China, but the volumes are so much bigger that these markets would struggle to absorb the whole amount and what could be sold would be done at a deep discount. And in the case of gas Russia would not be able to sell any to other markets, as gas has to travel through pipelines and currently there are no pipelines connecting its giant Yamal gas reserves to Asia.

Despite the threat of an embargo on Russian hydrocarbons, European countries are reluctant to carry through on the threat, as it is next to impossible to replace Russian gas quickly with alternative energy supplies. Russia currently accounts for some 40% of Europe’s gas imports. Liquefied natural gas (LNG) is the obvious alternative source of gas because this young industry doesn't produce enough to replace the 155bn cubic metres of gas Europe imported from Russia last year. The US has said it could send an extra 15 bcm to Europe, but that amount would do little more than replace the LNG Russia also sends to Europe; Russia is also the biggest exporter of LNG to Europe.

“Political considerations aside, quickly replacing Russian oil and natural gas imports would certainly be an extremely difficult undertaking for Europe,” IIF said.

The share of Russia’s oil and gas in the energy mix for each of the EU member’s states is very different. The UK still produces its own gas and so barely imports any Russian gas, but it is the most heavily dependent on Russian oil imports from the European countries. On the flip side Czechia buys a low amount of Russian oil but it is entirely dependent on Russian gas to fuel its economy.

For countries like Czechia, Hungary, Slovakia, Romania, Germany and Poland, all of which import more than half their gas from Russia, it will be extremely difficult to switch to another source of energy and impossible to do so at short notice.

“Due to the geographic proximity, Russia’s role as Europe’s largest natural gas supplier has been well-established for decades. Dependence on the country is highest in Central and Eastern Europe, including the Czech Republic, Hungary, Poland, Romania and the Slovak Republic. With EU-wide reliance on Russian oil at 10% and on natural gas at close to 35%, an embargo on the latter would be a more complex undertaking,” IIF’s Hilgenstock and Ribakova said.

A short-term stoppage of Russian gas deliveries to Europe would cause chaos. Unable to source enough LNG, European countries would be forced to restart coal-fired power stations, which can immediately be fired up, reversing commitments to phase them out as part of the EU’s Green Deal and “Fit for 55” plan to reduce carbon emissions and endangering the EU’s plans to hit climate targets on time.

Restarting mothballed nuclear power plants (NPPs) is a lot harder, as it takes at least a year to start up an NPP once it has been decommissioned.

The other measure that western countries can take is to simply use less energy. That means turning down the thermostats, introducing “no drive days” for motorists, and asking industry to produce less.

“It's possible to switch and cut out Russian gas use, but it's a wartime mentality. It will be like the Berlin Luftbruecke all over again,” Christof Ruehl, Senior Research Scholar, Columbia University, and the former chief economist at BP told bne IntelliNews in a recent webcast.

If Russia cuts off gas to Europe overnight then gas prices will spike further from the already elevated levels. Earlier this year the cost of gas on the Dutch TTF gas hub that sets prices in Europe had already risen to 16 times its normal level, but could go higher without ensuring Russian gas filling up Europe’s storage tanks ahead of this year’s heating season that starts in October.

The resulting energy crisis would lead to ballooning energy bills and could result in rolling blackouts or brownouts, reducing economic output and putting both economic and political pressure on governments. The effects would be disproportionately painful for lower income families, where basics like utility bills make up a larger share of the household spend.

The EU is conflicted, as in February the bloc set a goal of filling Europe’s gas tanks to 80% full by October 1 to prepare for next winter, which means the EU should be buying as much gas as it can starting now as the 2021/2022 winter season ends. But at the same time, some EU members are demanding that Russian gas be blocked immediately.

“What they are saying is we should buy as much Russian gas as we can now to make sure we are comfortable to put us into a position where we can cut Russian gas off next year and punish Russia. And we are signalling this policy to Moscow trying to persuade us to help us carry it out,” Professor Barry Ickes told bne IntelliNews in an online interview.

Western European countries are already scrambling to meet the challenge. For example, Germany, which had supported and defended imports from Russia for years, is pushing for the construction of four LNG terminals with a total capacity of 50 bcm by 2025-26, IIF reports.

“The capacity is slightly below Germany’s current annual natural gas imports from Russia. Due to limitations regarding the European pipeline system’s ability to flexibly distribute natural gas, especially from Western European LNG terminals to Eastern European countries, a greater geographical distribution of terminals will be critical,” Hilgenstock and Ribakova said.