There is a good chance that Russian gas supplies will be severed in the coming weeks. Europe will pay a very high price if it seeks to buy off Vladimir Putin.
On July 21 we will know whether Russia is beginning to turn off the gas taps to Europe. On that day, scheduled maintenance work on the Nord Stream gas pipeline end, and transit through the pipeline is scheduled to resume.
While Reuters has reported that the shipment of gas will begin again as planned — albeit at a reduced level — there are also signs suggesting the opposite, or at least of a substantial break. On July 14 Gazprom invoked a force majeure clause on European gas sales, quoting “extraordinary” circumstances. Even Hungary, whose government is probably the last in Europe still to profess the reliability of Russian gas supplies, is working up contingency plans, including buying more gas through the TurkStream pipeline and even on the open market.
Meanwhile, the European Union (EU) agreed to a seventh sanctions package against Russia. But amidst a heat wave now driving up energy consumption and putting pressure on liquefied natural gas (LNG) prices, further hindering gas inventory rebuilding before the winter, there is little appetite for a gas embargo. This leaves the decision of whether — or when — to switch off the gas in the hands of the Kremlin. It could happen now, in a week, or as the fall sets in.
While oil sales represent a significantly bigger source of revenue for Russia than gas, the difference has been shrinking in past months as gas prices skyrocketed and Russian oil has been selling at a discount. The Independent Commodity Intelligence Services estimated Russian gas revenue at €35bn ($36bn) in the first four months of the war, even as Russia reduced or turned off deliveries to 12 European countries. The government is intent on scooping a large part of this jackpot into its coffers, capturing $22.2bn of extra revenue this year with a windfall tax. Thus, turning off the taps completely is not without costs, but since Russia ran a $138bn current account surplus in the first half of this year — due in large part to collapsing imports — it may not be overly worried about losing dollars that it cannot spend.
If Russia does turn off gas deliveries to most of Europe — either on July 21 or thereafter — it will mean one of two things: that the Russian government has decided that it cannot avoid the long-term costs of such a step, because the EU is working hard to abandon the use of Russian gas; or that it does not anticipate any long-term costs from this decision, i.e., it expects to be able to return to business as usual in the foreseeable future. This would make a world of difference.
Russian policymaking is adrift. The measures taken by the government to stabilize the economy have so far amounted to firefighting and are devoid of strategic vision. Certain priorities — such as military equipment production or the development of transit routes to Asia — are visible, but do not rest on solid economic pillars. There are vague plans for import substitution and “technological sovereignty”, which try to improve on earlier schemes that have largely failed, and often shatter when they meet economic reality. Domestic economic policy is hurtling towards dirigisme, but this is institutional inertia rather than a carefully thought-out concept. The federal budget was cut by 1.6trn rubles ($22bn), but it is unclear if this is going to be enough to stabilize finances.
The greatest uncertainty concerns time frames. Russia remains an economy that first and foremost redistributes oil and gas rent. While the share of oil and gas revenue in the federal budget was only 36% in June, energy industries also impact other revenues by generating demand for goods and services. The overwhelming majority of regional budgets, which finance essential functions such as health care, education, and housing, are heavily subsidized from the revenue the federal budget extracts from energy-rich regions. Regional budgets are expected to turn into a deficit from next year on, regardless of budgetary transfers, which may have to be cut as the federal budget itself is expected to accumulate a deficit of 6trn rubles in 2022-24.
As the outlook for the cash cow industries worsens, so does the fiscal outlook for the federal government and regions alike, especially as spending on the military is ramped up. It is one thing for Russia to consider bearing the short-term costs of lost energy revenues for a set period of time, especially when it is awash with the hard currency it cannot spend. It is quite another to abandon the prospect of returning to the steady flow of revenues for the foreseeable future.
While cash reserves enable Russia to pay for its war of aggression for months and possibly years to come, the worsening outlook will, if time frames shift, require major and lasting adjustments in the economy, including recalibrating an export infrastructure that has been built for Western markets. This will take years: the Power of Siberia 2 gas pipeline, which is expected to connect west- and east-oriented gas export pipelines, for instance, is not expected to break ground before 2024. The future of grand LNG projects is increasingly uncertain as investors abandon them, often taking their technological know-how with them.
Nothing yet suggests that the government or the political and business elite are ready to face a radical long-term readjustment, and it is difficult to foresee what kind of tension such changes would cause in the elite and the population. Those who have spoken up about Russia’s approaching economic reckonings, such as Herman Gref, the head of Sberbank, or Sergey Chemezov, the head of the state technology corporation Rostec, sounded less like those describing plausible policy choices and more like technocrats pleading for help. And meanwhile, the misguided notion that if the Kremlin halts its war of choice before the end of summer, the economy will somehow “normalize”, is still very much present in discussions, even in politically neutral circles.
Thus it really matters how the EU reacts to Russian energy threats. Offering concessions in exchange for gas flows would not only kick the can down the road: it would give the impression to all parties concerned that blackmail works, and reassure Russia’s political and business elite that the costs of a protracted war are bearable, even in the long term.
Instead, EU leaders should do two things to radically change the cost-benefit scenario for Russia.
- First, they should accept the severance of Russian gas flows as the baseline scenario; prepare their industries and public opinion accordingly; work on an EU-level solution to pool energy resources; strengthen the cyber defense of critical infrastructure facilities; and coordinate imports with the goal of replacing Russian gas deliveries completely in the coming two years.
- Second, they should ramp up the delivery of military equipment to Ukraine — above all, long-range artillery weapons, which have proven very effective so far — allowing it to mount a counter-offensive against Russian occupiers in the summer as Russia’s military struggles with logistical problems.
Resounding Ukrainian victories in the coming weeks would simultaneously help justify the cost of defying Russia’s energy blackmail among citizens who are still inclined to support Ukraine, but are frustrated and concerned about the effects of a long, stalled war.
András Tóth-Czifra is a Non-Resident Fellow at the Center for European Policy Analysis. He is a political analyst from Hungary, based in New York City.
Photo: A view shows a screen with the logo of Gazprom at the St. Petersburg International Economic Forum (SPIEF) in Saint Petersburg, Russia June 17, 2022. Credit: REUTERS/Anton Vaganov
July 20, 2022