Could Russia act first to stop oil exports to Europe?

In the end, Russia has more to gain politically than Europe from an embargo.

While the EU discusses (with varying success) the possible parameters of an embargo on Russian oil, Moscow is using a respite to regroup and prepare for further steps. Although it is widely believed that its European energy exports are the last thing Russia will give up, the protracted conflict in Ukraine and the extension of Western sanctions increase the likelihood that Moscow will take the first step in this direction.

After all, manipulation of energy supplies is Russia’s most powerful weapon to pressure Europe. Moscow has already halted gas supplies to Bulgaria, Poland and Finland after refusing its request to start paying for supplies in roubles. He also imposed sanctions on Gazprom’s European subsidiaries.

Russia is the largest exporter of petroleum and petroleum products to the EU, supplying 2.2 million barrels per day of petroleum and 1.2 million barrels per day of petroleum products, according to the International Agency for energy (IEA). EU foreign affairs chief Josep Borrell estimated that oil exports bring Moscow $1 billion a day.

The United States and the United Kingdom announced in March that they would stop buying Russian oil (it is true that Russia did not account for a large part of their energy imports) and called on European countries to follow their example. Various expert groups have offered their own plans for an embargo: a phased approach, or the imposition of special tariffs or escrow accounts.

In early May, the European Commission announced a sixth sanctions package, including a ban on the import of Russian oil. Brussels, however, is still unable to garner unanimous approval for the package. The EU is likely to significantly ease the embargo, exempting pipeline deliveries.

It is obvious that even if the “special military operation” in Ukraine ended tomorrow, it would be impossible for Russia to renew its old relations with Europe, including on the commercial level. And so Moscow might decide to start by cutting off Europe’s oil supply, resigning itself to significant but not insurmountable losses. This could happen in the near future, or in the fall, before the start of the heating season.

Paradoxically, the expansive Western sanctions supposed to deprive the Kremlin of the means to finance its war contribute, at least for the moment, to fill the coffers of the State. Sanctions have increased the ability of the Russian budget to overcome declines in foreign exchange earnings, as there are few opportunities to spend foreign currency: the mass exodus of Western companies has led to a drastic reduction in imported goods. A series of easing of currency restrictions for the public and exporters hasn’t helped much: there’s still nowhere to spend foreign currency due to supply chain issues and corporate pushback. Westerners to work with Russian companies.

Meanwhile, high energy prices brought an additional 800 billion rubles ($13.6 billion) to the state budget in the first two months of the military operation, according to the Finance Ministry . Overall, oil and gas revenues doubled in January-April to 4.77 trillion rubles from 2.5 trillion in the same period a year earlier. Most of the revenue came from mining taxes and export duties on oil and gas.

The Russian government has suspended fiscal rules for 2022, meaning all oil and gas revenues are being spent instead of being put into reserves. This makes it possible to compensate for declines in income in other sectors, and to find liquidity to support the population and businesses. The combination of existing ruble reserves and high energy prices will allow the government to maintain social spending at current levels for at least a year or two. No one can predict what will happen beyond this horizon.

At the same time, some EU countries are particularly vulnerable to losing access to Russian oil supplies. Last year, Slovakia imported 96% of its oil (105,000 barrels per day, or bpd) from Russia, Hungary imported 58% of its total (70,000 bpd), and the Czech Republic imported half of its total (68,000 bpd) from Russia. Other EU countries are less dependent on Russian oil, but oil prices are one of the main drivers of European inflation.

If Moscow stops supplying oil to Europe in the near future, it will theoretically be possible to find substitutes, but much will depend on the willingness of OPEC countries to rapidly increase production, as well as the costs of freight and deadweight tonnage available on tankers. Finding substitutes could therefore take several months to several years.

At the same time, Russia could still sell oil for foreign currency to other buyers outside Europe. In March, Russia increased its supplies to India and China: up to 310,000 bpd to India (against few supplies in February), and from 70,000 bpd to 790,000 bpd /d to China, according to the IEA. In the same month, supplies to Europe fell by 420,000 bpd to 1.4m bpd in March, meaning Russia essentially shifted its lost European volumes to Asia. This process should continue, since the current high oil prices allow Moscow to offer its Asian buyers deep discounts.

However, Russia does not have all the cards in hand. In April, due to boycotts and sanctions, Russian oil production fell by nearly 1 million b/d. During the same month, oil transport to Europe increased to 1.6 million b/d (compared to 1.4 million in March). The main recipients of petroleum oil in Europe are Germany, the Netherlands and Italy. According to Kpler, Italy imported four times more oil in May than in February (450,000 bpd). Therefore, Europe has some oil reserves, while for Russia, stopping exports would mean further reducing production, closing oil wells and increasing transport costs: the diversion of such large volumes of oil inevitably makes raise freight prices.

If a Russian oil embargo is introduced, the economic losses for Russia and Europe will depend on how quickly it is introduced, how long it lasts and how OPEC countries react. In the end, Russia has more to gain politically than Europe.

European politicians will have to deal with several pressing tasks simultaneously: searching for alternative suppliers, explaining rising prices to voters and softening the blow of the embargo for the EU countries most dependent on Russian oil. Given that all of this will happen as the fighting in Ukraine continues, there will be a strong push to negotiate with the Kremlin.

Russia, for its part, will likely invoke arms deliveries to Ukraine to explain the embargo, thus sending a signal that the flow of oil will resume as soon as Ukraine stops receiving Western weapons. In other words, Moscow can get what it wants: a tough negotiating position on sanctions that excludes Ukraine from the dialogue.

An energy war between Russia and Europe would accelerate global inflation, exacerbate the global food crisis and raise the prices of energy-intensive goods to new levels. Russian authorities are well aware that there is no going back to the good old days of relations with Europe, but they can ensure that it is not just Russia that suffers. Every step Moscow has taken so far in the conflict with the West has followed the logic of escalation, and for now there is no reason to believe that this logic will change. Not only is there nothing left to lose now, but the number of supporters of drastic measures within the Russian government increases with each new round of sanctions.

By:

Mary I. Bruner