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AMBROSE EVANS-PRITCHARD. 13 July 2022 •
Vladimir Putin has prepared the ground for a drastic cut in supplies of both oil and gas at any moment, giving him the means to strike a psychological hammer blow against the Western democracies before a global recession erodes his energy leverage.
The coming weeks may be his best chance to try to force the West to the table on Russian strategic terms, locking in territorial gains on Ukraine’s Black Sea coast and in the Donbass before the delivery of heavy weapons from NATO raises the military cost for Russia to excruciating levels.
Mr Putin spelled out his operating premise at the St. Petersburg International Economic Forum in late June, calling the EU’s sanctions policy a double-edged sword that would cause Europe to lose its footing in the global economy and lead to a “system-wide decline” for years to come. He left no doubt that generating inflation in the West is a primary goal.
“This will aggravate the deep-seated problems of European societies. There will be a further growth of inequality, which will split their societies still more. Such a disconnect from reality will inevitably lead to a surge in populism and extremist and radical movements,” he said.
Last Friday, Mr Putin seemed to cock the gun for something more extreme, broadcasting his purpose in a staged meeting with officials: “Further use of sanctions may lead to even more severe – without exaggeration, even catastrophic – consequences on the global energy market,” he said.
European leaders have been formulating policy in a parallel universe, discussing unenforceable schemes for a $40-$60 price cap on Russian exports of crude, supposedly with extraterritorial reach into Asian markets. The false assumption – breathtaking in its serial fallacies – is that the Kremlin needs the money and will oblige meekly.
It supposes that Mr Putin will allow the EU to reduce its dependence on Russian fossil fuels in an orderly fashion and on its own leisurely timetable, even as several EU member states cross the line in Ukraine from engaged neutrals to something closer to co-belligerents. “We think Russia will seek to make Europe’s energy detox plan as debilitating as possible,” said Helima Croft from RBC Capital.
Vladimir Milov, Russia’s former vice-minister of energy, said Europe’s decision to stop purchases of Russian seaborne crude by the end of the year has brought matters to a head.
The talk within the Kremlin apparatus is that Russia must now take preemptive action, exploiting its energy lockhold to stop EU states rebuilding natural gas stocks before winter. “It is highly likely that no more gas at all is going to be flowing. The Russian leadership knows just how vulnerable Europe is,” he said.
The risk of a total halt to Russian gas supply is by now well-understood. Not a single Gazprom molecule has been flowing to Europe through the Yamal pipeline via Poland for six weeks. Flows through Nord Stream 1 via the Baltic have been running at 40pc of capacity since mid-June. They dropped to zero this week for ten days of scheduled maintenance.
Europe’s leaders strongly suspect that the Kremlin will concoct a pretext to keep Nord Stream 1 closed at the end of inspections on July 21 – the next red-letter day for the global economy. France’s finance minister Bruno Le Maire warned on Sunday that a “total cut-off” is more likely than not.
Germany’s Green vice-chancellor Robert Habeck is preparing to activate his country’s stage three “emergency” plan, with gas rationing for heavy industries. “Anything could happen,” he said.
Goldman Sachs estimates that the eurozone would contract by up to 2.7pc if the gas stops flowing, with GDP potentially falling by 3.2pc in Germany and 4.1pc in Italy. The first talk of an EU “energy bail-out” for Germany and Italy has begun. Others will be expected to share their scarce gas reserves – in other words, to do what Germany did not do with PPE kit at the start of the pandemic. This will be fractious.
What is less explored is what would happen if Mr Putin triggers a full-blown oil shock on top of the gas squeeze order to push the cost of living crisis to breaking point.
It is widely assumed that he would not play the oil card because the import revenue is too valuable – worth $700m a day, viz $400m for gas – and because crude is too fungible a commodity on global markets for targeted use against Europe. But this overlooks the internal structure of the Russian economy, and may underestimate Mr Putin’s willingness to create maximum havoc as an instrument of foreign policy.
Natasha Kaneva and Ted Hall at JP Morgan think the Kremlin may be seriously tempted to try. They argue that Russia could halve its total output temporarily and starve the world of up to five million barrels a day – 5pc of global supply – without doing lasting damage to its drilling infrastructure, or suffering an intolerable economic hit. They estimate that a shock and awe squeeze of this magnitude would drive prices to $380 a barrel, levels that would bring the global economy to a shuddering halt.
The more likely calibration is a cut of three million barrels a day. This would lift Brent to $190, still high enough to blast through the all-time record of $148 in mid-2008. “The tightness of the global oil market is on Russia’s side and strong public finances could absorb the revenue losses without too much difficulty,” they said.
Hopes have fizzled for a nuclear deal with Iran that would free up a million barrels a day of global supply. President Joe Biden is trying to coax more crude from Saudi Arabia but even the Kingdom is running out of spare capacity. The rest of OPEC is 2.5 million barrels short of production targets. The stars are aligned for Mr Putin to strike a quick knock-out blow.
Halting production is a technical headache. The longer that wells are left idle, the greater the damage from pressure and rising water content, above all in the declining Soviet fields of Western Siberia where permafrost is melting. Marginal wells might never recover. However, JP Morgan thinks Russia could cut several million barrels a day for a few months by rotating wells and by “throttling” wells to reduce output.
There is no immediate financial constraint. Russia’s National Wellbeing Fund has $116bn set aside in usable money. The treasury’s cash balance is a further $85bn. Together this is enough to cover a total loss of budget revenues from fossil fuel exports for almost a year, perhaps longer than Europe’s comfortable societies can endure the pain. Russia would be exchanging lower volumes for higher prices in any case, so it might not lose that much revenue.
Furthermore, Western sanctions against the central bank are creating a perverse incentive for the Kremlin to escalate. Russia is currently awash with more fossil fuel revenues than it can handle, unable to sterilise a current account surplus of 20pc of GDP by accumulating foreign reserves.
The result is a surging rouble, currently at an eight-year high against the euro. There is little that the Kremlin can do about this other than pushing through fiscal stimulus packages and imploring consumers to spend more on imports.
Mr Putin has good reason to think that Germany will throw Ukraine under a bus if the pressure is great enough. Berlin is currently blocking the release of €9bn of EU financial aid to Ukraine that was already agreed by the 27 states, ostensibly because it objects to the method of joint debt issuance.
Berlin has just violated the EU’s sanctions regime by strong-arming Canada into handing over a pipeline turbine in hopes that this will restore flows on the Nord Stream 1 pipeline. The Canadians obliged, with a delay and barely concealed disgust. Volodymyr Zelensky recalled his ambassador from Berlin.
The Kremlin must of course weigh large geostrategic matters. China has so far tolerated a global gas shock since it still relies largely on domestic coal for power. But as the world’s biggest importer of oil, it would be more than a collateral casualty if oil prices double or triple again.
Mr Putin likes to blow smoke in our faces, keeping us permanently off-balance. He may decide that the gas weapon alone is enough. But as former White House Russia guru Fiona Hill likes to put it: if you think he won’t do something beyond the pale, “yes, he will”.
This article is an extract from The Telegraph’s Economic Intelligence newsletter. Sign up here to get exclusive insight from two of the UK’s leading economic commentators – Ambrose Evans-Pritchard and Jeremy Warner – delivered direct to your inbox every Tuesday.