Russia Sanctions Impact: How sanctions are hurting the West more than Russia, and why it is good news for India – The Economic Times

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SynopsisRussia is frequently halting gas supplies to the EU through Nord Stream 1. As EU reels from skyrocketing energy prices, Russia’s gas revenues went up by 85% to USD100 billion. Meanwhile, India is saving valuable forex, as its oil import from Russia, at a big discount, has gone up from a puny 2% to 13%.

Every war has its cost. Economic, humanitarian, et al.

After Vladimir Putin marched into Ukraine on February 24, 2022, the West hit back almost immediately and imposed stringent sanctions on RussiaPutin retaliated by shutting down all pipelines carrying Russian gas to the West.

The prediction was that the Russian economy would collapse. While Putin may have suffered some setbacks in the war, looks like he has won the first round of the economic battle. By frequently halting gas supplies through its Nord Stream 1, Russia is now having an upper hand in sanctioning the West.

The pipeline is owned and operated by Nord Stream AG, which has Russian state-owned company Gazprom as its majority shareholder. Nord Stream 1 is the key pipeline that runs through Belarus and Poland and delivers gas to Germany and other European nations. It runs 1,200km under the Baltic Sea from the Russian coast near St Petersburg to north-eastern Germany. Since it began operations in 2011, the pipeline was being used to send a maximum of 170 million cubic metres of gas per day from Russia to Germany.

Germany had built another parallel pipeline, Nord Stream 2, at a cost of USD11 billion to double gas flow. The pipeline was completed last September but with the Russian invasion of Ukraine, it is now completely frozen.

This brings us to some pertinent questions:

  • What will happen if Russia cuts off its gas supplies to Europe completely?
  • How is the Russian economy holding up?
  • And where does India feature in the scheme of things?

What if Putin stops the entire gas supply to Europe?
Russia now accounts for 9% of the EU’s gas imports, down from 40% before the war. While the European Commission believes it can manage the risk of a total shutdown, it is certain that European countries won’t be able to skip the immediate disruptions. Germany is the most vulnerable because of its climate-focused push to get rid of coal-fired power stations. The tremors would also be felt in Slovakia, Austria, and parts of Italy.

Europe is on the brink of a recession. The growth engines of the EU, the largest economies — France, Germany, Italy, and Spain — are all facing a slowdown. International rating agencies have downgraded their growth prospects. On an average, there has already been a 30% hike in energy prices since the beginning of the year, and this is expected to double as winter approaches. Although the UK imports little gas from Russia, gas prices are set globally and are now around 450% higher than they were at this time last year.

While shutting its major gas supplies to Europe, Gazprom said it was for routine maintenance, and would be restored in a few days. However, it has now been said there are major leaks that need to be fixed. This could result in an indefinite shutdown of the pipeline.

According to Bloomberg energy data, power spot prices across Western Europe have climbed to unparalleled levels. The daily average prices have traded above EUR600 (USD599) per megawatt-hour (MWh) in Germany and above EUR700 per MWh in France, with peak-hour spikes as high as EUR1,500 per MWh. There is now a risk of even higher prices during the winter as Russia has halted all gas exports through Nord Stream 1 for an indefinite period.

European countries don’t buy the Russian story of pipeline ‘leaks’. They believe this is the next stage of Russia upping the ante against the western alliance, already reeling from an energy crisis.

Rystad Energy, independent energy research and business intelligence firm, in its report, has mentioned that nuclear and hydropower generation in the EU have dropped 14% and 25% year-on-year, respectively, erasing 110 terawatt-hours (TWh) of electricity supply from the grid. “This has been compensated by higher wind, coal, solar and gas generation. Overall, gas-power generation has grown 6% year-on-year to reach 39.1 TWh in July. Things will get even more challenging towards the end of the year as seasonal electricity demand increases – electricity consumption in December is normally 25% higher than in July, meaning that European consumption could reach more than 280 TWh per month,” the report noted.

“The coming winter is certain to be the most challenging Europe has seen in decades – and consumers or governments are expected to pay the price. If gas demand needs to be cut, we expect to see power supply issues emerging this month and worsening into 2023,” says Carlos Torres Diaz, head of power at Rystad Energy.

What does it mean for the Russian economy, Gazprom?
In the beginning of the Ukraine war, western countries tried to teach Russia’s USD1.8 trillion economy a lesson. Half of Russia’s USD580 billion currency reserves remain frozen. Most of its big banks are cut off from the global payments system SWIFT (Society for Worldwide Interbank Financial Telecommunication).

The US no longer buys Russian oil, and the European embargo will come fully into effect from February 2023.

This will shrink Russia’s GDP by 6% in 2022, the IMF expected, much better than the 15% drop many expected. Energy sales will generate a current account surplus of USD265 billion this year, the world’s second largest after China.

On the other hand, Gazprom has maintained steady revenues from gas sales as soaring prices have compensated for its decision to cut supplies to Europe.

The Kremlin this week said it would keep the Nord Stream 1 pipeline shut if the West maintained economic sanctions. This means Gazprom is now delivering about 84 million cubic metres per day of gas to Europe via Ukraine and Turkey, down from an average of 480 million cubic meters per day last year.

“It makes for a solid case that Gazprom will earn more from supplying less gas.”

— Ron Smith, oil and gas analyst at BCS Global Markets

According to Ron Smith, oil and gas analyst at BCS Global Markets, an investment-banking service provider, “The reduction in supplies is expected to push this year’s prices up threefold on average compared with 2021, helping Russia increase total revenues by 85% to USD100 billion.”

Last year, Gazprom exported gas to Europe and Turkey at an average price of USD310 per cubic meter and mopped up gross export revenue of USD54 billion. Smith estimates that over the whole of 2022, the company will supply 43% less volumes but at an average price of USD1,000 per cubic meter.

“It makes for a solid case that Gazprom will earn more from supplying less gas,” Smith adds.

What does it mean for India?
Even as Europe is reeling from a reduced gas supply from Russia, countries like India are relatively better in terms of access to Russian oil and other commodities.

In a meeting last week, the members of G7 countries – the UK, the US, Canada, France, Germany, Italy, and Japan – proposed to put a price cap on Russian oil. It also invited India to join the club. India imports more than 85% of its oil and gas requirements.

Elizabeth Rosenberg, assistant secretary at the US Treasury said, “India will have access to a lower price of affordable energy (Russian oil). It can leverage the price cap to negotiate a lower price with Russia. It is consistent with a price cap. We will not allow Russia to profit and get a war premium for invading Ukraine.”

But India has always maintained that it would continue to import Russian oil at discounted prices that would benefit its country. In fact, India’s share of Russian oil import has gone up from a puny 2% to 13% post the invasion. This helped New Delhi reduce its import bill.

Kremlin reacted to the G7 call and said it would stop selling oil to countries that will impose any price cap. If Russia stops its supplies, crude oil and gas prices will skyrocket.

The recent developments on the Russia-Ukraine front as well as a series of rate hikes, along with other measures by the US Fed, have helped the commodity prices to cool down. Prices of precious metals, basic materials as well as agricultural commodities have fallen significantly in recent weeks.

The Bloomberg Commodity Index is down nearly 17% from its all-time high recorded in March this year. For commodity importers like India, where nearly three-fourth of the inflation is driven by external factors including costlier imports, this provides a major relief.

Steel, aluminum, zinc, as well as fertilisers and agro commodities are now trading sharply below their all-time highs recorded this year. Gold and silver are also down 20%-30% from their peak.

The prices of edible oils, an important food commodity in India’s import basket, have also dipped. In May, Indonesia lifted its exports ban within three weeks of imposing it and supplies of sunflower oil from Ukraine have also eased.

The bottom line
Can EU manage without Russian gas?

Well, that will be a tall order although it has been slowly building up alternative sources. It is building its own energy systems with heavy investments in liquified natural gas (LNG) and plenty of idle capacity. According to Citigroup estimates, with historical utilisation rates for those plants running at 50% of capacity or less, the region can in theory handle enough to replace nearly two-thirds of Russian piped gas imports.

JPMorgan Chase predicts that “even without a Russian gas cut-off, Europe will spend some USD1 trillion on energy this year, up from USD500 billion in 2019. If the region were forced to consume its gas stocks to survive a Russian cut-off, it would then have to spend even more during summer frantically rebuilding its reserves to avoid an energy crisis next winter.”

The war between Russia and Ukraine is not only bleeding the two countries, but also the entire world. What will make immense economic sense if the West rethinks its approach towards Russia instead of isolating it with sanctions?

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