29 July 2022

Russia counterattacks in its economic war with the West

Moscow is exploiting the only significant leverage it has over European economies: energy.

BERLIN – Since February, the West has waged what amounts to economic warfare on Russia, using what the political theorists Henry Farrell and Abraham Newman have called “weaponised interdependence” between countries in a globalised world.

Western sanctions imposed on Russia in retaliation for the invasion of Ukraine have been among the most far-reaching in recent history. Fitch, a credit ratings agency, forecasts that the Russian economy will contract 12.5 per cent this year as a result, which would be the country’s largest recession since 1994.

Now Russia is counterattacking, using virtually the only sector where Western countries significantly depend on it: energy.

In 2021 fuel represented the vast majority – 62 per cent – of the value of goods exported from Russia to the EU. Russia is exploiting that reliance. Exports of natural gas from Russia to Germany via the Nord Stream 1 pipeline have been running at just 20 per cent of capacity since Wednesday 27 July. Gazprom, the Russian state-owned energy giant, officially blames problems with a Siemens gas turbine at a compressor station. The EU views this as a spurious pretext for Moscow to exert political pressure on the European countries which depend on imports of Russian gas for a significant part of their energy, Germany chief among them.

“The West has started an economic war against Russia, for entirely justifiable reasons,” Mark Galeotti, an expert on Russian politics and policy, said. “Now Russia is fighting back.”

European countries usually use the warm summer months to refill natural gas in storage before demand increases as the weather cools. If flows remain low, Europe will enter the winter with too little gas in storage to make it through the cold months without rationing, most experts believe. Storage across the EU is collectively about 67.5 per cent full, according to data compiled by Gas Infrastructure Europe. The EU’s target is 80 per cent by November, but some member states have set higher targets. Germany aims for its storage to be 95 per cent full by November, up from about 67 per cent currently.

The EU views a total shutdown of Russian exports of natural gas to Europe as likely. Brussels has accordingly brokered a plan for every member state to aim for a 15 per cent reduction in gas consumption, with certain exemptions for the island countries Ireland, Malta and Cyprus. The plan has been accepted by every member state bar Hungary, whose prime minister is the Kremlin-friendly Viktor Orbán, but not without some grumbling from countries less reliant on Russian energy such as Spain and Portugal, which view it as primarily serving Germany’s interests.

If Russia were to end deliveries of gas to Europe, the German economy would be hit especially hard. A rationing plan set out by the government would first limit industry’s consumption of energy, to keep supply to households and essential public services uninterrupted. Industry accounts for 30 per cent of German gas consumption, according to figures from the consulting firm Enerdata, with power generation taking up a further 21 per cent. The economic damage of a gas shortage would be severe. UBS, the Swiss bank, foresees a complete shutdown triggering a recession of almost 6 per cent in Europe’s largest economy, with ripple effects throughout the EU.

“Russia is seeking to put pressure on the Europeans in general, and the Germans in particular, with the prospect of economic damage harming social cohesion within countries and the overall cohesion of the Western alliance,” Galeotti said.

Galeotti added that Moscow’s decision to severely limit gas flows under implausible technical pretexts, rather than completely cutting off deliveries, allows it to dangle the prospect of fully restarting supplies if certain conditions are met, increasing its leverage over European countries.

Russia is able to absorb the cost of cutting deliveries to Europe for two reasons. The first is that gas only accounts for about 2 per cent of Russia’s GDP, according to the World Bank, less than half of the share of oil. The second is that the supply crunch largely instigated by Russia has caused European gas prices to spike, meaning a windfall for the Kremlin even as much lower volumes are delivered. Dutch TTF gas futures, the benchmark price for European gas, are currently at over €200 per megawatt hour, a nearly threefold increase on the pre-invasion price of about €71.

In the short term gas delivered by pipeline from Russia cannot be replaced by other sources. A combination of imports of liquefied natural gas and additional energy generation from coal and nuclear can only make up part of the shortfall, said Tara Connolly, senior gas campaigner at Global Witness, a human rights NGO. “We’re going to have to swallow some uncomfortable policies to get through the winter in Europe,” Connolly said, adding that governments will ultimately need to implement measures to reduce demand for energy.

Some governments have announced a series of modest energy-saving measures. Germany has banned heating private swimming pools during the winter and has suspended minimum temperature requirements in rented homes. Robert Habeck, the economy minister, has said he is taking shorter, colder showers and has encouraged his fellow citizens to do the same.

Yet the relatively restrained messages from politicians do not reflect the reality of how difficult the coming winter may be, said Simone Tagliapietra, a senior fellow at Bruegel, an economic think tank. “So far, governments have been able to neglect the issue and avoid telling citizens the truth. I still don’t see prime ministers, presidents and chancellors clearly saying that we are going into the worst possible energy crisis.”