Russia, US Tension Raises Energy Cutoff Fears

Russia has warned the West that the introduction of new US sanctions if it attacks Ukraine would prompt a complete break in relations.

Global security risks apart, such a scenario would also have a serious impact on Russia's economy and global energy markets.

The Russian stock market has already lost more than 20%, the biggest collapse since the beginning of the Covid-19 pandemic, on Western reports about a looming military conflict in Ukraine and the subsequent sanctions. Russia's major RTS and Moex indexes dropped by about 7% on Jan. 18 alone even though already-high oil prices were heading up to $90 per barrel.

Moscow has repeated several times it has no plans to invade Ukraine but the US Democrats introduced a new bill last week called the Defending Ukraine Security Act, that would require the president to impose sanctions on financial institutions and Russian officials, including President Vladimir Putin and members of the cabinet, in the event of "a renewed invasion or escalation of hostilities."

Russian Foreign Minister Sergei Lavrov in a telephone conversation with US Secretary of State Antony Blinken
this week said there was a need to end the "speculations about Russian aggression being allegedly prepared against Ukraine, but rather make the Kiev regime fully fulfill the Minsk agreements."

The sides remain far apart following last week's Russia-US and Russia-Nato talks on security guarantees. The West refused to accept Moscow's demand to block Nato's eastward expansion, including to former Soviet states, particularly Ukraine and Georgia, and to withdraw from countries that joined Nato after May 1997.

Russia, in turn, said it would not discuss the removal of its troops from its western borders, noting that they remain on Russia's sovereign territory. Adding to the tension, Russia and Belarus this week announced new military exercises to train the fast deployment of forces.

Raised Stakes

The Defending Ukraine Security Act would target Russia's major banks and sovereign debt and would authorize sanctions on providers of specialized financial messaging services, such as Swift.

The bill also requires the US president to identify and sanction sectors in the interest of US national security, including oil and gas extraction and production.

The document specifically says that Nord Stream 2 "is a tool of malign influence of the Russian Federation," and that the US should consider "all available and appropriate measures to prevent the pipeline from becoming operational," directing the administration to review its prior waiver of the pipe.

"Naturally, this is unpleasant but nevertheless, it's not a catastrophe," Russian Finance Minister Anatoly Siluanov was quoted as saying last week. "I suppose our financial institutions would manage if such dangers emerge," he said.

Sberbank Chairman German Gref said the state-controlled bank is ready for any scenario.

Indeed, Russia is better prepared for financial sanctions now. It has been growing its gold and hard currency reserves which reached $630.6 billion at the beginning of this year. The share of US dollars in those reserves went down to about 16% in the middle of 2021, according to the latest available data from the Russian Central Bank, thanks to Russia's de-dollarization efforts. In the past the US currency's share in Russia's international reserves amounted to nearly 50%.

Foreigners now hold only 20% of Russia's sovereign debt following an earlier US ban on buying newly issued bonds. In preparation for possible disconnection from Swift, Moscow revealed plans last year to stop using the US dollar as a reserve currency in its rainy day National Welfare Fund, which is being swelled by receipts from higher oil prices.

A Swift disconnection is seen by analysts as the last measure to be taken since it would also undermine trade with Russia and payments for its goods, which are critical for Europe and the US, including oil and gas, mineral fertilizers, titanium and others.

Although Russia is better prepared and potentially more resilient, the extra sanctions would be painful and lead to capital outflow, a shrinking of credit financing and a slowdown of the economy, analysts say.

Oil, Gas Implications

Russian energy companies have been silent on possible sanctions but a ban on purchases of Russian oil and gas is seen by experts as unlikely since Europe relies heavily on them. Russia accounts for about 40% of Europe's gas imports, while Russian oil's share amounts to about 30%. The Russian budget is still highly dependent on oil and gas sales which under current extremely high prices could only help to grow the state coffers further.

The Europeans, on the other hand, are worried about a possible cutoff of Russian gas supplies in the event of conflict in Ukraine. Russian gas transit to Europe has remained mostly uninterrupted for years despite varying degrees of conflict between Moscow and Kiev. The last time flows were interrupted was in the 2008/09 winter gas crisis, but during the most recent military escalation in 2014, transit flows remained stable despite cutoffs of direct sales to Ukraine. However, Ukraine's transit role has reduced significantly over the past decade, and Europe has more alternative routes to get its hands on Russian gas.