What's Driving Moscow's New Gas Payment System

Russia fired off a warning shot when it cut gas supplies to Poland and Bulgaria on Apr. 27 after the two countries refused to comply with Moscow’s demand for European companies to pay in rubles. Now, European gas buyers worry they could be next, given Brussels' view that Moscow's new payment system breaches EU sanctions. Proposed EU sanctions on Russian crude and products make aspects of EU-Russian energy trade even more politically sensitive.

• Russia’s new two-step payment system puts transaction risk, and contract risk, on the European gas buyer.

Moscow has expanded on what it meant by its Mar. 31 decree demanding European companies pay in rubles for gas under long-term supply contracts. European companies are to open two bank accounts in Gazprombank — one in the currency stipulated in the contracts (euros or dollars) and another in rubles. What occurs later is less clear. But in theory, the European company pays in euros or dollars. Gazprombank then exchanges this into rubles, by borrowing from Russia’s central bank and then depositing the funds into the company’s ruble account.

The problem for European gas buyers arises out of the different positions as to when the gas payment is finalized. To European firms, the transaction finishes when it pays in the contract’s stipulated currency, usually euros or dollars. But for the Russian side, the transaction is completed when the ruble payment is transferred into the ruble account. To the EU, this currency transaction is seen as breaching sanctions on Russia's central bank.

Contract sanctity is also at issue. According to Brussels-based think tank Bruegel, the rubles conversion puts the counterparty risk solely on the European gas buyer’s side, as the difference in timing could constitute a breach of contract. And if Gazprombank charges an exchange rate fee for the transaction, this will likely be subtracted from the transferred funds, which Bruegel says could also constitute a contract breach.

Bulgaria's experience highlights the uncertainty. After state Bulgargaz made its monthly payment for Russian gas in dollars, Gazprom returned the transferred money and effectively halted flows to Bulgaria the following day.

• The payment system seems aimed at protecting Russia from strict interpretations of existing sanctions, or from future sanctions.

Given the importance of gas flows from Russia, current EU sanctions do not target this trade — meaning Gazprombank, the key bank processing contractual gas payments, remains sanctions-free. But Moscow likely expects EU sanctions to tighten, and with good reason: Russian coal was hit in later EU sanctions packages, and the EU's latest proposed sanctions include the anticipated oil embargo and blocking Sberbank, Russia's biggest bank, from the Swift global payments system.

The thinking in Moscow could be that through its two-step payment method, Russian entities bypass sanctions and could potentially access euros and dollars if sanctions — or interpretations of existing central bank sanctions — are expanded in the future.

“We are not sure what is the interpretation from the European Commission of the regulation, but if currently, euros and dollars are still accessible, they could become inaccessible if the interpretation was tightened,” Bruegel senior fellow Francesco Papadia tells Energy Intelligence. “Payment in rubles obviates the problem because the Central Bank of Russia would not need to touch euros and dollars but only rubles.”

Russia insists it doesn’t want to trade in euros and dollars, discredited in its view by Western financial sanctions against Russia. But the Kremlin will still receive the same amount of euros and dollars from gas buyers and only then convert them into rubles. The payment mechanism in itself does not protect Gazprombank from any future sanctions. Nor does the scheme provide any significant support to the ruble rate either, because Gazprom was already obliged to sell 80% of its foreign-currency revenue anyway.

For Moscow, the biggest win could be political, including by sowing division within Europe over its sanctions regime — should uncertainty about payments and possible cutoffs prompt some European gas buyers to do Moscow's bidding and open rubles accounts — or simply by keeping Europe off balance, and in a reactive mode. Cutoff fears possibly causing prices to spike would also be to Moscow's benefit.

• The EU now says complying with Moscow’s demands constitutes a breach of sanctions but hasn't explained how firms should pay, leaving European gas buyers confused.

The EU is trying to save face by not acquiescing to Moscow’s gas cutoff threats while also proposing a phased EU oil embargo that would halt imports of Russian crude within six months and of products by year's end. But no gas embargo is yet being considered, and Brussels said last month that the payments system might be permissible under certain conditions.

After an extraordinary EU energy ministers meeting on May 2 held that the new payment scheme would breach EU sanctions, EU Energy Commissioner Kadri Simson said the European Commission would give further detailed compliance guidance. She added that Brussels was not aware of any European companies having opened ruble accounts. European gas companies have denied media reports of opening and even paying into some ruble accounts already. Two firms, Austria's OMV and Germany's Uniper, say they are discussing or pursuing sanctions-compliant payment methods.

For Brussels, the intent to hold a firm line on Russia is likely also driving its position. Given the EU view that the payment system would infringe EU sanctions, the understanding of Bruegel's Papadia is that the commission "does not limit itself to a formal interpretation of the sanctions, that, in our view, would be respected with the new payment method, but looks at the substance."

• Poland and Bulgaria's supply cutoff has heightened uncertainty as to who could be next.

The next round of contract payments for large European gas buyers such as Uniper come due at the end of May for volumes delivered in April. Europe’s two largest gas buyers, Germany and Italy, say they will not comply with Moscow’s new ruble payment rules but warn that a supply cutoff would make it difficult to prepare for the upcoming winter season. The EU on May 2 did not agree any measures to prevent or cope with further disruptions.

After Poland and Bulgaria's cutoff, fears are that Gazprom could target other contracts that expire this year. This amounts to a combined additional 11.9 Bcm/yr worth of contracts held by Italy’s Edison, the Netherland's Gasterra and Slovenia’s Geoplinwill, according to consultancy Energy Aspects. Gazprom’s now German-controlled subsidiaries could also be vulnerable.