The Big Picture

All-Out Energy War

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  • Western sanctions against Russia have escalated into an all-out energy war, as Moscow uses supply as a key tool to hit back.

  • Sporadic disruptions in Russian gas supply are becoming more entrenched, and now seem likely to spill over into oil as the West ratchets up its sanctions.

  • Raising the stakes is an intense producer-consumer struggle over control of the market and the energy sector’s trajectory.

Western sanctions on Russia after its Feb. 24 invasion of Ukraine were swift and sharp but initially steered clear of Russian energy exports, for fear of shocking the global economy. That plan is quickly unravelling, however, as the two sides engage in steady escalation. Gas supplies to Europe have become precarious, and oil disruptions look increasingly likely as sanctions pressures intensify.

Brussels initially set out an ambitious plan to cut its prewar reliance on Russian gas of 150 billion cubic meters per year, but without any specific sanctions. No such plan immediately emerged for oil. Even sanctions against Russia’s central bank were undertaken with the aim of keeping oil and gas flowing, by making export revenues more critical to Moscow.

Those early positions were unable to survive the realities of war. On gas, Europe proved naïve in thinking it could wean itself off Russian supply at its own pace, without recrimination. Moscow beat Brussels to the punch by restricting or cutting pipeline gas flows — spiking prices and plunging Europe into an energy crisis. Then, oil supplies fell foul of the emotions of war. After reports of civilian killings emerged in early April, the EU announced an oil embargo, albeit with start dates — Dec. 5 for crude and Feb. 5 for products — allowing it time to prepare.

The cycle of escalation continued. A parallel European ban on shipping insurance and financial services stoked US fears of a major supply disruption and price hike, prompting plans for a G7-backed price cap on Russian oil designed to keep supplies flowing. Moscow is now starting to fight back, and will likely use the same playbook as for gas — tapering oil supply to the market as it, not the West, sees fit.

Opec-plus’ decision this week to cut supply by 100,000 barrels per day was prompted to some extent by annoyance with the West’s interference — via stock releases, sanctions and price caps — in oil markets. Going forward, Moscow seems likely to subtly use its influence in the producer group to exert market pressure, while also deploying tactical cut-offs of oil supply — directly or indirectly. As with gas, these would squeeze the West with higher prices, supply crises and economic pressures, without hitting Russia’s own income too hard near-term.

Gas Weapon Playbook

The gas market is a good guide for what to expect in oil markets as sanctions tighten. Looking back, the linkage is clear: Moscow has squeezed pipeline gas supplies to Europe in reaction to growing Western pressure. Gazprom’s move to cut Nord Stream flows to 40% of normal levels in June coincided with a high-profile visit to Kyiv on Jun. 16 by the German, French and Italian leaders as the EU advanced talks for Ukraine to join the EU.

The next cut in Nord Stream supply, to 20% of normal flows, came in late July, as the EU was pushing ahead with a 15% voluntary reduction in gas consumption. Most recently, Gazprom’s Sep. 2 announcement of an indefinite complete halt to Nord Stream flows came hours after the G7 agreed to proceed with a price cap plan for Russian oil.

Russia’s next turn of the ratchet, as the EU pursues a plan also to impose a price cap on Russian gas imports, could be to further limit supplies via Ukraine. Dmitry Medvedev, deputy chair of Russia’s national security council and a former president, threatened such a cut-off last week, saying "there will simply be no Russian gas in Europe." This week, Russian President Vladimir Putin upped the ante, saying Russia won’t supply anything if that's not in its economic interests: “We will supply neither gas nor oil, nor coal, nor fuel oil.”

Oil Squeeze to Follow?

The gas cut-offs mean that Russia's pledge to halt oil supplies to those participating in an oil price cap scheme should be taken seriously. The oil price cap revolves around blocking tankers carrying Russian crude and products from obtaining maritime insurance and financial services from G7 countries unless their cargoes are priced under a certain level. The West’s dominance of the shipping sector in theory gives the plan heft.

Moscow is unlikely to accept this lying down. Firstly, it will look for workarounds. Energy Minister Nikolai Shulginov said Tuesday that Russia is talking to shippers about using insurance companies from friendly countries or setting up a new national insurance company in Russia — although sources say both options are at initial stages. Shulginov also noted a 140,000 b/d increase in crude export capacity through the Pacific Ocean port of Kozmino by October.

Still, analysts believe the potential for disruption to oil markets is significant. Consultancy Macro-Advisory put the potential loss to the market at 2 million b/d of crude from the EU ban alone. Product shipments are seen as facing a bigger pinchpoint.

This leads to Russia’s second option, retaliation. Targeted measures seem more likely than a fullscale export halt. Market expectations are Druzhba pipeline flows to central Europe, now at some 800,000 b/d, won’t face a full cut-off given both EU exemptions granted to Hungary, Slovakia and the Czech Republic, and Russia’s revenue needs. But a squeeze on those flows, to raise prices and rattle EU unity, is still possible.

Seaborne exports could also be in play, including in the run-up to the cap, although G7 member Japan hasn't taken Russian crude since April, and possible price cap supporter South Korea takes little. But restricting shipments to the market more broadly — even to "friendly" countries — would bring price gains to Moscow, and more pain for the global economy.

Moscow also has other oil market levers. Its hand is already apparent in some disruptions — chiefly the repeated closures of Kazakhstan’s main export route on Russia’s Black Sea coast. It can influence the Iran nuclear talks as a signatory, potentially throwing a wrench in the works, as it did in March. And it can tap into strong relationships to influence Opec-plus’ deliberations.

Traders are generally loath to project any price impact from Russian retaliation, although some bullish forecasters see prices rising by $20-$25/bbl for every 1 million b/d loss of supply. But more disruption, volatility and uncertainty seem certain in oil markets in the coming months, as both sides continue to ratchet up the stakes on Ukraine.

For more coverage of the Ukraine crisis, visit Ukraine Crisis: Energy Impact >

Policy and Regulation, Oil Supply, Oil Prices, Sanctions, Gas Supply, Gas Prices, Ukraine Crisis
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