On the whole, European and US leaders are continuing to make a very poor showing of the situation they instigated with Russia. The Biden Administration decided to seize $300 billion of Russian foreign exchange reserves, overconfident that they would crater the Russian economy. Ironically, however, the sanctions greatly reduced the Russian need for foreign exchange for trade, since respectable US and European companies took it upon themselves to stop or limit exports to Russia. And Russian banks don’t fund in dollars or euros (in contrast with the 1990s, when the economy was significantly dollarized). And the world still needs Russian oil, gas, metals, you name it.
So after an initial shock and awe plunge, the rouble is very close to its highs versus the dollar over the last two years…despite the dollar being at its highest level against major currencies in the last 20 years. From XE:
And Russia energy revenues have been fine, thank you very much:
Since the beginning of war in #Ukraine, #Russia has doubled its revenues from sale of fossil fuels to #EU. Even with overall decline in these sales rising energy prices have earned #Moscow about €62 billion, according to #Finnish Center for Energy and Clean Air Research CREA. pic.twitter.com/DuVkEA68Jc
— NEXTA (@nexta_tv) April 28, 2022
Russia projected a budget surplus before this crisis and its government income will be even higher due to the increase in energy revenues. Prime Minister Mikhail Mishustin told the Duma in early April that all receipts would now be spent into the economy. As you can see from the embedded document below, the government is embarking on more investment, loan discount, and tax relief programs. But Russia spent decades having to be a good budget-balancing-surplus running economy because (per above) it was significantly dollarized and had to look fiscally responsible to support the value of the rouble. Russia will suffer a serious recession, not just due to adaptation to having to produce even more internally, but also due to not being willing to run deficits when it is now able to operate as a fiat currency issuer.
And even though the real economy shock has yet to fully manifest itself, the Russian top team is doing what it can to get in front of those issues, and they’ve also been warning the public that a second phase of difficulties is in the offing, which they expect to be the most acute starting soon and for the following six months.
In other words, Russia managed the initial financial shock vastly better than the US and Europe imagined was possible. That leaves the West with the big problem that Russia can and is pushing back. It is telling that only very mild Russian counter-sanctions are putting Europe on tilt.
The US and even more so Europe look to be hoist on their own sanctions petard. Yet they’ll be damned if they’ll formally walk back, even though there’s a lot of fudging going on.
To recap: Putin announced its so-called “gas for roubles” program late last month, with details to follow. The reasoning was simple: Russia had just had $300 billion of what amounted to payment on past commodities exports stolen. It was not going to have payments on its gas exports to “unfriendly” countries subject to being clawed back again. The only way to assure that was to get payments in rouble, since rouble payment and clearing is under the control of the Russian Central Bank.
As we anticipated, Russia implemented pretty much the only version that would respect Putin’s boundary conditions, which included adhering to the terms of current contracts.1 So all that really changed was that gas buyers would have to set up accounts at Gazprom Bank, which was not sanctioned.2
Russia did not make this requirement effective until the next payments were due, and the earliest were the end of April..
If you take the war out of the picture, this matter would otherwise be a pretty routine commercial dispute: “You stiffed me on some (actually really big) payments. Rather than argue about that, I’m requiring a minor change in payment arrangements to prevent that from happening.”
But the screeching from Europe was astonishing. You’d think they believed they had the right to have Russia send them gas for free.
Amusingly, EU national leaders except of Hungary said no to Russia. Italy and Germany, the two biggest importers, were particularly noisy. The European Commission supported that action by warning that the Russian mechanism would violate sanctions.
Then it appears everyone began to work out that there was no ready or even medium-term substitute for Russian gas, as we’ve discussed long form and won’t belabor now.
On top of that, bad economic news started coming in even before any Russian gas cutoff took place. Per Eurostat, “European Union annual inflation was 7.8% in March 2022, up from 6.2% in February. A year earlier, the rate was 1.7%”
Inflation in Italy hit a 26 year peak in February. Germany’s producer price index rose a stunning 30.9% year to year. Food prices were rising sharply and expected to get worse. From Food Institute:
Aldi Nord in Europe expects increases of 20 to 50 percent in its purchase prices this week, reported WDR (April 4)….
Increases were already in the double digits in February. Bread rolls and semi-hard cheese were up 7 and 4.7 percent respectively, while egg (+16.3), lettuce (+17.1), butter (+20.4), tomato (+27) and cucumber (+30.3) saw more substantial increases, according to the Federal Statistics Office of Germany.
And heating price increases are expected to be grim. Recall that Germany has a high rate of residential rentals due to strong tenant rights. From a Der Spiegel interview with CEO Rolf Buch, head of Volnovia, the largest residential landlord in Germany:
Spiegel: What price increase should gas consumers expect?
Buch: It’s hard to predict. One thing is certain: we all need to address this issue now. Those who don’t increase their utility bills will face high surcharges next year. For some, this can be up to two months’ rent.
A week ago, the European Commission reversed itself. But Poland, Bulgaria, and Finland are still saying no. So Russia is halting shipments to them, which has led to screeches of “blackmail” and promises of yet more sanctions. Russia is also not allowing syphoning off of transiting gas, which it tolerated when Ukraine did it. From CNBC on Wednesday:
Early Wednesday morning, Gazprom released a statement saying it had halted supplies to Poland and Bulgaria — both heavy consumers of Russian gas — due to payments not being made in the Russian currency. It said supplies would resume once these payments were made.
In the statement, Gazprom warned both countries against any “unauthorized withdrawal” of gas supplies flowing through their territories.
“Bulgaria and Poland are transit states. In case of unauthorized withdrawal of Russian gas from transit volumes to third countries, supplies for transit will be reduced by this volume.”
Only 6% of Finland’s energy comes from gas, so even though 65% of that is from Russia, Finland has said in early April it expected to be able to replace that by fall. But Poland is in a pickle. 18% of its total energy is gas and half is from Russia, plus 30% is oil, of which 2/3 is Russia-supplied. Poland at least has enough gas reserves to carry it through the winter. Bulgaria by contrast imports 73% of its gas from Russia and has much lower reserves.
Research firm Algebris argued that Gazprom customers would not have great odds of prevailing in court if they sued:
In case of an interruption in supply, European buyers would likely invoke a breach of contract – suing Gazprom for non-performance. It is however not clear whether such case would be successful. A recent commentary published by the Oxford Institute for Energy Studies suggests that by transferring the ultimate decision to terminate supply away from Gazprom (as a seller exercising its rights under the relevant gas contract) to the customs authority, the Decree strengthens Gazprom’s case to plead force majeure. If the customs authority ordered a stop of delivery to a client due to the payment not meeting the terms of the Decree, Gazprom could seek to be excused from liability for non-performance by arguing the stop had been imposed by an act of government. This gives Russia significant leverage to weaponize the uncertainty of gas supply to Europe.
1 The “additions” to the most bare bone implementation was to specify one Russian bank for deposit of payments, as opposed to any Russian bank chartered under XYZ law, and to require the buyer to order or have a standing order for his payment currency to be exchanged for roubles on the Russia Stock Exchange (note that no way, no how are there remotely enough roubles trading outside Russia to pay for gas large gas trades). The latter stipulation is apparently seen as an important precedent that Russia plans to require of other commodity buyers.
2 The UK had sanctioned Gazprom Bank with respect to capital markets activities, then slapped on new sanctions that would have prevented them from buying Russian gas, not that they did much anyhow. They have now partially walked them back, allowing UK companies to make payments to Gazprom Bank through May 31.