In its arm-wrestle with the EU, the clock is ticking for Russia
Russia's "short window of opportunity"
Putin’s decision to launch a “special military operation” in Ukraine stirred the ire of the West, which then decided to slap tough sanctions on Russia, with the aim of hamstringing its ability to support its financial system. As of today, the war in Ukraine still rages on, and regardless of what one might think of it or who is the most at fault, this is a riveting development for every international affairs’ enthusiast — even more so for the realists such as my dilettante self. What is unfolding before our eyes could be the onset of a rollback of the process of globalization and the termination of the unipolar “End of History”.
In reaction to the Western sanctions that cut some Russian banks off from SWIFT, froze assets of Russian tycoons and assets of the Central Bank of Russia, Putin signed a decree to create a ruble payment system for Russian gas exports toward countries deemed “unfriendly”. At first glance, this new “Gas for Rubles” payment scheme looked ambitious, accordingly with Russia’s unabashed desire to de-dollarize/euroize the world and to bring about a new multipolar order.
A Short-Term Bizarre Scheme
But after further clarification, it appears that this scheme could well be softer on the EU than what many had expected. EU countries will continue to pay in euros through Gazprombank which will try to convert these funds into rubles afterwards, by selling them on Russia’s domestic foreign exchange market.
Most noteworthy, the conversion will not be automatic and nowhere in the decree is there any obligation to provide rubles at the market exchange rate. If effectively converted, the payment in rubles will be sent to Gazprom and only then, will the supply contract be considered fulfilled !
However, it remains to be seen how hundreds of millions of euros could be converted into rubles every day. Without a steady supply of European goods to the Russian market, this scenario seems very unlikely because of the sanctions that have been imposed on Russia. Furthermore, if the Europeans can't sell their euros on the Moscow Exchange, they won't be able to pay for the gas and gas supplies will be cut off.
In so doing, Russia can effectively secure gas payments, rebuild a current account surplus that is immune to any Western theft and prop up the ruble — in the short term. The revenue will be huge, albeit smaller with every passing year and the powerful energy leverage that Russia has over Europe today will inevitably fade in the middle to long term.
Too Late To Stop The Chess Game
Putin has decided to embark upon a geopolitical tussle with the West and especially the EU. Backpedaling now would prove — in the end — an enormous boondoggle for the Russians. That’s why he cannot quit the chess game halfway after encountering the first setbacks.
From a sheer realist point of view, he cannot afford to miss out on the “short window of opportunity” that is presenting itself. Now is a good chance as the West is more vulnerable than ever. Western countries are currently engulfed by monstrous inflationary pressures and Europe is undergoing an energy crisis. This trump card happens once in a generation; the situation is unique in its nature and the composition of factors that develop in favor of Russia.
“Without Russian gas, there would come a virtual breakdown of our industrial networks”
~ Siegfried Russwurm, the president of the Federation of German Industries (BDI)
Inflation is tearing the debt markets, something that doesn’t get along with ballooning public debts and current account deficits. The debt market cannot exist in conditions of persistently negative real interest rates. By destroying the stability of the debt markets, it is possible to destroy the entire architecture of the sturdily built financial system — on top of which sit the US and its Western allies — and along with them, their economies. Without a single shot.
Developed countries do not have the tools and resources they used to have. They cannot increase budget deficits and cannot conduct a stimulus monetary policy. In the conditions of a devastating inflationary “blowout”, there is zero room for maneuver, and the demand for debt will be negative, i.e. more sales than purchases.
This means that companies and governments will be unable not only to fund new obligations, but also to service existing ones. This will change everything. Previously, this liquidity gap was closed by central banks through Quantitative Easing or QE, acting as a lender of last resort, but since March 2022, all QEs are being closed (the Fed, the Bank of England, the ECB, the Central Bank of Australia and Canada).
The debt markets don't like inflation. Russia has the leverage to destabilize world commodity markets and ratchet up prohibitive inflationary pressures. Now is just the perfect moment : QE is winding down, inflation in developed countries hit record high for half a century, colossal debt burdens, supply chain disruptions, astronomical bubbles and imbalances in the markets.
“Real-Time Market Monitoring Finds Signs of Brewing U.S. Housing Bubble”
~ Federal Reserve Bank of Dallas
A Carrot And Stick Approach In Dealing With The EU Will Imperil Russia’s Long-Term Interests
What if Gazprombank fails to convert the euros provided by European buyers into rubles ? Will the Kremlin have the political determination to carry out its threats ? Or will it falter and take the carrot instead of the stick ? Moscow must jettison its antiquated belief that Russia will be part of a “wider West” in the foreseeable future, and must remain adamant in its dealing with the EU.
The gas blackmail will probably not be an option in 2 to 3 years. The West will gradually abandon Russian energy resources and this reality must be accepted as irreversible. In 3 years, in 2025, not a single ton of coal will most likely be delivered to Europe from Russia. Likewise, the main consumer of oil is transport and there is a rapid rejection of combustion engines, a trend that has been going on for many years. Sooner or later, not a single barrel of oil from Russia will be delivered to Europe — due to lower consumption and diversification of supplies.
With gas, everything is more difficult, Europe's dependence of roughly 40% on Russia cannot be easily replaced, but every year the dependence will decrease, both by boosting LNG supplies and by reducing domestic consumption. In 2010-2015, gas consumption in Europe fell by 120 billion cubic meters, so reducing consumption by 70-80 billion cubic meters in 2 years from the current base is realistic. Even without the LNG factor, this is half of Russian supplies to the EU (155 billion cubic meters). US officials already agreed to supply the EU with an additional 15 billion cubic meters of liquified natural gas by the end of 2022.
Moreover, the US is now the main growing LNG market in the world, and the ability to replace gas supplies from Russia depends on the US. Net LNG exports began to grow from mid-2016, and according to updated data, by December 2021, the monthly volume of LNG exports is 9.5 billion cubic meters. This even exceeds the limits of US’ LNG infrastructure.
The Almighty LNG
If the December intensity is maintained, the US will become the world's main LNG exporter, ahead of Qatar and Australia, which now supply 105-110 billion cubic meters per year. US LNG exports have doubled since 2019 ! Europe’s plans to fast-track the construction of new LNG terminals — including floating ones — coupled with the US’ plans to aggressively ramp up LNG exports to Europe will inevitably offset imports from Russia.
All in all, the clock is ticking for Russia. When push comes to shove, Moscow cannot sit on the fence. Putin’s threats must prove more than just a mere saber-rattling if his true intentions were to upset and reshuffle the world order. Any realist would take advantage of the current situation to bring an entire continent to its knees. Hesitating, teetering and postponing, instead of taking a sledgehammer to Western economies pronto is a pathway for a game over.
Or Putin could force the Europeans into buying rubles against gold and expand payments in rubles to more Russian commodities’ exports.