Russia Gas Blackmail: Putin Brings Knife Into Shootout | Business and economy

On Wednesday, Russian President Vladimir Putin escalated the geo-economic war between his country and the West by suspending gas supplies to Poland and Bulgaria, citing the two countries’ refusal to pay in Russian rubles.

This decision, decried by the West as “blackmail”, once again demonstrated Putin’s conviction that Russia’s status as a raw materials exporter will allow him to resist and counter the crippling sanctions imposed on its economy since its invasion of Ukraine.

In reality, however, Putin’s decision amounts to bringing a knife to a shootout.

The decision to suspend gas supplies to two European nations will not only fail to strengthen the Russian economy, but it will significantly increase the Kremlin’s long-term economic losses.

But to understand why Putin’s decision will not produce the desired result, we must first examine his motives.

Sanctions have deprived Russia of foreign exchange reserves worth hundreds of billions of dollars, Russian imports are collapsing amid restrictions on dual use and IT technologies, and Western companies are pulling out of Russia or s self-sanction by refusing to sell goods there.

Putin, however, still seems to feel like he can win the economic war waged over his invasion of Ukraine. At first glance, there seems to be a reason for the confidence displayed by the Russian state: the ruble has more than recovered its pre-sanctions value, hitting a two-year high against the euro on April 27, and Russia is once again increasing its foreign currency holdings amid sky-high oil prices.

All this, of course, contradicts the real state of the Russian economy. First, the disruptions to supply chains caused by the sanctions are crippling Russia’s production capacities. In March, for example, there was a whopping 72% drop in passenger car production in the country. The Kremlin is also almost certain to formally default on its foreign debts in the coming days, which will make it extremely difficult to finance any future reconstruction of the economy. Moreover, Russian wealth abroad is increasingly under threat, and the much-celebrated recovery in the exchange rate has only been achieved through extreme capital controls.

Russia’s Central Bank and Putin’s advisers to the finance and economy ministries know that the ruble maintaining its value depends largely on hydrocarbon prices and the Russian state’s continued control over trade. They are also wary of the amount of ruble liquidity which has already diminished in light of the existing sanctions against the Russian banking system. As Putin’s brutal war on Ukraine continues, sanctions are set to expand. Washington has warned that it could still completely cut off ruble convertibility and that there is no significant western demand for rubles.

This is precisely why Putin ordered European gas companies to pay in rubles for the natural gas they buy from Russia. Gas payments in local currency would leave the window open for ruble convertibility – something the Kremlin desperately needs given that oil prices are unlikely to remain so high permanently.

Right now, the global financial system runs on the US dollar, and the Kremlin is aware of that. But as Russia’s Security Council Secretary Nikolai Patrushev said in an interview with state media on April 26, Russia is now working to create a “double-loop monetary and financial system.” in which the ruble would be backed by both gold and commodities “to bring the ruble exchange rate in line with real purchasing power parity”. Russia forcing Europe to pay for gas in rubles n is only part of this major plan.

But there is little reason to believe this plan is working – with or without ruble payments for gas from Europe.

The Soviet Union tried to do this before – including a brief period of “ruble-gold” in the early 1920s – and, for all its ideological fervor, failed to make it work. The attempt is far less likely to succeed in Putin’s ideologically bereft state.

Putin is militarizing his country’s gas supply and foregoing the profits that could be made by selling locally to Poland and Bulgaria – which have refused to renew contracts – to demonstrate the seriousness of his demand for the rouble.

Some European gas companies have already capitulated – four European gas companies have reportedly already made payments in rubles and others are set to do so, including Italy’s ENI, despite warnings from the European Union.

It could be considered a Russian victory. But even if EU unity crumbles on the issue and gas payments ensure ruble convertibility remains in place for now, Putin is overplaying his hand.

Moscow had received praise for acting less overtly political in European supply and price markets ahead of its invasion of Ukraine. He witnessed beneficial European reforms, arbitration court decisions and market liberalization. The Nord Stream 2 Baltic Sea pipeline project, intended to double the flow of Russian gas directly to Germany, was underway.

However, Russian aggression in Ukraine changed all that, and Berlin canceled the pipeline project in response to Russia’s recognition of its proxies in Donetsk and Luhansk on the eve of the invasion.

Of course, Europe will remain dependent on Russian gas for at least one to two years. But Putin’s actions have already spurred the search for alternatives – including the Baltic pipeline linking Norway and Poland which is expected to be put up for tender later this year. All of this will only accelerate in light of its decision to suspend gas supplies to Poland and Bulgaria, which has definitively put an end to the idea that Russia will not militarize its gas exports.

The EU could increase its LNG imports from sources other than Russia by almost 70 billion cubic meters this year, more than 40% of what it received from Russia. Maximizing production in the Dutch Groningen gas fields and working with Azerbaijan and Algeria (as well as Turkey and Morocco, through which key gas pipelines pass) could do more to fill the gap.

Before the war in Ukraine, Europe had little incentive to rapidly reduce its dependence on Russian gas. But Putin’s own actions — first the illegal invasion of Ukraine, then the overt militarization of gas exports — created the political will to tackle the problem.

Putin teaches Europeans that interdependence between Russia and the West has failed as a strategy. But its economy remains a one-trick pony, dependent on commodities and forced to respond to sanctions rather than deliver its own serious blows.

A lesson for Putin can be found in what is known as “Healey’s Law” (named after Denis Healey, the British Chancellor who himself experienced the difficulty of resetting a country’s finances when he negotiated an IMF bailout in 1976): “Follow the hole rule; if you’re one, stop digging.

As for Europe, Healey’s Law contains a corollary that applies: “When your opponent is in a hole, why would you want to take his shovel away from him?”

Putin may have won a short-term victory, but he is digging the grave for the Russian economy.

The opinions expressed in this article are those of the author and do not necessarily reflect the editorial position of Al Jazeera.

About Dwayne Wakefield

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