Why Russia's Attempt To Use Energy As A Weapon Against Ukraine Has Backfired

The west has a sufficiently diversified economy that it was able to adapt quickly. Global warming reduced the impact of winter and technological upgrades in identifying and fixing energy systems offset the impact of Russian bombing in Ukraine. 

But Russia has been unable to overcome the EU embargo on its oil as well as the NATO-imposed price caps on its oil. And the willing buyers like China and India are demanding substantial price discounts. All of which has lessened Russia's use of oil, its primary economic asset, as an effective weapon. JL

Georgi Kantchev and Joe Wallace report in the Wall Street Journal:

Putin‘s use of energy as a weapon of financial war is backfiring, threatening the core of Russia’s beleaguered economy and curtailing its geopolitical influence. Russia’s bet to squeeze Europe by cutting off gas flows since last summer appears to have unraveled for now. Mild temperatures, brimming storage facilities and record imports of liquefied natural gas from the U.S. and elsewhere have helped Europe escape a serious energy shortage this winter. The Russian oil industry is having trouble adapting to a EU embargo and a U.S.-led price cap on its crude. A Kremlin threat to cut supplies in response failed to boost prices, showing Russia’s weakened hand.

Russian President Vladimir Putin‘s use of energy as a weapon of financial war is increasingly backfiring, threatening the core of Russia’s beleaguered economy and curtailing its geopolitical influence.

Western sanctions, falling prices for Russian fossil fuels and strategic miscalculations are hurting the country’s oil-and-gas industry while the war in Ukraine is poised to stretch into a second year. Ultimately, the strain will erode Moscow’s status as an energy superpower, according to analysts and former energy officials and executives.

Russia hoped cutting off natural gas would cause Europe to freeze and weaken its support for Kyiv, officials on the continent say. Warm weather and ample supplies from other producers have derailed that effort so far. European gas prices tumbled 15% Monday to levels last experienced in September 2021.

 

The Russian oil industry, meanwhile, is having trouble adapting to a European Union embargo and a U.S.-led price cap on its crude. A Kremlin threat to cut supplies in response failed to boost prices and hasn’t materialized, showing Russia’s weakened hand.

Russia has diverted much of the oil that went to Europe, but in doing so it has replaced an array of buyers with two big importers: China and India. Refiners there command low prices, in part because delivering farther afield raises shipping rates.

With gas, Russia needs to build huge pipelines eastward to sell all the fuel that used to head to Europe. That would take years. And in the long run, lost access to technology and Western know-how will likely undermine production potential as Soviet-era oil-and-gas fields dwindle.

All these issues will potentially be magnified when a fresh round of sanctions goes into effect next month.

“Because of sanctions, the Russian economy becomes ever more dependent on energy exports,” said Thane Gustafson, professor at Georgetown University and a historian of energy in Russia. “And when those themselves decline, the Russian economy’s ability to invest those…and its ability to modernize its legacy infrastructure [go] down.”

Russia’s earnings from fossil-fuel exports fell 17% in December to the lowest level since the start of the Ukraine invasion, according to the Finland-based research organization Centre for Research on Energy and Clean Air.

Analysts and former Russian energy officials and executives say Russia will remain a major oil-and-gas producer with the ability to swing global prices. But they say Moscow will struggle to maintain output at prewar levels and sell it at international market prices, cutting into its biggest source of tax revenue and capacity to wield commodity exports as a tool of influence.

The reshuffle is making Russia more reliant on China, threatening to realize longtime fears in Moscow that it would become a junior partner to Beijing. Lower output could also weaken Russia’s hand in its relationship with Saudi Arabia, the core of the Organization of the Petroleum Exporting Countries Plus oil cartel.

“Russia is still an energy power but its role has dramatically changed,” said Vladimir Milov, former Russian deputy energy minister and now an opposition politician living abroad. “Russia will have a smaller market share in oil and gas, it will make less profit and it has lost some of its geopolitical leverage as well.”

Evgeny Gribov, who quit as an executive at Lukoil PJSC, Russia’s second-biggest oil producer, shortly after the invasion, said the ban on exports to Europe and loss of Western technology are “going to have a hugely negative impact on the oil-and-gas industry, and then consequently to the Russian budget.”

“Oil-industry taxes will go down substantially,” he said. “Oil companies will reduce investments, which has a huge negative multiplier to the Russian economy.” 

The immediate pain is concentrated in gas. State-owned Gazprom PJSC’s output fell to 413 billion cubic meters in 2022 from 515 billion in 2021 after the firm cut off most of its European customers, which used to subsidize barely profitable sales at home.

Production of crude oil and a related hydrocarbon called condensate has held up at about 10.7 million barrels a day, said Livia Gallarati of Energy Aspects, down by 400,000 barrels a day since the eve of the war. Ms. Gallarati expects output to slip starting Feb. 5, when an EU ban on Russian refined fuels could force refiners to slow their own crude consumption.

Analysts don’t expect Russia’s energy industry to buckle quickly as Venezuela’s once-mighty oil sector did under U.S. pressure. One reason: the Biden administration, eager to ward off high gasoline prices, designed the price cap in such a way that Russia has a financial incentive to keep producing.

A steady deterioration of production and revenue is more likely, analysts say.

According to all future scenarios developed by the International Energy Agency, Russian fossil-fuel exports will never return to 2021 levels, “leaving Russia with a much-diminished position,” the IEA said last year.

Europe’s energy links with Russia initially gave Moscow the upper hand in its economic war with the West. West Germany first traded steel pipes for gas with the Soviet Union in the 1960s, and those ties deepened down the decades. When they frayed last year, energy prices shot up, piling particular pressure on Europe while sending a gusher of revenue to Moscow.

The money helped Russia fund the war in Ukraine and placate its population at home with handouts. Oil and gas are the backbone of the Russian economy and provided 45% of the federal budget in 2021.

But prices have since fallen and the long-run outlook for production—and the Russian economy—has darkened. 

Russia’s main kind of crude, Urals, used to sail to Europe at roughly the same prices as global benchmark Brent. Most of the oil now heads on the weekslong voyage to India, and many mainstream shipping companies and traders are unwilling to handle it. Urals is trading at just over half the price of Brent, according to price-reporting agency Argus Media. At $45 a barrel, it doesn’t fetch much more than Russia’s estimated cost of production, when capital expenditure is included—though a weaker ruble should bolster local-currency tax revenue.

Last week, Russian Deputy Prime Minister Alexander Novak, who oversees the energy industry, said the EU ban and price cap are the biggest risks it faces. In a meeting with President Putin, he said he hoped that the situation would be temporary and that the oil discount would narrow, according to an official transcript. 

“We need to look at this discount so that it does not create any problems with the budget,” Mr. Putin told Mr. Novak according to the transcript.

Mr. Novak said oil producers haven’t reported problems finding buyers for February, and that Russia will take all necessary steps to ensure supplies to new markets. Officials have said Asia is a big focus, alongside the expansion of domestic infrastructure.

Russia’s bet to squeeze Europe by cutting off gas flows since last summer appears to have unraveled for now. Mild temperatures, brimming storage facilities and record imports of liquefied natural gas from the U.S. and elsewhere have helped Europe escape a serious energy shortage this winter. Executives say filling stores for the 2023-24 winter remains a challenge.

Russia, meanwhile, lost its biggest customer. “The German problem, or the central European problem, was that…half of [our eggs] were in the basket of Putin,” German Economy Minister Robert Habeck said this month. “He destroyed that.”

Over time, analysts and former executives say Moscow will struggle to maintain, let alone expand, production. Western oil companies have exited, external funding has dried up and sanctions are impeding technology imports. Russia has already faced delays on its flagship oil venture, Vostok Oil. Another oil project expected to experience difficulties is Sakhalin-1, which the Kremlin pushed Exxon Mobil Corp. out of last year.

With sanctions cutting off Russia from most of the Western financial world, analysts at Rystad Energy estimate that investments in exploration and drilling fell to $35 billion in 2022, down from $45 billion in 2021 and below the Covid-induced lows of $40 billion in 2020.

“The lack of foreign…investment, technology and money and experience of more difficult geographies and regions is just going to over time whittle away at the ability of the Russian oil sector to maintain production,” said James Henderson, a researcher at the Oxford Institute for Energy Studies.

Moscow’s big hope is to peddle its energy to China.

But while Beijing has increased its oil-and-gas purchases from Russia since before the war, its oil imports have recently stagnated, and Russia’s pipeline gas exports to China are less than a 10th of what it used to export to Europe before the war. Beijing has yet to agree to a second pipeline carrying Russian gas