Russia has $630 billion to spare as it plans to cut European gas flows

After months of seemingly endless preparations, Biden and the West’s worst fears were finally realized on Thursday after Russian forces launched their Dreaded attack on Ukraine. Sweeping away international condemnation and the first tranche of sanctions from the United States and its allies, Russian President Vladimir Putin declared the start of a “special military operation“aiming at”demilitarization” of Ukraine. Russian forces have would have fired missiles at military control centers in Kiev, with Ukrainian Foreign Minister Dmytro Kuleba claiming via Twitter on Thursday that Putin had “launched a full-scale invasion,” from the country.

Some commentators draw parallels between Russia’s aggression against Ukraine and Hitler’s invasion of Poland in August 1939 in what promises to be Europe’s greatest crisis since World War II. Russia’s invasion of Ukraine represents one of the continent’s worst security crises in decades and is expected to have profound implications for the global economy, particularly given Russia’s unique position as a Europe’s preeminent energy supplier.

Crude oil and gas prices rise as Russia hits major cities in Ukraine, hitting levels not seen since 2014. Brent (CO1:COM) (NYSEARCA:BNO) futures jumped + 8% early Thursday to trade above $105 a barrel at some point. , while WTI (CL1:COM) (NYSEARCA:USO) futures rose by a similar margin and even hit $100 a barrel at one point.

Markets braced themselves for this kind of outcome given that Russia is the first 3rd oil exporter and its 2nd exporter of natural gas. Russia produces 10% of the world’s oil and is the largest European supplier of natural gas.

“This is a triple whammy for the global economy, with a toxic combination of higher inflation, weaker economic growth and greater uncertainty. The only silver lining is that growth is strong , a buffer to any downturn, and policymakers and investors are already prepared for high inflation,” eToro strategist Ben Laidler writes.

Laidler says the risks of supply disruptions are low, noting that Russia reliably supplied the West during the Cold War. Yet he predicted high commodity prices for longer, with the current oil “risk premium” just the latest driver in a structurally very tight market.

But not everyone is so optimistic.

“While Western governments are likely to exempt energy transactions from sanctions, the blizzard of new restrictions will force many traders to be extremely careful in handling Russian barrels. Gas transiting through Ukraine is likely to be disrupted, affecting the supply of several Central and Eastern European countries and increasing gas prices in Europe“, analysts at political risk consultancy Eurasia Group told CNBC.

Close the gas taps

The million dollar question here is what would happen if Russia did the unthinkable and completely cut off gas supplies to Europe.

After all, for several months Russia has repeatedly been accused of intentionally interrupting the gas supply leverage its role as a major energy supplier to Europe amid a growing dispute with Ukraine. Two months ago, natural gas prices in Europe hit record highs after a pipeline that brings Russian gas to Germany shifted flows east. Westward gas crosses the Yamal-Europe pipeline 2,607 miles long, one of the main routes for Russian gas to Europe, have gradually declined, a move the Kremlin says has no political implications. Western politicians argue that Russia has used its natural gas as a weapon in the political tug of war linked to Ukraine, as well as delays in the certification of another controversial pipeline, North Flow 2. Russia has, of course, denied any connection with state-owned companies Gazprom (GZPFY) claiming to have fulfilled its contractual obligations to customers.

That hasn’t stopped many energy analysts from being deeply concerned about the risk of a total supply disruption to the EU – which receives around 40% of its gas via Russian pipelines, including several cross Ukraine.

Indeed, Russia is in a better position than ever to pull off such a diabolical maneuver.

According to David Frum of The Atlantic and author of Trumpocalypse: Restoring American Democracy (2020), Russia’s invasion of Ukraine was greatly aided by high energy prices, especially natural gas, in the ongoing energy boom. Frum notes that the price of Russian gas in spot markets topped $10 per million metric BTUs in June 2021 before tripling to the current $30 per million metric BTUs. The sharp rise in energy prices has helped Russia’s foreign exchange reserves reach $630 billionor 42% of the country’s $1.5 trillion GDP.

With these massive financial resources, Russia could inflict real havoc on global energy markets if it chooses, with natural gas markets likely to be hit the hardest as gas is harder to replace. In theory, the Russian gas pipeline could be partially replaced by liquefied natural gas from the United States, Qatar or other suppliers; unfortunately, it is very difficult to accelerate the production and shipment of LNG.

According to Kateryna Filippenko, Principal Analyst for European Gas Research at Wood Mackenzie, “If all gas flows stopped today, Europe could be fine in the short term, given higher storage stocks and weak summer demand. But in the event of a prolonged disruption, gas stocks could not be replenished during the summer. We would face a catastrophic gas storage situation close to zero for next winter. The prices would be exorbitant. Industries should close. Inflation would skyrocket. The European energy crisis could very well trigger a global recession.

Troy Vincent, senior market analyst at researcher DTN Markets, agrees with Filippenko’s view and told CNBC that “there is simply no alternative“to Russian oil and gas volumes”which do not result in much higher prices and potentially the development of severe shortages.”

Putin is, of course, well aware of this, and could use oil and gas as an ace in Moscow’s hand in the unfolding drama.

Liquidation of the Russian market

Russian stocks sold off sharplyplummeting more than 40% on Thursday as the ruble hit a record low against the dollar.

the MOEX The index plunged as much as 45%, while the RTS index, which is denominated in dollars, fell 37% at 7:15 a.m. ET. The crash erased around $70 billion of the value of Russia’s biggest companies.

Russian banks and oil companies have been among the hardest hit by trading volatility, with stocks in Sberbank (SBRCY) – Russia’s largest lender – at one point losing 57% of its value. Rosneftin which BP inc. (NYSE:BP) holds a 19.75% stake, which dipped as low as 58%, before stabilizing a bit. BP shares fell 4% in London.

Gazprom, the giant gas company behind the Nord Stream 2 gas pipeline, fell 40%.

By Alex Kimani for Oilprice.com

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