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Economic analysis suggests that an EU embargo on Russian raw materials is justified in the long term, although in a shorter perspective it will cause additional costs. However, strategic planning dictates that giving up Russian fuels is an investment in energy security and sovereignty, similarly to the diversification of gas supplies to Poland, which is now bringing in economic profits, writes Wojciech Jakóbik, editor-in-chief at BiznesAlert.pl.
The worst decision is no decision
It is necessary to determine the perspective of the analysis at the outset. Gazprom restricting the supply of gas to Europe since the summer of 2021, which I described in a separate article, can be treated as Russia launching a war against the West with energy as its weapon. The energy crisis fuelled by this company has been relentless ever since, so it cannot be said that we are not yet bearing the consequences of the Western-led eastern policy in Ukraine. It can be argued today that the Russians were probably fueling the crisis precisely in order to paralyze the western response to the attack on Ukraine. I proposed this idea in a piece from June 2021, where I asked whether the gas price crisis was a prelude to war. Turns out that’s exactly what happened. It should be added that now the Russians are limiting the supply of oil, perhaps in order to further lift the price of this fuel to USD 139 per one Brent barrel, which had not been seen for over a decade, but which appeared right after the aggression on Ukraine started. This action was taken before the embargo on Russian oil, and was intended to further paralyze the West. Thus, two theses are proven wrong. Data from the last six months shows that it is not true that we are not yet bearing the costs of the Russian attack on Ukraine when it comes to energy. It is also false to believe that that we will not bear them if we remain passive. Quite the contrary – inaction can cost even more than an EU embargo. The economic consequences of inaction were well summarized by Maciej Jaszczuk from the Subiektywnie o finansach (Subjectively About Finances – ed.) portal, which I recommend as a source of reliable economic information. Also, in the long-term perspective the embargo on Russia’s raw materials will pay off economically.
After the plague and the war, there will be famine
The absence of an EU embargo on Russian raw materials, which is supposed to wear out the Kremlin’s still well-oiled economic machine, will cause additional economic losses in the long term. The military crisis across Poland’s border poses a risk that investments will flee and insurance costs will soar. The first news about the withdrawal of capital from our market due to the war in Ukraine has already appeared in the pages of BiznesAlert.pl. Maciej Jaszczuk writes that the growing wave of migrants, will increase the costs of social policies and the burden on infrastructure. Consumption is also growing, which will continue to drive the already record breaking inflation. Jaszczuk also states that due to the hostilities, the crop sowing area in Ukraine was half as large as it should have. It is worth adding that the record gas prices, deliberately raised by Gazprom which is limiting supply, have also reduced the production of fertilizers in the world, threatening crop shortages in the summer of 2022 and record food prices on the Old Continent, and famine in Africa. Fertilizer prices shot up in late March by 43 percent on the stock market in the US Tampa. Major grain exporters like India will try to ease the situation, but these attempts will be made more difficult by record low harvests resulting from shortages and record prices of fertilisers. There will also be a secondary price increase. For example, the issues explained above will cause record increases in cooking oils prices, which will also up the costs of other foods. It should be noted that the Polish market is relatively well secured due to the long-term contract between Grupa Azoty and PGNiG, which allowed Azoty not to reduce the production of fertilizers, in contrast to its competitors from the European market. From this perspective, it should be said that Poland was right to stop the hostile takeover of this company by the Russian Acron. Deputy Minister for the Treasury at the time Mikołaj Budzanowski, has recently assessed in an interview with the Polish Radio that at about that time the Russian narrative that Poland did not need an LNG terminal emerged. Similar voices appeared in January 2022 in relation to the Baltic pipeline, just before the Russian attack.
It’s not a question of whether but how to kick Russian fuels
Therefore, import of raw materials from Russia should be stopped not just for the sake of becoming independent and lowering the prices thanks to diversification, but also to stop the Russians in Ukraine. The longer the war lasts, the greater will be the burden on the Polish economy. Russia turning Ukraine into a second Sudan is a recipe for permanent destabilisation in our part of Europe and capital flight. The longer the war in Ukraine continues, the greater the famine will be this autumn. The more money we spend on dealing with the crisis caused by Russia, the fewer resources for the necessary armaments in the event of a Russian attack on NATO’s eastern flank will we have. And the Kremlin makes this threat regularly, just like in the past it threatened with an attack on Ukraine, which it then carried out.
The EU embargo on Russian raw materials is the best way to undermine the revenues of the Russian budget, of which a third comes from the sale of hydrocarbons (37 percent according to the Federal Customs Service), including about three quarters (75 percent) from oil. Coal, the target of the European Union’s fifth package of sanctions, accounts for EUR 4 billion of revenue per year, and supplies to Europe account for 11 percent of Russia’s exports. Four billion euros is not much, compared to the fact that Russians earn about EUR 660 million according to data from Bruegel from in early March. Any economic sanctions now affecting Russia’s energy, banking and arms sectors are, so far, to some extent offset by record commodity prices. This is one of the reasons why Trafigura trader can offer the Russian Urals blend at a price lower by even 37 dollars, than the one on the stock market in order to encourage clients with discounts. However, it should be recalled that the price is a secondary issue for Russians and is adjusted arbitrarily for political needs. The Russians are willing to sell their fuels at a loss, if there is justification for this on the political level. At this point there are no takers in the West, but there are clients in Asia. However, it is worth noting that it will be difficult for Russia to quickly redirect hydrocarbons from Europe to the East, as there are no gas pipelines to China from the Yamal resource base, a problem familiar from the tale of the 2014 deal of the century between Gazprom and CNPCP. Moreover, Asian markets’ ability to absorb more oil is limited. Paradoxically, greater sales of Russian oil in Asia may lead to a greater supply of this resource from other sources in Europe, as Wood Mackenzie suggests. The supply from Russia is estimated at a total of 3 million barrels and cannot be completely redirected from Europe to Asia. This means that the Russians are not able to make the economy immune to the EU embargo on their raw materials. For this reason a strike like this could paralyse the Russian progress in Ukraine, and probably that is why they prefer to paralyze the West with fear of an embargo.
The longer the war lasts, the greater the losses will be
Meanwhile yielding to Russian pressure is a recipe for a long-term energy crisis that could be used by Russians to replace governments in Europe with pro-Russian ones. It is worth monitoring which political forces in the West are scaremongering about high prices in case of an adequate reply to the Russian aggression. It turns out that a significant part of them proposes a pro-Russian policy. Finally, it should be noted that any costs of responding to Russia’s actions will be lower than those resulting from inaction if the war spreads from Ukraine to the West, and this possibility should be taken into account in strategic planning. The West has already miscalculated the risk of a Russian attack on Ukraine and cannot repeat this mistake again, at most it will be positively surprised. The dispute over whether to become independent of Russian fuels has lost its point after Russia had attacked Ukraine. In the long term, this is the right way to go not only because of the cohesion of NATO and the European Union and the common foreign and security policy, but also for economic reasons in the energy sector. Will Europe bear the costs of the EU embargo? To begin with, it is worth noting that the costs are already rising, as I wrote above, and will continue to grow regardless of our decision, so we should “pick our own poison” to use an old saying. An EU embargo on Russian raw materials would also raise energy and gas bills, as well as gas prices at the stations. This would increase inflation and interest rates on loans. Before the attack on Ukraine, but after Russia added fuel to the energy crisis, the European Commission proposed EU-level countermeasures, which included subsidizing energy bills for the poorest (e.g. the energy allowance in Poland), lowering the surcharges that impact utilities prices, such as VAT and excise duty (lowered in Poland as well). These solutions are still working and will be expanded at the EU level in a way that has not been determined yet. These include agency purchases of gas reserves before the next heating season, a climate policy rebate that reduces energy bills and other measures to reduce the energy crisis. The long-term solutions include becoming independent of Russian fuels, which will lower the prices, just like in the case of the Yamal contract with Poland, which could be abandoned thanks to numerous alternatives. It turns out that the policy of diversification undermined the flagship thesis of the Russians that LNG from the US cannot pay off. In the context of the energy crisis, the PGNiG-Cheniere agreement may be the cheapest in the portfolio of the Polish PGNiG, due to the price difference in Europe and the still well-supplied European market. It is from this that LNG supplies to Europe are now reaching historical records. From this perspective, cutting off from Russian raw materials is a costly solution in the short term and economically beneficial in the long term, as best demonstrated by the success of Poland’s gas supply diversification policy. The absence of an embargo will not protect us from the increases anyway, because the Russians want to further reduce the supply of raw materials to fuel the energy crisis, to put even more pressure on the West.
Together or apart – from bad to worse
Paradoxically, the current crisis is also an opportunity to redesign Europe’s economic model. The dependence on gas supplies from Russia, which accounts for 41% of imports and is symbolised by the frozen Nord Stream 2 project has to end, which perhaps requires an earthquake to make it happen. It is necessary to become independent of Russia’s raw materials, but it remains to be decided how. Should Poland talk about the fact that it will introduce unilateral sanctions against Russia earlier than other countries of the European Union, or continue the old-fashioned way and announce the abandonment of dependence on Russian raw materials as soon as possible. From this point of view, it remains to be decided, first, when to abandon supplies from Russia: whether to wait for the expiration of long-term contracts with Gazprom, Rosneft and Tatneft, or to do it earlier. Secondly, whether the EU embargo should be used for this purpose, or whether to act unilaterally in the absence of consensus. The maximum objective is an EU embargo, which would effectively weaken Russia in the war in Ukraine, before it has time to adapt to the current Western sanctions. The possibility that this objective will not be achieved quickly due to a lack of consensus in the European Union must be taken into account. Compromise solutions are under consideration, such as a Russian hydrocarbon tax imposed on Russian sellers, or a trust account to raise funds to pay the Russians. In an optimistic scenario, it is possible to impose sanctions on raw materials, as well as to impose them on the banking sector for participating in energy transactions with Russia, which was already done to Iran. Such a solution, introduced unilaterally by the Americans, for example, will leave the Russians alone with their raw materials, they will have to limit the output. The pessimistic scenario is a lack of action and the entry into a new form of interdependence through a mechanism for converting the currencies of gas contracts with Gazprom into rubles, which the European Commission opposes, but which pro-Russian countries like Hungary may agree to. The dismemberment of the European Union and NATO sanctions policy against Russia with the use of energy is the worst-case scenario and the likely goal of the Kremlin.
Independence from Russia is a long-term gain
Regardless of this, the abandonment of gas, oil and coal supplies from Russia is profitable in the long term for individual European countries, which, in the absence of an embargo, should legally terminate long-term contracts and abandon spot supplies from the Russian market. All payments to Russia finance its war efforts in Ukraine, while co-dependance in the energy industry is making the West vulnerable to an energy blackmail for political purposes, which is still used even after the war has started. This is evidenced by the dispute over payments in roubles and Kremlin’s regular threats about stopping the oil and gas supply altogether. There is a suspicion that the Russians are already limiting the supply of oil, as they did with gas. The need for business predictability makes it necessary to look for partners elsewhere, regardless of whether we treat the abandonment of Russian hydrocarbons as a sanction or a defense of economic and political interests. The import portfolio of the EU countries will change to the detriment of Russia, as it happened in Poland in the case of natural gas. In the short term, in the event of an EU embargo, it will be necessary to reduce consumption by lowering industrial production, because Europe will not meet all the demand from outside Russia today, but in the long term it should be revived thanks to supplies from new directions. An economy independent of supplies from Russia will be safer, and again the example of Poland comes to mind, which does not have to worry about the gas crisis, because it could abandon gas supplies from Russia overnight, which Germany and Hungary, which have been dependent for years, cannot say. The absence of imports from Russia therefore creates economic stability. It is also an opportunity for further energy transformation. “Russian raw materials serve mainly to drive European industry, this is another argument for the development of green technologies,” explained Andris Piebalgs, former Commissioner for Energy from Latvia, during a conference of the Florence School of Regulation. He recalled that the countries perceived as hostile in Russia are those that spend the most on armaments and are most independent of Russian raw materials: Poland and the Baltic states. Piebalgs stated that this is another argument for reducing the vulnerability to the interruption of supplies from Russia. According to him, we are already paying at gas stations an additional premium for the Russian attack on Ukraine and will pay the more, the longer the Kremlin is allowed to continue its policies.
The reduction in the supply of Russian fuels in Europe can be compensated by a) reserves, b) diversification, c) reduction in demand. I have already talked about the wiggle room Poland has in my articles about turbo-diversification in the oil and gas sector. A separate issue is the ban on coal from Russia, which is possible thanks to the law on countering support for Russian aggression in Ukraine drafted by the Ministry of Internal Affairs and Administration, since imports from this direction were carried out with the participation of private entities from the regional heating sector and individual consumers. It can be considered that this is a unilateral sanction adopted by Poland, although Germany also declared the abandonment of coal from Russia this year. Proponents of a purely economic approach, however, should look at this idea more favorably, due to the fact that a decrease in supply from Russia will increase interest in the supply of domestic coal, which had been less competitive, but now the update of the Polish Energy Strategy provides for a periodic increase in extraction, due to the energy crisis and the ban on Russia coal. The EU embargo will be imposed by the countries of the European Union or, in a certain way, it will be imposed by itself, because it is Russia’s policy to deter its customers in the West. The data show that this is already happening in the oil sector, because Russian oil is becoming untouchable. The Economist reports that Russian oil is becoming less popular. Oil exports from Russia on March 24 reached 2.3 million barrels per day, and this is almost 2 million tons less than on the 1st of March, according to the Kepler company.
Obvious obviousness supported by numbers
Strategic planning should go beyond ad hoc problems caused by the embargo, or the fact that some EU states stopped importing Russian fuels. Russia’s hostile policy raises economic costs because of the energy crisis, and an adequate response to it will raise these costs further, but not as much as inaction, which would bring even greater losses. Whatever the fate of the debate on the EU embargo, it is justified to abandon raw materials from Russia, including for economic reasons. Investments in the LNG terminal worth billions, the Baltic pipeline and another floating terminal in the Bay of Gdansk give stability to the Polish economy, which does not have to introduce a state of increased risk in the gas market in the face of new threats from Russia, unlike Germany, which has already announced this state due to its dependence. It may turn out that Poland will make money on the re-export of gas from outside Russia to Germany precisely thanks to a long-term investment in energy sovereignty, understood as independence from one supplier. It would seem that the debate about the Yamal contract in Poland has already shown that such a thesis is obvious, but Russian disinformation, which uses the energy crisis still diverts some of the public from this obviousness, probably in order to make the West afraid of the embargo on Russian fuels. In the long term, abandoning them will benefit the economy.
