The energy of sanctions

Economic sanctions are beginning to affect the Russian power sector. How much can the ‘energy isolation’ change the Russian energy strategy?

Few people would object to the statement that the sanctions can destroy Russia’s economy, which is dependent on fuel exports, even though some Russian analysts and even the Ministry of Foreign Affairs are promoting the idea that sanctions should not be afraid of because the countries that declared the ‘embargo’ would lose much more than the ‘punished’ Russia.

“What risks are the two sides to the process taking, and should Russia expect ‘sharp turns’?” analyst of FOREX CLUB Group Valery Polkhovsky investigated. “Even at the closest view, the mutual severity of potential trade restrictions appears striking. The European economy covers about 30% of their needs with Russian gas.”

In spite of that, European adherents of the sanctions are putting hopes on the USA; Barack Obama has expressed readiness to help reduce Europe’s energy dependence on Russian gas.

At the same time, according to the FOREX CLUB experts, “the elimination of the export item related to the sale of oil and oil products, which account for approximately 54% of the exports, may be a problem for Russia. Restrictions may cause a shortage followed by a price growth. High oil prices may trigger a slowdown of the entire global economy.”

The August round of ‘US’ restrictions has outlined new challenges for Russia’s power sector. A ban has been imposed on supply of equipment for deep mining (over 152 meters) and development of the Arctic shelf and shale oil and gas reserves. This means control of exports of certain technologies and products. Any attempts to transfer technologies of ‘unconventional’ production of energy sources are at threat. This is a direct attack on Russia’s Arctic projects and development of certain fields in West Siberia. The impact of economic restrictions has already been felt by some oil and gas companies, which appealed to the government for “financial assistance”. However, it should be noted that before the sanctions even tax benefits would not always encourage investors to engage in the development of the North intensively.

As for the social and economic impact, according to the experts, “for the Russians complete elimination of this income item would result in devaluation of the national currency, moderate inflation, and a decline in consumption of imported products… The consequences may indeed be destructive. The budget deficit will start growing rapidly and may reach 50%. Accordingly, the ruble will be under great pressure, which will be followed by large-scale devaluation. After that, imports will go down to a minimum, as will the quality of consumed goods and services. All of that will be accompanied by high inflation and declining real incomes and quality of life…”

“The consequences of the sanctions that restrict the exports of Russian fuel for the two sides will be as follows,” Valery Polkhovsky concluded. “For Europe it is a threat of an energy collapse and a significant reduction of competitiveness plus a loss of a large and important market. For Russia, there is a real threat of total destruction of the existing economic model with possible social unrest.”

Dwelling on versions of negative scenarios is not a pleasant thing. Given that the sanctions mainly hit fossil fuel technologies and do not involve ‘green’ energy alternatives, in theory the situation can be described as positive for renewable energy. However, this is only in theory, because in Russia the ‘green’ energy is still regarded as an expensive toy.

In any case, Russia as a country is put at the question of how and from what to live (which means, “Who to sell oil and gas to?”). We could suspend reserves, as some pragmatic countries do. However, in that case Russia will need to reorient the structure of revenues of the state budget urgently. It is obvious that the situation with sanctions has exacerbated the need to address the single-sector structure of the national economy. Russian and Western economists had warned for many years that the priority of the “oil and gas pipe” in foreign policy would eventually expose the country to the most serious challenges.

According to the experts from non-government environmental organizations, energy companies should not go out with an outstretched hand but rather stop spending billions on extremely environmentally risky Arctic projects that have no economic future in the modern conditions. On the other hand, they could finally stop burning billions of cubic meters of associated petroleum gas. On the national scale, a focus on a low-carbon strategy and resource conservation is a key to future prosperity.