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  1. Analysis
May 23, 2022

Russian sanctions and Europe’s plans

EU countries have started planning for a sudden end to energy supplies.

By Matt Farmer

As the reality of European sanctions against Russia sink in for both parties, European companies are seeking to relieve the pressure these have caused in the continent. For some, this has meant radical changes to comply with sanctions, while others negotiate ways around them.

In Brussels, EU politicians continue to negotiate the bloc’s sixth sanctions package against Russian businesses and state affairs. Although representatives of Hungary’s Putin-sympathising government continue to impede progress of the package, EU officials remain optimistic over its passage. Most expect the next round of sanctions to come before mid-June. In the meantime, countries are adapting to losing the security of Russian oil and gas.

Currency disputes and circumnavigating sanctions against Russia

Since the end of March, Russia has demanded that other European countries pay for energy in roubles. Almost all existing energy contracts specify payment in euros or US dollars and converting these to roubles would require a rouble-based Russian bank account.

Russia has already stopped supplying gas to Bulgaria and Poland after the countries refused to comply.

In May, the European Commission clarified that opening a bank account with a sanctioned Russian bank would not break the bloc’s sanctions. However, the EU expects companies to make a “clear statement” that they consider their obligations fulfilled when paying in currencies specified by their contracts. Payments in currencies not specified by contracts would constitute a breach of sanctions. As a result, the governments of both Germany and Italy have told companies that they may open accounts in roubles to pay for Russian energy without breaching sanctions.

French energy giant Engie has said it will make it will continue to pay Gazprom for gas, doing so in euros. The companies have made arrangements to avoid breaching sanctions, but the move has attracted criticism from Ukrainian companies and French citizens. Engie is not alone, with German giant EnBW, Sweden’s Alfa Laval, and Hungary’s MVM CEEnergy all among those maintaining a business relationship with Russia.

The cut-off date

Russia has already turned off gas supplies to Poland and Bulgaria, demonstrating its resolve to respond to sanctions. Both countries, particularly Poland, have denounced Russia’s aggression and moved to reinforce Ukraine without direct military intervention, making them high-profile targets.

Just over half of Poland’s gas imports came from Russia, leaving it with a large hole to fill. From October, Poland will have access to the new Baltic Pipe pipeline, carrying 10 billion cubic metres of gas from Norway per year.

Stakeholders made their final investment decisions on the pipeline in 2018. Despite having less gas security than planned at the time, PGNiG, the Polish state-owned oil and gas company, has said that it expects the high cost of gas to suppress demand so much that it will not need all the Baltic Pipe’s new capacity.

Russia has also targeted its neighbour, Finland, as it moves closer towards the NATO defensive alliance. Russia’s state-owned utility Inter RAO ended its power exports to Finland in mid-May, although both sides said that this came as a result of non-payment. Later, after Finland and Sweden submitted their applications to join NATO, politics played a more obvious role in decision making.

From the start of the year to mid-March, Finnish gas imports from Russia averaged 3.2 million cubic metres per day. Finnish state-owned utility Gasum handled these, refusing to pay in roubles. On 20 May, Finland’s Gasum announced that Gazprom would shut off its gas connections from the following morning, generally considered a response to Finland’s application to join NATO.

President and CEO Mika Wiljanen called this “unfortunate” but said “we have prepared carefully for this situation and if there are no disruptions in the gas transmission network, we will be able to supply gas to all our customers in the coming months”.

German law changes allow nationalisation

In Europe’s largest economy, just under half of gas imports come from Russia. Poland’s disconnection from Russia’s gas has caused a flurry of policymaking in Berlin; the country has started making plans to ensure the security of its energy supplies if unexpectedly and instantaneously cut off from Russian gas supplies. The country’s gas storage sits at approximately 33% full.

Vice-Chancellor Robert Habeck said: “We must therefore prepare ourselves for the situation to come to a head. Therefore, with the amendment to the energy security act, we are once again significantly sharpening our instruments and bringing them up to date.”

The country’s government has started debating legal amendments that would allow emergency repossession of its largest energy companies. This allows the establishment of trusts to administer companies if the government perceives a risk of supply disruption of that it may “not fulfil its tasks serving the functioning of the community”. Trusts would also assume the voting rights of shareholders.

This law could affect any company involved in “highly important” energy infrastructure that ensures consistent supply or public safety. Gazprom Germania has already faced this fate, with its voting rights now held by grid regulator Bundesnetzagentur.

Ultimately, the German Government remains reluctant to fully nationalise any businesses due to the amount of fear this would cause among remaining private companies and the markets they trade in. However, if the market is already ruined, Germany may have little to lose by ensuring the operation of companies via their nationalisation.

In the case of a complete shut-off, businesses would compete for units of gas via auction. If this happened, Bundesnetzagentur has said some businesses may receive no gas whatsoever, but that it would consider the size and criticality of a business when distributing “rationed gas”.

Europe’s longer-term divestment of Russia

Addressing the longer term, EU countries have advanced their green energy plans. In March, EU Commission President Ursula von der Leyen announced plans to phase-out two-thirds of Russian fossil fuels before the end of 2022. Under the REPowerEU strategy, Russian imports would end by 2030.

The strategy promises a broad increase to renewable investment, building on the upcoming “Fit for 55” legislation package. Alongside this, the EU Parliament has discussed increasing its renewable energy target. Fit for 55 would likely adjust the target in any case, but the invasion of Ukraine has pushed EU legislators to debate an increased target in a separate law, sooner.

At the same time, Germany, Denmark, the Netherlands, and Belgium have agreed a €135bn agreement to develop their offshore wind and green hydrogen infrastructure. Before 2050, this will develop 150GW of offshore wind capacity, accounting for half of the EU’s current mid-century target.

However, these will be offset in the short-term by increased coal burning by countries looking for a cheaper alternative to petrochemicals. The European Commission has acknowledged the likelihood of coal burning increasing by approximately 5% over the next decade, with statements saying that the environmental cost would be worth the security gains.

On this, EU climate chief Frans Timmermans said: “You might use coal a bit longer. But if, as we propose, you rapidly speed up the introduction of renewables, you then have the opposite movement. If we can actually do as we plan, we will bring down our emissions even quicker than before.”

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