Russian energy embargo 4/6
How vulnerable is Russia to an energy embargo?
< < < Part 3 Economic consequences of the embargo in the short to medium term
How vulnerable is Russia to an energy embargo?
I have started this article with the notion that the West (and really the EU) feels compelled to introduce an energy embargo on Russia and has actually started implementing it by stopping purchases of Russian coal. The war in Ukraine is going ahead at full steam and Europe wants to do more. We might want to stop for a second and think about sanctions and their goals in general.
Sanctions could be used to coerce – or cause enough pain and damage to the adversary so to make it unbearable to continue the previous course of action, contain – or create barriers that would make future actions difficult to implement, for economic embargoes this would translate into deprivation of resources for future actions, or punish – cause pain and damage that might not necessarily stop the current actions of the adversary, but make him and others think twice before any future attempts in condemned behavior.
At the first glance, energy sanctions will be devastating for Russian economy and deprive it of resources needed for the war effort, compared to the situation of unhindered energy sales. However, it may not be necessarily so.
At the moment the war effort does not rely on imported goods, so the amount of hard currency, Russia earns for its energy exports is almost irrelevant. Russia might need some hard currency later to buy some high-tech equipment to rebuild its arsenal, but for now, it is using the already existing stock of military machinery, domestically produced fuel, food, and other army supplies, and so far, not even at expense of general population or civil economy.
For many years Russia has been running a budget surplus, and now, without oil revenues, it would have to cope with a deficit, so it would have to either curtail government expenditure, leading to unemployment, which would cause discontent amongst the strongest government supporters – pensioners, civil servants, teachers, employees of large companies with state orders, and security apparatus – the police, FSB, Rosgvardia and the army. Another solution would be to print money which would lead to inflation and would also cause discontent. The only difference is how the suffering will be allocated in the society – in the first case, it will go mostly to salary earners, in the second – to people living off their savings.
However, Russia is already facing this crisis. Russia already has a disbalance between the available amount of goods and services and money in circulation, but it is caused by supply embargo and boycotts. It does not matter how much foreign currency the country earns if it cannot convert the money into goods for its consumption. This phenomenon explains the strengthening of the rouble to pre-war levels despite strong inflation in the last two months, the hard currency is worthless to the people who cannot spend it abroad or on Aliexpress and it is worthless to (former) importers, many of whom are cut off by their suppliers. An autarchic economy that voluntarily or involuntarily is cut off from international trade does not get much value from exports.
For some time, the government might mop up excessive rouble liquidity by selling hard currency to the population, which might see it as a better saving instrument, but with severely limited ability to spend it, the demand might dry up.
Some currency will still be needed to facilitate the trade between Russia and China, which might not join the embargo and serve as a conduit for otherwise unattainable foreign goods, but this trade channel will most likely be bottlenecked and limited in capacity, so the amount of currency needed might be also limited. Clearly, the first use of this trade channel will be to obtain goods and materials needed to re-stock and strengthen the Russian arsenal, with other needs covered only as an afterthought.
With this circumstance in mind, we might come to a conclusion that albeit the deteriorating economy and resulting discontent might indeed become a problem for the regime, the lack or presence of foreign revenues as such might not be a tool to solve it. The government will probably choose to keep propaganda and security forces well supplied and looked after – there probably will be enough resources for this cohort – and use them to prevent and disperse any disturbances caused by falling living standards.
There are reasons to believe in Russian resilience – even after the Central Bank assets freeze Russia still has available foreign reserves equal to at least 2 years of pre-war imports, and according to analysis in the previous chapter, it might still be able to earn hundreds of billion dollars (or more likely, yuans) per annum even in the case of reduced exports if this reduction would lead to supply shock and price hike.
This logic would hold for Russia until it would either be allowed back into the international trade system or until the world would manage to replace the Russian energy supply with a combination of alternatives and adaptation measures, which would take several years. When that would happen, especially in combination, the utility of international trade for Russia will go up and the availability of hard currency will go down. A rational statesman or politician should be calculating their moves into such a not-so-distant future, but Mr. Putin’s actions were anything but rational on a much larger scale, so we should not hope for long-prospective rationality here either. Apparently, the Russian leadership is willing to incur very high costs and losses at the moment with the hope of creating a very different world order, with different payout functions and some grand benefits to Russia.
And returning to the question at the beginning of the chapter, we might conclude that an energy embargo might have a very low coercion value to stop the war now, quite limited containment value for the next couple of years, and probably some substantial punishment and deterrent value over the long term.