Russia’s latest gambit in the Ukraine conflict is to open a currency war with the West. Vladimir Putin’s declaration that Russia will only accept roubles as payment for natural gas bought by 'unfriendly' countries is the latest salvo in the long-running attack by Russia and China on the petrodollar system.
The EU settles most of its gas purchases from Russia in euros or US dollars. Demanding western buyers switch to roubles is both offensive and defensive. It is clearly a desperate rear-guard action by the Kremlin to prop up the currency.
Sanctions freezing some $300 billion (£230 billion) of Russia’s foreign currency and gold reserves prevented the Russian central bank from supporting its currency. The rouble has fallen by as much as 40 per cent against the dollar since Russia invaded Ukraine, but recovered some of those losses this week. A big factor in that recovery was Putin’s demand for rouble-denominated gas payments.
This declaration is the most outwardly brazen challenge yet to the global hegemony of the euro and US dollar currency system, which has been under sustained pressure for some time. The volume of Russia-China trades settled in greenbacks has fallen from an estimated 90 per cent in 2015 to less than 50 per cent in 2020. This is the result of a concerted campaign by Beijing and Moscow to break the petrodollar’s stranglehold on oil trade settlement.
Other big oil exporting countries are open to currency diversification too. Saudi Arabia is believed to be in negotiations with China to accept oil payments in yuan, while Iran is discussing a mooted switch to rupees with India.
Implementing Putin’s edict is far from straightforward, particularly because EU-Russia gas trade is governed by existing contracts. Numerous EU gas buyers were quick to state that their contracts don’t contain a provision allowing for settlement in roubles. And even if they did, it would force Western companies to deal with sanctioned banks, which seems like a non-starter.
Putin’s calculation could be that the EU can’t function without Russian gas, so might roll back or soften some of the sanctions measures in order to facilitate continued gas flows. But it is strewn with risks. If it succeeds, it cuts off the flow of foreign currency to some powerful people inside Russia who might turn on Putin. If it is imposed unilaterally, EU gas buyers can claim breach of contract. Gazprom’s reputation as a reliable gas supplier would be ruined forever.
If contracts are amended to accommodate rouble settlement, this opens the door to renegotiating other elements, thereby allowing European companies to reduce the amount of gas they buy from Russia – an objective that the EU Commission has finally embraced with surprising vigour.
The trouble for the EU is that it lacks leverage. Putin, like a child, is now exploiting that weakness and testing the limits of EU tolerance. He is essentially forcing EU leaders to choose between either funding his murderous invasion of its own back yard in a currency of his choosing, or triggering a severe energy crisis that could precipitate a recession deep enough to bring down the entire post-war European project.
His calculation is that Russia’s relationship with Europe is asymmetrical. While there is clearly a co-dependency – the Kremlin needs the cash as much as the EU needs the gas – it is lopsided. And some European leaders have been keen to remind him of the barrel he holds them over.
German chancellor Olaf Scholz staunchly opposes sanctioning Russian gas, telling the Bundestag this week how painful it would be for Germany. Meanwhile, the EU Commission is pushing to refill European gas stocks to 90 per cent by 1 November. This might give Putin extra comfort, as it would seem to indicate Europe will buy more Russian gas in the short term, even as it strains to wean itself off the fuel this decade.
It is hard to see this situation playing out in a way that does not result in Russian gas exports to the EU being severely disrupted or even cut off altogether. Making unreasonable demands is a means of goading European companies into making legally questionable moves, such as non-payment of take-or-pay penalties. This can be used in defence when the pipeline flow valves are fastened shut: ‘They didn’t pay, we had no choice.’
Putin’s motives are transparent and his willingness to cut supplies should not be doubted. Having gambled on the foolish big invasion itself, then all subsequent smaller gambles are worth making too. The Kremlin must be anticipating disruption to euro-denominated EU gas payments at some point as European leaders grasp for ways to punish Russia for its actions in Ukraine, so there is little to lose from trolling them with outlandish demands for roubles.
Putin’s powerplay will again test European resolve. Scholz and his Italian counterpart Mario Draghi are both reticent, but EU leaders are seriously discussing whether to open avenues to buy roubles to pay for Russian gas. If rouble payments do transpire, European consumers will be both funding Putin’s war and ameliorating the worst impacts of Western sanctions against his regime. The question facing Berlin, Rome and other EU capitals is whether this is better than the alternative. If a cut-off is indeed inevitable, then why suffer the humiliation?