The sanctions of war remain a problem for the G7

Russia’s war in Ukraine hangs heavy over the G7 meeting as countries wrestle with the fall out in energy and food markets.

| 7 min read

The G7 summit aims to send out a message of unity from the participants. It will pledge more support to Ukraine, offer longer-term financial help to emerging market countries as an alternative to China’s Belt-and-Road initiative, and seek to accelerate action to tackle climate change. Argentina, India, Indonesia, Senegal and South Africa are also in attendance at the summit.

In practice, the war in Ukraine hangs heavy over the meeting as countries wrestle with the fallout in energy and food markets.

When the Nato allies and others put sanctions on Russia to damage its economy as it attempted to end or shorten the war, they allowed important delays and exclusions for oil and gas. Europe pointed out that the European Union (EU) depends on 40% of its gas supplies and more than a quarter of its oil on Russia - and it could not reduce that to zero in a hurry. It was agreed that this year Russian hydrocarbons would still be purchased from Russia as the EU rapidly moved to reduce dependence.

In 2020, The EU generated 70% of its energy from fossil fuels, with the other 30% split between nuclear and renewable electricity. Oil, at 36% of total energy, and gas, at 24%, were bigger than solid fuels, with plans to phase out coal before other, less polluting, hydrocarbons. Germany was especially dependent on Russian gas and had agreed to the construction of a second direct pipeline, Nordstream2, to import more. Many other continental countries rely on Russian gas, with four major pipelines west from Russia taking it to customers. Nordstream pipelines come under the Baltic Sea. One runs through Poland, one through Ukraine and one from the south and the Black Sea.

Moscow’s commodity cash keeps coming in

Russia has concentrated on trying to sustain its markets for oil and oil products against a background of high prices. It has been selling around 5.5 million barrels per day (bpd) of crude oil and 2.5 million bpd of products. It has encountered rising buying interest from India and China to offset lost customers in Europe.

In May, India and China were taking close to 2 million bpd between them, compared to 700,000 bpd in February, though they require a substantial price discount. Products have been in strong demand worldwide as there have been shortages of refining capacity adding to the strains in the crude oil market.

Russia has been allowed to route large quantities of crude to its refineries in Sicily, Romania and Bulgaria run by Lukoil. As a result, Russia has benefitted from strong foreign exchange receipts for oil and oil products, and the state has collected extra taxation. So far, the sanctions have failed to dent the money Russia enjoys from its oil trade, which helps finance the war. There needs to be more-rapid change if the west is to end its reliance on Russian crude and products by December.

It appears that Russia is out to undermine the stated EU policy to get gas in store up to 90% of storage capacity by the winter.

This ability to avoid the financial impact of sanctions on its lead export has left Russia confident enough to actually reduce the flows of gas to Europe despite the EU saying it will carry on buying Russian gas. Russia claims the reduction of flows through Nordstream to 40% of capacity has been necessitated by technical matters. The flows through the Ukraine pipe are also down and the Yamal pipe via Poland is not being used by Russia at all.

It appears that Russia is out to undermine the stated EU policy to get gas in store up to 90% of storage capacity by the winter from the current level of around half. Russia would prefer to deal with a Europe this winter that needed gas and did not have full stores as a buffer. The interruption to normal volumes has led to a further escalation of the gas price.

The weaponisation of energy supplies

Germany is dusting down contingency plans related to action needed should the flow of gas to be turned off altogether this winter. There would probably need to be rationing by allocation as rationing by price would mean very high prices. Germany is busily putting in more liquified natural gas (LNG) import facilities, and the US has promised to make more gas available, though the bad fire at the large Texas LNG exporting plant is not helping. Romania is going ahead with developing its Black Sea finds, but this will not be contributing this winter. Norway will sell as much gas as it can into the rest of Europe.

All of this means that the sanctions which are damaging other parts of the Russian economy are taking time to bite in the crucial energy sector. If Russia continues to leave the European gas market undersupplied this will keep energy prices higher for longer and will damage energy-dependent industries. It has a direct knock-on effect to fertiliser and petrochemical prices and availability.

All the time the war grinds on in its violent way, we need to expect disruption to the energy and industrial activities of Europe. Other gas and oil suppliers, led by the US, will benefit from the higher prices this sustains. Other parts of the Russian economy are being harmed by sanctions as they deny access to the products and components Russia needs. In due course, it might impede new investment in producing hydrocarbons in Russia.

The G7 will struggle to find quick solutions to the problems of inflation.

The world remains very reliant on oil and gas and is back to needing 100 million bpd of crude. Russia’s 10 million bpd is an important part of this equation. Much of it is still being produced and supplied, though the pattern of sales is shifting towards Asia and there is doubtless activity in sanctions-busting illicit cargoes. The recent weakness in the global oil price reflects recession fears, as a marked world slowdown would once again hit demand as it did in 2020 with the Covid-19 lockdowns.

The G7 will struggle to find quick solutions to the problems of inflation, threatening recession and the war in Ukraine. It is looking at reducing bioethanol in motor fuels temporarily to tackle the food shortages and undertaking another review of how it might be able to get more Ukrainian grain to market. It will promise more weapons and financial assistance to Ukraine. These pressures make tackling both inflation and recession at the same time much more difficult, with the danger of more supply interruptions to come.f

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The sanctions of war remain a problem for the G7

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