‘The pain that could be inflicted by Russian sanctions against the European Union, could be much higher than the sheer financial numbers seem to reveal!’ My answer to Marcel de Boer’s column.

One of the savviest journalists of Dutch financial newspaper ‘Het Financieele Dagblad’ – and a very nice person on top of that – is macro-economist Marcel de Boer. More than once, I printed some of Marcel’s insights on this weblog.

Next to his articles in this newspaper, Marcel maintains a daily blog at fdmarceldeboer.wordpress.com. This blog is always a good read for everybody, who either masters Dutch or uses Google Translate and ignores the crippled translations.

At this moment, Marcel and I have an occasional, ongoing discussion with respect to the situation in The Ukraine and Russia. This situation has been on our retinas continuously, since the crisis went ablaze in March, after the Winter Olympics had passed. 

As Marcel does not have a personal involvement in Russia, unlike me, it is much easier for him to view at things from a distance and with his financial/economic glasses on.

Today, he wrote again an article well worth reading, about the consequences of Russian sanctions for the European Union. It is to this particular article that I want to react.

How painful is the conflict with Russia for the Euro-zone economy?

The Russian president Vladimir Putin stated this week that he is hatching a plan, concerning economic counter-measures against Europe and the United States. Will we step in our own trap, when this conflict escalates into a genuine economic war? Probably not!

‘ When Europe announces a new leg of sanctions, we will have to find out which people and companies are working in the Russian Federation and how they do this’, according to Putin during his April 29th visit to Minsk, the capital of Belarus. He seemed to emphasize that he could make life very difficult for companies working in the key industries of the Russian economy, like the energy industry. However, Putin also stated: ’Of course, we prefer not having to establish these counter measures’.

Gary Hufbauer, a specialist at the subject of international sanctions from thinktank Peterson Institute, stated against Bloomberg that Putin does have the power to make companies like Shell, ExxonMobil and BP bleed. Still, Putin will probably be reluctant to use these powers. He knows that when he hurts his trade partners and foreign investors, this will eventually blow up in his face. Hufbauer: ‘Although Putin shows that he knows how to play the game, he is not looking for further escalation’.

Michael Corgan, a professor at the University of Boston, emphasizes that the Russian economy is too small. Economic retaliation by Putin – irrespective whether it concerns hitting foreign investors in Russia or shutting down the gas tap for Europe – will hurt the $2,000 billion Russian economy simply much harder than the $16,800 bln American or the $17,400 bln European economy. 

Economist David Mackie of JPMorgan Chase stated:’ There will only be a meaningful impact when gas exports from Russia to Europe stall, or when the global confidence and risk appetite suddenly implode’.

When the Russian gas supply will be shut down, the question is whether this is a temporary glitch or a longer-lasting one. For a few months, the Euro-zone could endure without the Russian gas. The supplies are – especially due to the warm winter – sufficient for almost the remainder of the year. Only when the shut down of the gas delivery would last until the winter, things could get rough. In that case, the growth in the Euro-zone could drop to or even under zero percent, according to Mackie.

The dependency of Russia through other channels (exports, bank deposits and direct investments) is too limited to have a considerable effect.

There is more information and a number of interesting tables in this column, which makes it a particular good read. Further, I agree with Marcel and the involved economists that the whole EU exposure to Russia is fairly limited on a macro level.

Nevertheless, something is bothering me in this article. This is the gas component.

Every other Russian economic sanction can be overcome by the European economies, without blinking an eye. These sanctions can be extremely painful for individual banks, luxury car manufacturers, some large energy companies and especially small, exporting enterprises in the manufacturing and agricultural business. These companies could all lose a large share of their possessions or their sales revenues. But, that is about it!

The gas, however, is a whole different ball game… This gas is something that Russia owns in virtually unlimited amounts and that we need to maintain our daily lives in Europe, as it is fairly impossible to replace by a substitute fuel these days. Besides that, the Russian gas is delivered all over Europe through a vast infrastructure of pipelines.

The current Russia vs ‘Ukraine and the West’ crisis could develop itself in the wrong direction and turn into a long-term ‘battle of economic starvation’ from both sides. In this case, I am fairly sure that Vladimir Putin will not hesitate to shut down the gas supply to the West and Ukraine for a longer period, if he thinks that he must do so.

Putin has proven in the past, beyond a reasonable doubt, that he is capable of actually doing such things. Especially, as the Chinese would probably be more than willing to purchase the excess amounts of gas from Russia. The language ‘Mandarin’ has without a doubt an adequate translation for the German expression ‘Realpolitik’ and one man’s meat is another man’s poison, isn’t it?!

Of course, countries like Saudi Arabia or the United States would be more than willing to replace parts of the Russian gas supply to the EU, to not let Vladimir Putin win this economic, cold war. Still, this Arab or American gas would have to be shipped in by gargantuous tankers through the European seaports and afterwards it would have to be transported to its final destination; probably by inland vessels, trains and trucks.

This whole route is fairly dangerous, as mass transportation of gas outside pipelines always offers a substantial amount of risk to the surrounding environment, that a potentially devastating accident occurs.

And then the one million euro question remains, whether sea transport alone could offer sufficient gas to cover the needs of the whole European Union. I have serious doubts about that. And although the Dutch gas reserves in the province of Groningen still could last us for a few decades, this would probably only be enough to cover the needs of The Netherlands and perhaps Belgium and Luxemburg.

As the rising number of earthquakes in Groningen shows, the exploration of natural gas in The Netherlands is only suitable in fairly limited amounts and it is far from risk free. Besides that, the societal acceptance of gas exploration is waning for the inhabitants of Groningen, who are sick and tired of the increasing number of smaller and bigger earthquakes and the damage that has been caused to their houses during the last few years.

These circumstances cause that shutting down the European gas supply is much more than just a blunt weapon for Vladimir Putin. Consequently, while the financial / economic effects of Russian sanctions would be limited, the psychological effect of having insufficient gas in Europe could be very serious.

When the Russian gas supply would be shut down and when there is not enough gas available from other sources, people would litterally feel being ‘left in the cold’ by their government. Consequently, they would start to protest against this. These protests and the reaction of the governments against them, could cause considerable societal unrest. 

This is something to think about, when we are contemplating the Russian sanctions.