The Russian annexation of Crimea has resulted in a series of sanctions by the West. So far the sanctions (asset freezes and travel bans) imposed on key individuals of the Russian government and business elites, followed by similar sanctions on some key members of the US and the EU by Russia in retaliation, have had a limited impact on the two sides. However, the US and Europe have been threatening Russia to levy further economic sanctions if the latter continues to move further in Ukraine. The key issue, however, is whether EU can afford to impose trade sanctions on Russia that would block the energy exports that Europe relies upon. This can be analysed in the context of the composition of bilateral trade between Russia and the EU and the impact of economic sanctions on various members of the EU.
After a brief interruption during the 2008 economic crisis, trade dependence between the EU and Russia has been rising since 2010, reaching a record level in 2012 (with exports worth EUR 123.4bn and imports EUR 215bn)[i]. The EU is Russia’s most significant trading partner, while the former is the third key trade partner of the latter. However, there is a notable difference in the nature of dependence between the two. While the major imports to the EU from Russia are mineral fuels and lubricants (accounting for around 84% of total imports from Russia), the Russian economy depends on EU chiefly for machinery and transport equipment (50% of total exports from EU to Russia), as well as chemicals and manufactured goods[ii].This huge reliance of the European states on Russian oil and natural gas will prove to be a major hindrance for the European Union to extend economic sanctions on Russia.
Now, suppose the EU imposes trade sanctions on Russia, this would inhibit energy supplies into the European countries. Thus, it becomes important to see which countries rely heavily on Russia for their crude and natural gas resources. The EU’s most integral country, Germany, is Russia’s largest gas customer. Since it imports around one third of its total oil and gas imports from Russia, the export-oriented German economy remains extremely vulnerable if trade ties with Russia are disrupted[iii]. Furthermore, the Baltic States (importing around 75% of their energy requirements from Russia, with Lithuania’s dependence alone exceeding 90%), Poland (69%), Greece (38%), Netherlands (21%), France and Italy (both around 18%) are other countries which remain exposed to the Russian oil and gas[iv]. In fact, a freeze on Russian energy imports would result in a catastrophe for European countries, in particular for the Central and Eastern ones. It would also have broader economic repercussions as Russia is one of the major oil producing countries in the world.
There is no denying the fact that cutting gas supplies to Europe will hurt both sides as they are major trade partners. Russia generates most of its revenue by supplying its oil and gas to EU countries. As per the state-owned monopoly, Gazprom, Russia sells approximately three-fourths of its gas exports to Western Europe[v]. Moreover, the Russian economy is currently facing a slowdown (GDP growth declined to 1.3%y/y in 2013 and is expected to deteriorate further this year).[vi] Also, the prolonged Russia-Ukraine crisis is further impairing investor confidence, leading to accelerated capital outflows. Thus, given the current situation that Russia faces, trade sanctions are going to have a deleterious impact on the country.
However, as Russian gas still dominates the European market and fuels and lights their economy, Russia has leverage against the European Union. In fact, Russia had been using its energy economics as a diplomatic tool to maintain its influence and control over European countries. It curtailed gas supplies to Ukraine in 2006 and 2009, leading to troubles in Europe since about half of the Russia’s gas to the EU comes through Ukraine[vii]. The recent restrictions on gas supplies to Ukraine following the annexation of Crimea have once again raised tensions with the European Union.
Thus, it can be said that Europe is not in a position to impose trade sanctions on Russia unless it reduces its energy dependence on it. Diversifying the EU’s energy sources would allow it to hurt Russia’s energy sector (which generates around half of its government’s revenue), and thereby effectively punish Russia for its military intervention in Ukraine. The EU has been worried about its reliance on Russian oil and gas and has tried to diversify its energy sources but so far the supplies from elsewhere cannot replace those from Russia. Norway has turned out to be a competitor to Gazprom and there are further opportunities to expand its natural gas production. LNG supplies from the Netherlands can also be enhanced. In addition, Algeria has the capacity to export Liquefied Natural Gas (LNG) to Europe. However, these LNG sources would be cost prohibitive when compared to Russian supplies[viii]. Shale gas from the US is considered to be another alternative which can help to reduce the EU’s dependence. The Obama administration has been pressed to expedite the production of shale gas which can then be transported to European countries. However, it will take several years before it could replace the current gas supplies from Russia as proper transportation channels need to be built. Another alternative is a technology transfer from the US. The ‘hydraulic fracturing’ technology and horizontal drilling being used in the US can also be used for shale gas production in European countries such as Britain, France and Poland, where researchers have found existence of extensive gas deposits. However, there are concerns about the environmental damage of using this technology[ix]. Hence, the dependency on Russian gas cannot be eased anytime soon.
Relations between the two countries go beyond oil and gas. Russian tourists are a source of income for a number of European countries, including Italy, Spain and Greece. In addition, there are investment relations between Russia and large countries like the UK and France.
Therefore, levying economic sanctions upon Russia does not seem to be a promising solution for the EU to prevent Russia from further destabilising Ukraine. Any decision by the EU regarding an extension of sanctions upon Russia will be taken after due consideration is given to its economic needs, as retaliation from Russia is likely to have serious consequences for European countries.
Photo credit: picture-alliance/dpa
[i]Eurostat Press release: “EU-Russia summit”, January 24, 2014, http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/6-24012014-AP/EN/6-24012014-AP-EN.PDF
[ii]Eurostat data: “EU28 trade by SITC product group”
[iii]Bloomberg: “Merkel, Hollande warn on Russia sanctions revealing EU split”, March 20, 2014
[iv]Figures in brackets show extent of share of mineral fuels and lubricants imports into these countries from Russia to total such imports into respective countries, with data taken from UN Comtrade Database
[v]CS Monitor: “Why Europe can’t hit Russia with its biggest club: energy sanctions”, March 18, 2014
[vi]The Moscow Times: “OECD slashes Russia growth forecast”, May 6, 2014
[vii]Deutsche Welle: “Germany’s Russian energy dilemma” , March 29, 2014
[ix]CS Monitor, op. cit.