Economic sanctions are the main Western response to Russian military threat in Ukraine. On paper that means a lot, because the power difference in this area is enormous. The economy of the joint NATO countries is tens of times larger than that of Russia itself. However, sanctions are not without risks: if Russia is punished, Europe in particular will also cut its own flesh, because Russia’s entanglement with the EU is not small.
The Finnish BOFIT Institute, a major source on the Russian economy, states that half of all oil produced in Russia, half of its oil products and almost two-thirds of its gas finds its way to the EU. In total, the EU, together with the UK, accounts for 42 percent of total Russian exports. Conversely, a third of all Russian imports come from the EU.
This entanglement is also financial: Russian direct investments abroad account for 380 billion dollars (335 billion euros), half of which is in the EU. Russian banks have assets worth 130 billion abroad, of which, again, half are in the EU.
That seems like a good target for sanctions, but the vulnerability is also great the other way around: foreign direct investment in Russia itself amounts to $480 billion, plus another 180 billion in investments. It should be noted, however, that much of this money is actually of Russian origin and enters the country via, for example, Cyprus – a third of European investment flows into Russia via this route.
As can be seen with the gas, on which Europe is highly dependent, sanctions will also hurt the EU countries themselves. How much pain depends on the scope of the sanctions themselves, and on the course of the conflict on which the use of those sanctions depends.
gas and oil Prices stabilize after sharp increase
A barrel of oil for almost 100 dollars and a gas price that has risen more than 10 percent this Tuesday. These are the visible consequences on the energy market of Russia’s military action in Ukraine.
After the sharp increase, prices remained stable for most of Tuesday. A new spike occurred early in the afternoon when German Chancellor Olaf Scholz announced that he was temporarily suspending approval of Nord Stream 2, the pipeline from Russia to Germany. As a result, gas became a further 2 percent more expensive.
The price movements show the power of Russia as a gas and oil producer. Partly due to the increased tensions in Ukraine, energy prices have been at a high level for some time. It is the first time since 2014 that a barrel of oil, the European benchmark Brent, costs almost 100 dollars. That price level is the result of a gradual increase. In August, a barrel cost about $66 and a highest price of $97.84 was recorded on Tuesday. Given the increase of more than 3 percent on Tuesday, there is no question of a panic reaction. Russia accounts for more than 10 percent of global oil production, but its role as a gas supplier is more important for Europe.
On Tuesday, gas cost 80 euros per megawatt hour, an increase of 10 percent compared to the day before. To put it in perspective: there is no record for a long time. Much higher peaks were reached last autumn, with 21 December as the provisional high. Then the gas price registered a record of more than 166 euros.
Not only the tense situation around Ukraine had been factored into the price for a long time. In many countries, including the Netherlands, fewer stocks will have been built up in 2021. Added to this were the tensions surrounding Nord Stream 2 and the relatively limited supplies of the Russian state gas company Gazprom.
Europe gets 30 to 35 percent of its gas from Russia. Some Eastern European countries are almost entirely dependent, while the share of Russian gas in the Netherlands – an estimated 15 percent – is much lower. Yet Gazprom’s role has only grown in recent years. Production in Groningen has fallen drastically, the other gas fields in the Netherlands (outside Groningen) are at their maximum capacity and the same applies to supplier Norway.
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Raw materials Sanctions create scarcity
In addition to commodities such as oil and gas, Russia also exports many types of metals. The European Union depends on Russia for a considerable list of important materials. For example, 40 percent of palladium – a scarce silver-white metal – comes from here. This substance is widely used in catalytic converters of vehicles, jewelry and dentistry. Vanadium, of which 32 percent of the import comes from Russia, is often processed in steel.
But for many more raw materials, Russia is an important trading partner, such as aluminum, nickel or phosphate (an important ingredient of fertilizer). Many sectors could be confronted with (even) higher prices, scarcity and long delivery times due to a further escalation of the conflict on the eastern Ukrainian border. Many industry in Europe will therefore run into problems due to sanctions.
The dependence on other countries for the supply of raw materials that are critical to the European economy has been under discussion for years. Especially with regard to the energy transition, Europe still gets too many raw materials from China and Russia, said the French Minister of Ecological Transition, among others. Barbara Pompili last December†
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Wheat and corn Disruption of the trade flow of agricultural products
No country exports as much wheat as Russia. Together with Ukraine, the number 5 on the list of wheat exporters, it provides many millions of people with one of the most important nutrients, from Bangladesh to South Korea and Egypt. If the conflict on the eastern Ukrainian border, where much agriculture takes place, escalates further, there is a risk that this critical trade flow will be seriously disrupted.
That means millions of people are at risk of even more food insecurity than there already is. World food prices have risen rapidly since the start of the pandemic in 2020. According to the Food and Agriculture Organization of the United Nations (FAO), (nominal) prices have not been this high since 2011. Worsening food scarcity could fuel domestic conflict, wrote the Center for Strategic and International Studiesan American think tank, in early February.
Egypt is such a precarious country: 60 percent of wheat imports in 2020 came from Russia, and another 25 percent from Ukraine. This great dependence also applies to Turkey, where 75 percent of wheat imports came from the two countries that same year. Turkey would soon see the economic crisis worsen domestically due to already skyrocketing inflation. Food prices already rose by 55 percent in January compared to a year earlier.
Also, many countries depend on maize from Ukraine (number 4 on the list of exporters). For example, in 2020 both China and the Netherlands obtained more than half of the total maize imports from the country. This also applies to other nutrients, such as grain. For example, Lebanon and Libya depend on Ukraine for 50 and 43 percent of grain imports, respectively.
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Financial world ECB already sounded the alarm weeks ago
European banks have been warned for a few weeks now: an escalation of Russian aggression against Ukraine could affect you too. The European Central Bank, the supervisor of the major banks in the eurozone, sounded the alarm at the end of January. Some European banks are active in the Russian market, where there is a risk of recession. And all of them, in the event of severe financial sanctions by Europe or the United States against Russia, must be careful not to violate those sanctions, under penalty of hefty fines.
Banks’ exposure to Russian customers – individuals or governments – is highest in Italy, France and Austria, according to data from French economist Eric Dor of the IESEG Institute in Lille. In Italy and France it is just under 20 billion euros (UniCredit, Société Générale), in Austria (Raifeissen) 14 billion euros. This is followed by the United States, Japan, Germany and the Netherlands, where ING has provided around 5 billion euros in credit to Russia, the bank recently reported to the ANP news agency.
UniCredit is already getting hot underfoot. Bank chief Andrea Orcel was in a video call with President Vladimir Putin at the end of January, along with other Italian businessmen. Moments later, UniCredit announced that it would not take over the Russian bank Otkritie – for “geopolitical” reasons.
A severe financial sanction against Russia that has been discussed in recent weeks is the ban on Russia’s access to Swift, a cross-border cross-border bank network that is managed from the US. This would also severely affect non-Russian financial parties doing business with Russia. But this option is reportedly now off the table, because it would complicate payments (including for Russian gas) too much. It would also accelerate Russian (and Chinese) efforts to build an alternative to the American-dominated system. Sanctions against individual Russian banks will come. These were announced on Tuesday by the United Kingdom and the EU.
Much of the money flows between Russia and other countries are anything but transparent. Wealthy Russians have deposited hundreds of billions of dollars abroad. Money flows go through Cyprus or through the Netherlands – and often end up in London or in tax havens. If these assets are affected by sanctions, this will also affect Western financial parties that profit from this in one way or another.
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