Olly Bartrum warns that the UK government should do more to prepare for the high prices and supply problems that the UK would face if Russia’s gas exports to Europe are cut off
The majority of Russia’s energy trade (which comprises natural gas as well as oil) remains untouched by sanctions. The US and the UK have announced that they will stop importing Russian oil, but this only accounts for 5% of Russia’s oil exports. The EU has not banned Russian energy imports, the gas trade remains untouched by official sanctions, and the main Russian banks that process energy transactions (Sberbank and Gazprombank) have been excluded from the SWIFT ban. This means the Russian government continues to have access to a ready supply of foreign exchange reserves (despite the sanctions on its central bank) because the country continues to receive around $1bn a day in foreign currency for its energy exports.
There is much further that West could go, either by extending the financial sanctions or by curtailing imports of Russian gas. So, as the conflict continues, there is a real possibility that Russian energy exports could get (partially) cut off due to an escalation of sanctions by the West or retaliatory action from Russia. This would have severe consequences for EU economies and, contrary to the current narrative of the government, for the UK, which is integrated into global energy markets.
The UK government is reportedly working on an ‘Energy Supply Strategy’ which focuses on an expansion of oil and gas extraction from the North Sea, but this alone would barely move the dial on prices in the short term. A comprehensive response is likely to require further targeted support for low-income households and UK cooperation with the EU to prevent energy shortages in the event of further disruption to Russian energy.
The government's argument that “the UK is not dependent on Russian gas supply” is misleading. Although the UK (unlike the EU) imports only a small amount of gas directly from Russia, EU and UK gas prices move together because their markets are connected. Moreover, because gas-fired stations are used to manage fluctuations in electricity use, UK wholesale electricity prices follow the same pattern as gas prices. As a result, any reduction in gas supply from Russia to the EU will have an effect not only on energy prices in the EU but also on the prices for gas and electricity faced by households and businesses in the UK.
Any disruption to energy supplies – ranging from light disruption due to tighter financial sanctions to a complete cut-off of imports – would cause a spike in prices that would pass through to inflation, exacerbating the cost of living crisis. To prevent a large proportion of households from sliding into fuel poverty, the government would need to take further action to limit the impact of rising prices on the most financially vulnerable households.
The government’s package of support announced in February to mitigate energy price rises was very broad based, making it expensive and risking some of the most vulnerable facing financial distress. In the event of further price rises, support should be more targeted to protect those most in need. While rising energy costs affect everyone, the impact on the poor is particularly severe because they have less disposable income – and any financial distress among this group can have significant second round effects on the economy because it feeds through to lower consumer spending (rather than lower savings, as is the case for higher income households). Moreover, middle- and high-income households have built large stocks of savings during the pandemic that will help to cushion the blow.
A complete cut-off of Russian energy supplies could well lead to energy shortages across Europe next winter. Although higher energy prices will reduce demand, it may not fall sufficiently to match lower supply – in part because price controls will limit price rises. Because the UK and the EU are connected by gas pipelines and use the same alternative sources of gas – North Sea, Norway, North Africa and liquified natural gas (LNG) imports) – any shortage of supply from Russia will affect the UK as well as the EU.
When the UK was an EU member it was part of formal agreements that governed the response to energy shortages. In particular, there was an obligation on the UK to agree with other EU countries in the North Sea region on a plan to preserve energy supplies for households in case of supply problems, for example by shutting down non-critical industries. The UK is no longer obliged to join EU efforts to curtail demand, and could technically refuse to participate in efforts to forcibly curtail energy consumption. While imposing restrictions on energy use would certainly have a short-term economic cost, if the UK failed to take any action – and the EU faced blackouts as a result – the UK may be seen as free-riding on the EU and risk fracturing what has been a united European response to Russia’s invasion of Ukraine. At the same time, efforts to increase energy supply (such as increasing LNG imports) or reducing demand will need to be coordinated and implemented at scale across the continent if they are to have a discernible effect on the price and availability of UK and EU.
Taking sanctions further would inflict acute damage on the Russian economy and put substantial pressure on the Russian government by cutting off its most important source of foreign currency. But it would also come with significant costs for the UK and the EU. To be ready for this scenario, the government needs to make plans for providing more targeted support to disadvantaged households and, prepare to cooperate with European neighbours to manage scarce energy supply.
- Kwasi Kwarteng, Twitter, 8 March 2022, https://twitter.com/KwasiKwarteng/status/1501229857987960834