Living without Russian gas: What could the government do to manage a possible cut-off of gas from Russia?

The sanctions imposed on Russia since its invasion of Ukraine in February have had a devastating impact on its economy. Most severe was the move to reduce the Russian central bank’s access to its foreign exchange reserves, which has limited the bank’s ability to stabilise the rouble, the value of which has fallen sharply.

But Russia is still able to access a large flow of foreign currency in payment for its energy exports. Most of its energy contracts are denominated in dollars or euros and payments have increased due to the rise in energy prices over recent weeks. As a result, this trade could be providing Russia with as much as $1 billion in export earnings every day. This flow of foreign currency is being used to fund Russia’s imports and has helped stabilise the rouble.

This has led many commentators and politicians to argue for Europe to cut off energy imports from Russia with immediate effect. This would be an unprecedented escalation of sanctions, though the effect of such a move would also seriously affect the EU and UK economies.

This paper focuses on the impact of a cut-off of Russian natural gas. This is because while a disruption of Russian exports of oil and other fossil fuels would also have severe impact on prices, and likely require some response by government, gas is significant for two key reasons:

• First, gas markets are limited to particular regions (such as the EU and UK) by infrastructure – it is not possible to directly pipe natural gas from the US to Europe, for example. Therefore, prices and supply are set regionally. This means that disruption to gas exports is likely to lead to higher prices in Europe than disruption to oil because it is more difficult to substitute supply. For the same reasons, disruption to Russian gas would lead to the risk of physical shortages in Europe, while the corresponding risk for oil is much less acute.
• Second, gas is also particularly important to the UK and other EU countries for heating and electricity. In the UK, over 80% of homes are fuelled by natural gas boilers and almost 50% of its electricity comes from gas-fired power stations.

To manage the impact of a potential cut-off of Russian gas, governments across Europe need to plan now. This paper sets out some of the options the UK government has to mitigate any fallout from such a move – first looking at ways to target the root of the problem, by boosting alternative sources of energy supply or reducing demand, then ways it could step in to protect households and businesses from the effects of higher prices.