The war in Ukraine has turned against Russia and its authoritarian president, Vladimir Putin, with Ukrainian forces routing battered Russian units and retaking surprising amounts of turf in northeast Ukraine. But Putin still has some potent weapons he can deploy, and an energy war with the West is erupting in parallel with the military war in Ukraine.

Despite bruising sanctions, Russia remains the world’s third largest exporter of oil and natural gas, and in coming months, Putin seems very likely to test how much leverage that can provide against Ukraine’s American and European allies. Developed nations, led by the United States, are crafting a counteroffensive, to thwart Putin's effort to extort energy purchasers. Hundreds of millions of consumers are the potential collateral damage if Putin’s energy war inflicts the pain he intends, or the American-led blocking action backfires.

The most urgent threat is Russia’s throttling of natural gas to Europe. Russia has stopped gas flows through the Nord Stream pipeline, Europe’s single-biggest source of gas. It may halt other gas shipments, just as Europe needs the fuel for winter heat. Before the war, Russia provided about 40% of Europe’s gas. That's now down to about 9%. Despite aggressive weaning, Europe may simply not have enough gas this winter. European gas prices are six times higher than they were at this time last year and 14 times higher than they were two years ago.

European governments are considering price caps and other measures to limit the pain on consumers, but such measures have their own problems. A new UK price cap on household energy bills, for instance, undermines the incentive to conserve amid a supply shortage. That could cause the gas to simply run out.

“Price controls are going to encourage rather than discourage consumption, which means there are going to be blackouts,” Ed Morse, head of commodities research at Citigroup, said during a Sept. 9 webinar sponsored by the Brookings Institution. “The uncertainties around this winter are enormous. Winter in Europe is going to be the worst imaginable, in terms of power generation.”

'Many market participants believe Europe will relent'

Europe has scrambled to find new sources of natural gas, including shipments from the United States, the United Arab Emirates and other exporters. Goldman Sachs thinks Europe will avert a catastrophic winter, with prices declining if European gas supplies stabilize. Goldman forecasts price declines of about 50% for European natural gas during the winter, which would be a major relief—and a sign that Putin’s plan to freeze Europe has failed.

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But that’s just gas. In June, the European Union announced a ban on the purchase of most oil and oil products from Russia, beginning Dec. 5. The six-month delay was meant to give energy purchasers time to find new sources and prevent chaos in markets. If there’s a natural-gas crisis, however, the oil ban would go into effect just as Europeans are struggling to heat their homes and businesses are competing for scarce power. That could squash political support for the oil boycott, and force a delay or reversal of Europe’s ban on Russian oil purchases.

Markets seem to be betting the ban won’t happen as scheduled. “Many market participants believe Europe will relent,” Helima Croft, global head of commodity strategy at RBC Capital, said during the Sept. 9 Brookings event. “The view is there’s no possible way Europe can go forward with this sanctions package.”

Pricing underscores that view. Russia exports nearly 8 million barrels of oil per day, with about 5 million barrels going to Europe. If the European ban goes into effect on schedule, Europe would buy oil from other sources and Russia would try to find other purchasers, to make up for lost sales to Europe. But that probably wouldn’t go smoothly, at least not at first. Russia, for instance, would probably not be able to fully replace all lost European sales. The International Energy Agency thinks Russia’s overall exports would drop by about 20%. Since Russia is a major global oil supplier, that lost supply should push up prices, and do so well before the ban goes into effect, since traders lock in futures prices months in advance.

That isn’t happening. Brent crude, the European standard, peaked for the year at $122 per barrel in June, and has since dropped back to around $92. If markets anticipated a supply drop associated with the European ban, prices should be going up, not down. If markets are right, and the European ban slips or doesn’t happen, then prices make sense. But if the European ban holds, oil may be undervalued, with a price spike coming as Dec. 5 approaches. If that happens, US prices would rise too, given that oil is a global commodity and prices change in similar proportion everywhere.

Putin is also unlikely to simply go along with whatever Europe decides. It’s possible he could begin to withhold oil from global markets, to jack up prices and cause more trouble. That could jam up Russian oil producers, which can’t easily turn wells on and off, and don’t have much spare storage capacity. Plus, Putin needs the energy revenue to finance his assault on Ukraine. Still, Putin may get more reckless as his options dwindle.

“His best shot at this point is to break the resolve of the Western alliance by precipitating an energy crisis,” Craig Kennedy of Harvard’s Davis Center for Eurasian and Russian Studies said during the Brookings event. “He’s starting with gas, but I wouldn’t be surprised to see him winding down oil production as well.”

The price-cap plan

The US Treasury Department has a separate plan to reduce Russia’s energy revenue, which has remained buoyant during the war because of higher oil and natural gas prices caused by the war itself. Under that plan, the United States and many other advanced nations would form a buyer’s cartel paying no more than a set price for Russian oil—perhaps $20 to $40 per barrel lower than the market price. In theory, Russia would still sell oil at the lower price, because it would still be turning a profit, plus avoiding problems with shut-in oil. If enough large purchasers enforced the price cap, nations that don’t join the cartel—such as China and India—would still negotiate low oil prices with Russia, because they’d be saving tons of money. Russia would have trouble finding any nation willing to pay market price for its oil, if everybody else is getting a huge discount.

The price-cap plan isn’t finalized, and it may not go according to plan if the United States and allied nations do manage to roll it out. Russia would undoubtedly look for every possible way around the price cap, including pirated tankers and black-market transactions to disguise the origin of Russian oil. As Putin gets more desperate to punish Ukraine’s allies and salvage what he can from the Ukraine invasion, he may come up with novel ways to weaponize energy. Winter is normally chilly, but energy markets may simmer until Putin is either cornered, or defeated.

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