Europe scrambles for natural gas solution as Putin squeezes supply

Source: CNBC

The European Union is racing to find alternative suppliers of natural gas after Russia's Gazprom cut flows to two EU nations, sparking fears that others will soon follow.

EU Commission President Ursula von der Leyen said this latest aggressive move by Russia is another reminder that we need to work with reliable partners and build our energy independence.

The developments come as Brussels is fearful about nations and energy firms circumventing strict international sanctions on Russia — imposed on Moscow in the wake of its unprovoked invasion of Ukraine.

Gazprom, Russia's state-owned energy firm, cut supplies of natural gas to Poland and Bulgaria earlier this week after both nations refused to pay for the commodity in rubles — something that President Vladimir Putin requested amid growing Western support for Ukraine.

The decision puts further pressure on the EU, which imports roughly 40% of all its natural gas from Moscow, to find alternative solutions.

"It contributes to opening the eyes of those who were still thinking Russia would not use gas as a leverage," one EU official, who did not want to be named due to the sensitive nature of the situation, told CNBC about Russia's latest move.

European Commission President Ursula von der Leyen went further Wednesday, accusing the Kremlin of blackmailing the bloc.

Kremlin spokesman Dmitry Peskov dismissed accusations that Moscow was using its gas supplies to blackmail European nations Poland and Bulgaria, saying Russia was a reliable energy supplier. He also declined to say how many countries had agreed to switch to paying for gas in rubles, Reuters reported.

But the pressure could escalate if Gazprom chooses to cut supplies to other EU nations. The Kremlin warned Wednesday that other countries will face the same issue if they do not pay in rubles — something that the commission, the executive arm of the EU, opposes as it would breach current sanctions.

"Russia's move to halt gas flows to Poland followed Berlin's decision—under intense political pressure—to supply Ukraine with air-defense weaponry. The implied threat is that Russia will cut off Germany's gas supplies if Berlin continues to ship arms to Ukraine," analysts at Gavekal, a financial research firm, said in a note Thursday. "The economic effects would be catastrophic," they added.

Ruble payments

As such, the commission has been working on becoming less dependent on Russian gas. It signed an agreement with the United States, earlier this year, where the EU will receive at least 15 billion cubic meters of liquefied natural gas this year.

"We are working hand in hand with our Member States to secure alternative gas supply from other partners, too," von der Leyen also said Wednesday.

In the meantime, Brussels will have to decide how to keep paying for Russian natural gas without breaching the bloc's own rules. Russia issued a decree in late March saying European companies will continue to pay for gas in euros to Gazprombank — an institution that is not part of European sanctions — and then this cash would be converted into rubles in a secondary account opened by these energy firms.

The EU has decided to keep paying for Russian gas in dollars and euros to Gazprombank and then the institution converts it to rubles when sending the money to Gazprom. This is after Russia's gas firm decided to cut supplies to Poland and Bulgaria for not paying for the commodity in rubles.

But this is where the commission has concerns. The institution wants to make sure that once European companies make the first payment in euros, then the contractual obligation is actually met.

The commission is also wary of European companies having a second account at Gazprombank and the Central Bank of Russia coming into contact with that cash, potentially breaching European sanctions.

"EU and European officials continue to warn companies that making ruble payments to Gazprom would breach sanctions," analysts at consultancy firm Eurasia Group said Thursday in a note.

The solution that's on the table is having Gazprombank make the conversion into rubles and paying that amount into a Gazprom account.

Hungary, for example, said Thursday that it will allow the conversion of their gas payments from euros and dollars to rubles, as demanded by Putin. Media reports said that nine other nations are also paying for their gas in euros to Gazprombank, which then converts them.

German Economy Minister Robert Habeck has said that doing so could be compatible with the sanctions that are in place. Either way, the matter further clouds Europe's worsening economic outlook.

Speaking to CNBC Thursday, Italy's central bank governor, Ignazio Visco, said that if Russia were to cease all supplies of gas, then his country would be in a recession later this year and the next, albeit a modest one.

Earlier this week, the CEO of UBS Ralph Hamers also expressed worries about how changes to natural gas supplies could dent the economy.

"Russian gas that's a different — a much bigger challenge and that is really because large part[s] of industries are dependent on gas as their base commodity to make their product ... so that's what could cause the second order effect specifically in the European economy," he told CNBC's Geoff Cutmore.