Putin’s Gas-for-Rubles Gambit Hits EU Fault Lines as Stakes Rise

(Bloomberg) — After suffering months of punishing sanctions, Vladimir Putin used a powerful tool to impose some economic pain on Europe — and to fracture the unity of his opponents — by shutting off natural gas this week to a pair of NATO members.

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The Russian president’s decision to cut off Poland and Bulgaria and the risk of more disruptions hits Europe where it really hurts, and where the bloc is least prepared to adjust. The continent needs several years to arrange alternative supplies to power its industry and heat its homes, but Putin forced the issue with his sudden announcement last month that he wouldn’t accept anything but rubles for shipments after Apr. 1.

Now, with more payments for that fuel coming due next month, Europe will see if he’s bluffing. The Kremlin has already said more cuts will come if it doesn’t get its own currency. The European Union warned that accepting Moscow’s terms would breach sanctions, but some countries that aren’t ready to go without Russian gas sought workarounds or edged toward accepting Putin’s terms.

Several European companies are trying to proceed with business as usual. OMV AG, Austria’s biggest fossil-fuel company, said it expects Russian natural gas flows into Europe to continue. Italian energy giant Eni SpA has made preparations to be able to comply with Putin’s demands.

Raising the stakes further will be risky for both sides. Poland and Bulgaria can get along without Russian gas supplies, but cutoffs to major buyers like Germany or Italy could throw the continent into recession. For Putin, Poland and Bulgaria were easy targets — critics of the war in Ukraine that account for less than a tenth of Russian exports. Turning off the taps on bigger buyers risks cutting off the flood of foreign currency that’s helped the Kremlin fund the war, as well as protect the economy and the ruble amid the sanctions onslaught it brought.

Putin regularly highlights the price spikes and other disruptions surging energy costs have brought to Europe, even as he plays down the more dramatic impact of sanctions at home. But Moscow has regularly underestimated the U.S. and European commitment to stand up to the Ukraine invasion, surprised first by the breadth of sanctions, including on the central bank, and then by the extent of military aid to Kyiv, which has helped stymie the Russian advance.

The ruble requirement helps shore up the currency by creating more demand and could protect Russia’s export income from EU sanctions or seizure. But the main benefits for the Kremlin seem to be political.

Putin’s move has landed the EU in unknown territory, an EU diplomat said. The bloc had hoped that its first bursts of sanctions would be enough to destabilize Putin, possibly by triggering a run on Russian banks, the diplomat added.

Read more: Why Putin’s Demand for Rubles Has Europe Scrambling: QuickTake

For now, the EU is trying to paper over divergences between member countries, who have largely been able to ignore a range of other simmering spats to unify against Russia. Countries like Poland and the Baltic state have been demanding a tougher stance on Russia over its war in Ukraine, but those who rely largely on Russian supplies, like Germany, Austria and Hungary, have sought to ensure sanctions hurt Putin more than Europe.

Officials of the European Commission, the EU’s executive arm, said companies won’t be in breach of the bloc’s sanctions if they only open an account in euros and declare their obligation complete. Whether Moscow will accept this has yet to be determined. And to make a potential solution even more complicated, Slovakia signaled recent demands by Gazprombank could mean that even opening an euro account could breach the sanctions.

The commission’s stance has failed to satisfy many companies and governments. Several ambassadors from EU member states asked for more clarity at a closed-door meeting in Brussels on Wednesday. The EU’s next move is expected in time for an emergency meeting of the bloc’s energy ministers in Brussels on Monday, perhaps with further guidance from the commission.

Hungary, which says it plans to continue buying Russian gas, rejected accusations it plans to violate sanctions and said companies in other countries are quietly doing the same. “Please don’t spread the lie that Hungary is breaking ranks with some sort of common European position,” Foreign Minister Peter Szijjarto told reporters on Friday. “It’s not true, the others are just aren’t being this honest.”

Read more: Europe Starts Splintering in Its Response to Russia’s Gas Threat

The EU is unlikely to change its guidance, according to an official familiar with the matter. Its guidelines on the Russian decree are purposefully ambiguous, according to another diplomat, because the EU is concerned that a hardline stance could prompt Putin to shut off gas abruptly, and wants to buy time to boost stocks. The bloc is also trying to keep the door open to potential compromises on the legally complex issue.

Part of the EU’s response to Putin’s decree will be a sixth package of sanctions that is expected to target Russian oil — a top source for Russia of foreign currency. The commission is expected to start presenting its latest proposals to groups of ambassadors as early as this weekend.

Read more: Germany Says Won’t Block Embargo on Russian Oil to Punish Putin

The gas fight comes as the EU is seeking to boost its depleted gas reserves before the next heating season. National governments and the European Parliament are currently fast-tracking a regulation that requires countries to ensure that storages are filled up to 80% before next winter and 90% in the following years.

The European Commission said last month the bloc could replace nearly two-thirds of Russian gas imports this year by tapping alternative supply sources, building up renewables and boosting energy security. On May 18, the commission is set to present a set of laws to implement the plan.

The Kremlin is well aware that its gas leverage won’t last. For the moment, Russia has sold about 21 billion euros ($22.2 billion) in pipeline gas to Europe since the start of the war on Feb. 24, accounting for nearly half the Kremlin’s energy sales to the continent, according to estimates by the Center for Research on Energy and Clean Air, a think tank.

In addition to the financial pain, cutting off that flow completely would also force Russia to shut many of its Siberian gas wells, since it doesn’t have other free pipeline routes to resell the fuel to other customers. In contrast, Russia has been able to divert substantial amounts of its oil exports to buyers in Asia as Europe has cut its purchases in recent weeks.