EUROPE ASIA FOUNDATON - Insight
A former senior Indian Ambassador offers his perspective on the war in Ukraine
After the end of the Cold War, lines are being drawn across Europe again. The Ukraine crisis has forced Chancellor Scholz to announce an increase in the German defence budget to 2 per cent of GDP. Since the war began on 24th February, the Brent crude price has jumped from $95.42 per barrel to touch a peak of $139 per barrel on 7th March following the announcement that Biden Administration was considering a freeze on Russian oil imports. Though it has since come down to $107.3 per barrel, it can resume its upward trajectory in case sanctions are deepened against Russia. EU depends upon Russia for up to 40 per cent of its gas requirements. Unlike oil, gas import needs elaborate infra-structure in terms of pipeline or LNG terminals. It will not be easy to make alternate arrangements on the scale needed. The energy crisis has eclipsed the climate agenda with governments scrambling to tie up more fossil-fuel supplies in the immediate context. The war in Ukraine has rendered more than 3 million people homeless. The refugee burden will strain the economy of neighbouring countries unless conditions are restored for their return.
A sharp hike in oil and gas prices could tip the world economy into recession. The immediate precursor of the financial crisis of 2008 was an increase in oil prices to $147 per barrel. If secondary sanctions are imposed on Russian exports, oil prices could easily cross $150 per barrel according to an estimate by McKinsey (1). Gas prices in Europe have already crossed Euro 118 per MWh. Though the US has offered to supply 15 billion cubic meters (bcm) of LNG to the EU in 2022 (2), this is barely 10 per cent of Europe’s annual imports of 155 bcm of gas from Russia (3).
Russia exports 5 million barrels per day (mbd) of crude oil. Out of this nearly 3 million barrel per day is imported by EU (4). It will be difficult to find a replacement for Russian oil exports at this scale. Shale production cannot grow by more than 1.4 mbd this year according to an estimate by JP Morgan Global Research (5). If the sanctions against Iran are lifted, this could bring an additional 1 million bpd of crude to the world market. Together, Shale oil and Iranian supply will still fall short of the volume of Russian exports. Besides, increasing Shale oil production will take time.
While further deepening of sanctions against Russia will hit the EU economy, the Russian economy is already affected. Russia cannot use its dollar reserves. Though the EU continues to buy Russian oil and gas, oil contracts are mostly denominated in dollars. Russia has asked for payment in Russian roubles; this demand has been rejected by EU countries. The EU and Russian officials have discussed a euro-rouble swap mechanism. This would avoid forcing companies to buy roubles from the central bank (6). While both sides have an interest in averting the immediate crisis, there is no mistaking the long-term trend of Europe diversifying away from Russian supplies. Russia may lose its most valued customer. China buys much less of Russian oil and gas.
Ukraine and Russia are two of the world’s largest wheat exporters. The war has increased the price of wheat, a staple diet in many countries. The steep increase in food prices had accompanied the hike in oil prices in 2007, which was one of the contributing causes of the 2008 financial crisis.
Wars have complex causes, and the consequences often go beyond the calculations of either side. The Ukraine war started with Special Operations undertaken by the Russian forces. Behind Russian actions lies their fear of NATO expansion to their immediate border. Writing in 2014, Henry Kissinger had cautioned that ‘Ukraine should not join NATO’ (7). His advice was ‘if Ukraine is to survive and thrive, it must not be either side’s outpost against the other - it should function as a bridge between them.’ This remains as valid today as it was then.
There are no winners in this war. The Ukrainian people have suffered, NATO’s prestige is dented and Russia has to accept that there is no military solution to its quest for security. It has an interest in a secure neighbourhood and an outlet on the Baltic Sea. It has larger interests in EU markets for its energy exports and avoiding the start of a fresh arms race with the US and its European neighbours. During the Cold War, it did not depend on western markets. The dependence is mutual and limits their options.
There are 5 steps to the process of returning to normalcy. De-escalation should begin with an immediate cease-fire. Second, there should be an affirmation of Ukraine’s territorial integrity and sovereignty. Helsinki Conference affirmed that the borders in Europe should not be changed by force. The principle remains valid today. Third, Ukraine on its part has to confirm that it will not be part of NATO or any bilateral defence arrangement against either side. Fourth, Ukraine should be provided security guarantees by US, EU and Russia. Fifth, any ambiguity about Russia’s Black Sea Fleet at Sevastopol should be removed as suggested by Henry Kissinger.
The EU could help in welcoming Ukraine to membership of the European Union. This will satisfy one of the key demands of Ukraine, without raising any security issues. Russia could contribute to Ukraine’s reconstruction. Sanctions have to be phased out. They did not bring about a cessation of war. Their continuation would not only deprive Russia of exports revenue but also increase the cost of energy to Europe.
The alternative to a cooperative approach will be continued confrontation. Currency war will create an impetus for finding alternatives to the use of the dollar as an international reserve currency. Its share of global financial transactions has come down from 70 per cent to 60 per cent already. As IMF pointed out, this could result in fragmentation of the international payment system into regional arrangements, though the Chinese Yuan cannot be a replacement for the dollar (8). It is not freely convertible and lacks transparency. High energy prices could tip the world into recession. Diversifying energy sources is not easy. The US has offered 50 BCM LNG by 2030. This will take a decade, and still amount to only 1/3rd of the current volume of 155 BCM gas supplied by Russia to Europe. By then EU’s demand would have gone up. Switching to renewables does not quite fill this gap. Being intermittent, they need to be supplemented by a stable energy source when the sun is not shining and the wind is not blowing. This balancing power is supplied by gas in Europe. An increase in renewable share in the grid has the paradoxical effect of increasing the need for gas. The crisis has already undermined the climate agenda with countries changing focus from clean energy to energy security.
Worsening relations between Russia and the west would be a boon for China. Russia would be more dependent on her for market and political support. In turn, it will be more amenable to providing sensitive technology and natural resources to China. Assured of a safe hinterland, China will have a free hand in Asia-Pacific. This does not auger well for Taiwan’s security. The Soviet challenge to the West during the Cold War was limited to the military sphere. China offers competition both in economic and military fields. It is an economic competitor to the EU; it offers a growing military challenge to America. The EU and China concluded their virtual summit on 1st April with President Xi calling on the EU ‘to pursue an independent policy towards China’ (9). China would like to wean the EU away from the US. EU is China’s biggest market; Russia is a strategic partner. China would like to have both. Ukraine in the meantime needs peace urgently.
D. P. Srivastava
The author is a senior fellow of the Vivekananda International Foundation. He is a former Indian Ambassador to the Islamic Republic of Iran, before which he was Ambassador to Czech Republic and Libya and Indian High Commissioner to Malta.
2 April, 2022
Surging Oil Prices Could Spark A Global Recession, March 26, 2022
Oil Price, EU Intake of Russian Gas Remains High Amid Lower Wind Output, March 25, 2022
FT, Can US natural gas relieve Europe from Russian supply dependency, March 29 2022
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Russia sanctions threaten to erode the dominance of US dollar, says IMF, 31st March 2022
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