EXPLAINER: Russia wants gas payments in roubles. Will buyers make the switch?

President Vladimir Putin has said Russia, the world’s largest natural gas producer, will soon require “unfriendly” countries to pay for fuel in roubles, raising alarm about a possible gas crunch in Europe.

Gas buyers are seeking guidance on how such payments could be made, given that Russia and swathes of its companies are under sanction for the Kremlin’s invasion of Ukraine. Many warn the move may represent a breach of contract.

What is behind the change?

Russia’s economy has been dealt a crippling blow by Western sanctions, though the European Union, reliant on Russian oil and gas, has stopped short of placing curbs on energy imports.

Currently, nearly all Russian gas purchase contracts are denominated in euros or US dollars, according to consultancy Rystad Energy.

Payments in roubles would shore up the Russian currency which has plummeted since the February 24 invasion. Putin’s speech lifted the rouble 9% against the dollar on Wednesday, March 23.

Why does it matter?

Europe gets about 40% of its gas from Russia, paying 200 million to 800 million euros ($880 million) per day so far this year.

Dutch gas prices, the European benchmark, have spiked due to concerns over whether countries would be willing to pay roubles or even be able to.

Adam Posen, head of the Peterson Institute for International Economics, called it “a gambit by Putin to split the (EU/US) alliance.” If countries agreed to the demand, the “sanctions alliance erodes greatly,” he wrote on Twitter.

Is it legal?

Several buyers have said they will continue paying in euros as their contracts do not allow for a change in currency. Some legal experts say it is unlikely Russia can unilaterally change contracts’ terms.

“Contracts are made between two parties, and it is usually in US dollars or euros. So if one party unilaterally says ‘no, you’re going to pay in this,’ well, there’s no contract,” said Tim Harcourt, chief economist at the Institute for Public Policy and Governance at the University of Technology, Sydney.

Another complication is Western banks’ wariness of trading Russian assets.

“Even if a buyer is willing to pay in roubles, it may prove quite challenging given the sanctions put in place against a number of Russian banks,” ING Bank said.

If Russia insists on rouble payment, “this would potentially leave other parts of these contracts open to renegotiation, such as their duration,” ING added.

What would the mechanism be for rouble payment?

Bulgarian Energy Minister Alexander Nikolov said a counterparty in Sofia could handle transactions in roubles, “so there’s no risk for the payments under the existing contract.” He gave no details.

Claudio Galimberti, senior vice president at Rystad, said it is possible for Russia to devise new contracts requiring rouble payment but then, governments would need to hold roubles in their central banks or buy them on the open market.

Rouble payments are technically possible as sanctions are only partial, one banking executive with expertise in forex markets said. A Western buyer could pay euros or dollars to their bank, which would in turn send it to a Russian bank and ask them to pay Gazprom in roubles, he added.

It is still unclear whether Russia’s central bank can provide enough rouble liquidity to enable European clients to source the currency.

How will the switch affect counterparties?

The banking executive said Western banks are constrained in their Russia dealings. “Every single transaction goes through a thousand times more scrutiny,” he added.

Rouble trade will also bring currency risk, requiring Western banks to hedge exposure, raising transaction costs.

Foreigners would “need to be able to access a range of instruments, including repo and swaps, so they can manage liquidity and currency risks,” Renaissance Capital economist Sofya Donets said.

It’s unclear if this is possible, given Russia has implemented capital controls and curbed foreigners’ participation, she added.

Are there long-term effects?

While the rouble may enjoy a short-term boost, the shift would pressure Russia’s ability to service foreign debt and pay for imports, consultancy Capital Economics told clients.

If the measure is expanded, Russian commodity exporters will also see hard currency flows shrivel.

But a successful switch could contribute to reducing the dollar’s role in global trade, with long-term implications for US borrowing and financing costs. Countries irked by the frequency at which Washington applies financial sanctions would try to shift further away from dollar trade.

But could it be a false alarm?

The banking executive drew parallels with Russian bond payments, which Moscow had threatened to make in roubles rather than dollars. When faced with the prospect of default, Russia coughed up the dollars, he said, adding, “I think it is more about posturing.” – Rappler.com

$1 = 0.9087 euros