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Market Extra: ‘Energy is being increasingly weaponized.’ Analysts weigh up risks after Russia cuts gas to two EU countries

For now, a cutoff of Russian gas to two European Union countries is manageable, but the situation would shift dramatically stoppages should extended to bigger countries such as Germany, say analysts.

Futures tracking Europe’s wholesale gas price reached a high of €119 per megawatt hour in early trading Wednesday, before paring back to €105.79, a gain of around 4%. The euro
EURUSD,
-0.25%

was under pressure, while European stocks
SXXP,
+0.47%

pulled back from earlier losses, as U.S. equity futures climbed.

State-controlled Russian giant Gazprom
RU:GAZP,
said Tuesday that it had cut natural gas deliveries to Poland and Bulgaria as they refused to pay in Russian rubles, as demanded by President Vladimir Putin.

“Today’s events can work as an added incentive for the EU, and especially Germany, to find a way to work out a RUB payment mechanism given the significant economic toll a halt in gas flows would have in the region, which would be much greater than that of Poland or Bulgaria,” said a team of Goldman Sachs commodities strategists, led by Samantha Dart, in a note to clients.

While “very unlikely,” a full interruption of Russian flows to Germany could drive European gas prices to over €200 /MWh this summer, warned Goldman.

Poland said it has ample supplies to cope with the shut-off, and has been preparing for this possibility, while Bulgarian officials said they were seeking other sources.

Commerzbank analyst Carsten Fritsch said the Polish gas cutoff affects the Yamal pipeline, which hasn’t played a big role in suppling gas to Europe in recent months. Gas flows to Germany via that pipeline account for less than 2% of Russia’s pipeline deliveries to Europe since the beginning of the year. 

Four European gas buyers have paid for gas supplies in rubles, and other potential cutoffs aren’t likely until the next round of payments are due later in May, Bloomberg reported on Wednesday, citing a source close to Gazprom.

Still, Germany was reportedly meeting with EU partners on Wednesday to discuss the cutoffs. EU countries have been working toward cutting their dependence on Russian gas and oil, but that hasn’t been a smooth process as countries such as Germany and Italy are far more reliant.

Politically, the latest development “raises the stakes for the EU Commission’s decision on whether the new gas payment system would violate sanctions and, hence, will likely keep market volatility elevated,” said Goldman strategists.

The gas cutoff came in a week that has seen pledges of stronger support for Ukraine by western allies and visit to the embattled country by U.S. Secretary of State Antony Blinken. Russia’s foreign minister, Sergei Lavrov, warned of increasing risk of World War III and of a nuclear conflict.

‘’Energy is being increasingly weaponized as the war in Ukraine looks set to enter the long haul and expectations grow that a crude oil embargo will end up being slapped on Russia by the EU,” said Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown, in a note to clients.

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