While the US and UK have already signalled their intent to stop using Russian oil, the situation is rather more complicated for a number of countries in European Union. Public support for a proposed EU embargo on Russian oil is low in Germany, for example, while the results of the French presidential election will determine that country’s future strategy.
There is widespread recognition that a European ban on Russian oil and gas would be a game changer in terms of damaging Russia financially. But it would also have implications for energy prices at a time when inflation is rising at a worrying pace and the European post-Covid recovery isn't strong enough to maintain healthy economic growth.
Of the 11 million barrels of oil Russia produces every day, around four million are exported. FX broker FXPro’s senior financial analyst, Alex Kuptsikevich, reckons Europe will play a long game by banning exports of technologies for drilling and abandoning Russian oil when real alternatives appear, a process he says will take more than a year.
“Should Europe be forced into a ban on Russian imports the economic consequences could be extremely damaging for the euro,” explains Craig Erlam, Senior Market Analyst at FX broker Oanda. Russia has potentially led Europe down that path by demanding that payments for gas deliveries be converted into rubles - a process Brussels has warned could contravene sanctions imposed after the invasion of Ukraine.
“If governments in Europe decided to increase their use of fossil fuels (even in the short term) to reduce dependence on Russian oil the euro would probably breathe more freely in the short term, but this is unlikely,” says Erlam.
A return to coal-fired generation would slightly dampen the demand for oil to generate electricity in cities. However, it would do little to help businesses that cannot replace their energy source easily.
“In such a situation the authorities would need to expand stimulus to support demand,” adds Kuptsikevich. “The ECB would also have to be more inflation-tolerant and not hasten to raise interest rates in order to avoid pressing the EU economy.”
These monetary and fiscal responses are fundamentally negative for the euro. A strong currency market reaction would require governments and central banks of other countries to act differently, which can be expected from the US Federal Reserve in particular.
If European leaders had the guts to reduce their dependence on Russia oil and gas it would mean higher inflation in the short run, which would then boost the ECB hawks and have a positive impact on the euro. However, it is clear that the ECB can only fight one battle at a time and inflation will certainly be that battle.
That is the view of Ipek Ozkardeskaya, Senior Analyst at online trading firm Swissquote, who expects oil currencies to continue trending higher. “We have already seen the Norwegian krone and the Canadian dollar strengthen against the dollar and we could expect to see further and sustainable gains in these currencies that are already benefitting from firmer oil prices,” she says.
Ozkardeskaya adds that in the longer term major fossil energy importers such as Europe will benefit from a transition to net zero emissions. “However, this transition won't be quick enough as despite the willpower to move fast the supply chain crisis and capacity and infrastructure limitations will slow down the transition,” she adds, suggesting that it could be another five years before Europe is able to ramp up its move away from fossil fuels.