Proxy War - Further reductions of gas flows - as well as oil - are major risks for key European markets (e.g., Germany, Italy, Hungary, Slovakia)

A turnaround on the battlefield or sanctions escalation by the West could cause massive Russian retaliation

Gas shortages are becoming clear and will prompt further increases in inflation, recessions, and gas rationing across key European markets; the only questions are the severity and duration. While households and key industries will be protected, MNCs need to segment core consumer and business segments that face far higher costs, limiting their spending notably. Firms should look to optimize their product portfolio, focusing on offerings that are less gas intensive to manufacture, helping reduce their indirect exposure to gas cuts. Firms should put in place contingency plans for the risk of skyrocketing oil and gas prices should Russia retaliate with deeper cuts to gas and/or oil flows against additional escalatory measures taken by the EU in the coming months (e.g., a price cap on oil or confiscation of Russian FX reserves). 


After cutting gas flows via Nord Stream 1 for annual planned maintenance, Russia only revived flows to 30–40% of capacity, and then soon cut to just 20%. Europe has responded by initiating contingency plans for rationing gas this winter, agreeing to cut gas consumption across the bloc by 15%. On the battlefield in Ukraine, after Russia’s slow, grinding advances in Luhansk oblast, the deployment of Western High Mobility Artillery Rocket Systems (HIMARS) has slowed Russia’s artillery campaign and therefore its advances, with Ukraine planning a major counteroffensive in Kherson oblast imminently. At the same time, Russian Foreign Minister Sergey Lavrov updated Russia’s new and expanded war aims, noting that Russia intends to annex the territory of Donetsk, Luhansk, Kherson, and Zaporizhia via referendum by mid-September. Meanwhile, Ukraine’s finances and economy are coming under extreme pressure, forcing the devaluation of the hryvnia, a drastic interest rate hike, money-printing by the central bank to fill budget gaps, and requests by bondholders to restructure payment plans as the country trends toward default.

Our View

Ultimately, Russian President Vladimir Putin is likely seeking to achieve a position of overwhelming leverage before agreeing to peace talks, meaning prolonging the war to the end of the year at least, transforming the conflict into a test of resolve in a war of attrition against the West. To achieve this, Putin has retaliated for EU oil sanctions with steep cuts to gas exports to Europe, while also minimizing Russian casualties in Ukraine by limiting infantry combat and relying on constant long-range artillery barrages to sap Ukrainian morale. In Putin’s plan, by winter, with food and energy prices soaring from the war, the US and EU in recession, gas rationing in Europe, and food shortages globally, Putin believes he will win this test of resolve, causing the West to cave and force Ukrainian President Volodymyr Zelenskiy to make concessions. However, inadequate manpower, poor and flailing Russian morale, and other reasons throw these plans into doubt.

The risk of further escalation both on the battlefield as well as in the ongoing energy war is rising notably, with the potential for extreme Russian retaliation becoming a worry. In Ukraine, the import and deployment of HIMARS and other advanced Western weaponry have notably reduced Russian stockpiles of artillery in Russian-seized territory, impacting supply chains and significantly reducing the volume of artillery barrages, helping counterbalance a critical area of Russian advantage in the war. As the Russian side takes a brief operational pause, Ukraine is using this Western weaponry to launch a counteroffensive in the southern Kherson region to seek to alter the strategic direction of the war, presenting a severe test of Russia’s manpower and morale. Should Ukraine be successful in its southern campaign, the risk of Russian retaliation with a non-conventional response (chemical, biological, or nuclear) becomes higher.

Equally threatening is the escalation of the Western sanctions regime in this proxy war. The G7 continues to assess the prospect of implementing a price cap on Russian oil, which Russian officials have stated would cause them to shut down oil output, nullifying the price cap and causing global oil prices to skyrocket. Likewise, as Ukraine’s finances are being depleted and Western governments face tighter budgets amid recessions and cost-of-living crises, the political compulsion to confiscate Russia’s sanctioned FX reserves and transfer them to Ukraine grows each day. Such a move would similarly incite harsh retaliation by the Kremlin, e.g., further gas and oil cuts.

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