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By Vitalii Hnidyi and Pavel Polityuk
TROSTYANETS/LVIV, Ukraine (Reuters) - President Vladimir Putin threatened on Thursday to halt contracts supplying Europe with a third of its gas unless they are paid in Russian currency, his strongest economic riposte so far to crushing Western sanctions over his invasion of Ukraine.
European governments rejected Putin's ultimatum for Friday, with the continent's biggest recipient of Russian gas, Germany, calling it "blackmail". Moscow did, however, offer a mechanism for buyers to obtain roubles via a Russian bank.
The energy showdown has huge ramifications for Europe as U.S. officials circle the globe to keep pressure on Putin to stop a five-week invasion that has uprooted a quarter of Ukraine's population.
Europe wants to wean itself off Russian energy but that risks further inflating soaring fuel prices. Russia has a key revenue source at stake even as it reels from sanctions.
Facing stiff resistance from Ukraine's military, Putin has played one of his biggest cards in the demand on European energy buyers.
"They must open rouble accounts in Russian banks. It is from these accounts that payments will be made for gas delivered starting from tomorrow," Putin said.
"If such payments are not made (in roubles), we will consider this a default on the part of buyers, with all the ensuing consequences ... existing contracts will be stopped."
Putin sent troops on Feb. 24 for what he calls a "special military operation" to demilitarise Ukraine. Western countries say Putin's real aim was to topple Ukraine's government.
At talks this week, Moscow said it would reduce offensives near the capital Kyiv and in the north as a goodwill gesture and focus on "liberating" the southeastern Donbas region.
Kyiv and its allies say Russia is instead trying to regroup after taking losses from a Ukrainian counter-offensive that has recaptured suburbs of the capital plus strategic areas in the northeast and southwest.
In a late night address, Ukrainian President Volodymyr Zelenskiy warned of "battles ahead" in Donbas and the besieged southern port city of Mariupol.
"We still need to go down a very difficult path to get everything we want," Zelenskiy said.
Peace negotiations are set to resume by video conference on Friday. Seeking to bolster its position, Moscow is redeploying forces from Russian-backed breakaway regions in Georgia to Ukraine, Britain's defence ministry wrote on Twitter.
The reinforcements indicated Russia had sustained unexpected losses, it said.
With the war exacerbating global fuel prices, President Joe Biden launched the largest release ever from the U.S. oil reserve and challenged oil giants to drill more.
"This is a moment of consequence and peril for the world," Biden said as he announced a release of 180 million barrels starting in May. But that amount fails to cover a U.S. loss of Russian oil, which Biden banned this month.
Western governments say Putin's demand for rouble payments would be a breach of contracts in euros or dollars.
An order signed by Putin allows customers to send foreign currency to a designated account at Russia's Gazprombank, which would then return roubles for the gas buyer to make payment.
"Russia would have to physically halt gas flows to EU 27 (European Union member states) to force the issue, marking a major escalation not even performed at the height of the Cold War. It would mark another major financial blow to Russia's coffers," said analysts at Fitch Solutions.
U.S. and European officials say Putin has been misled by generals about his military's dire performance.
The U.S. ambassador in Moscow, John Sullivan, told Reuters that the United States and Russia were "in the Mariana Trench as far as diplomatic relations go," referring to the deepest place on Earth.
In a show of support for Ukraine's government, EU Parliament President Roberta Metsola said late on Thursday that she was on her way to Kyiv.
'THE CHILDREN ARE SHAKING'
The war has been particularly fierce in Mariupol, a gateway to the Black Sea which links a strategic corridor between Donbas and the Russian-annexed Crimea peninsula.
The mayor's office estimates 5,000 people have died.
Tens of thousands have been trapped for weeks with scant food, water and other supplies in the city that was once home to 400,000 people but has been pulverised by bombardment.
In a Russian-held part of Mariupol, people climbed out of cellars to appear, ghostlike, among the ruins. One man named Pavel placed a bowl and spoon as a tribute on a makeshift grave in a patch of grass, marked with a plain wooden cross.
"Our friend. March 16. Driving in a car. A bullet hit him in the throat. He was dead in five minutes," he said.
Elsewhere, there was evidence of Ukraine's successful counter-attack in Trostyanets, an eastern town. Burned-out Russian tanks and abandoned ammunition littered muddy roads.
"We spent 30 days in the basement with small children. The children are shaking, even still," said a woman named Larisa.
Ukraine's state nuclear company said all Russian forces that occupied the Chernobyl nuclear station had left the defunct plant, possibly concerned over radiation.
Britain and the United States imposed sanctions on Russian media outlets and the country's technology sector. Canada said Russia cannot be a constructive partner in the G20, a group composed of most of the world's largest economies.
"The bottom line is: It can't be business as usual to have Vladimir Putin just sitting around the table pretending that everything's okay," said Prime Minister Justin Trudeau.
(Reporting by Reuters bureaux; Writing by Peter Graff, Andrew Cawthorne and Rami Ayyub; Editing by Frank Jack Daniel, Alexandra Hudson and Daniel Wallis)