THIRD WAVE OF SANCTIONS: BEST CARDS, CHALLENGES AND DANGERS FOR RUSSIA

Although especially targeted by the third wave of sanctions imposed by the US and the EU, the Russian oil and gas industry (the main source of revenues to the state budget) seems not to be very affected. On the contrary, one may say after reading the releases issued by the European and American oil and gas companies that seem equally determined to continue their activity in Russia. At the same time, in the economic field in general, following the retaliation decisions adopted by Russia, it looks like the West is in the position to register losses. Beyond appearances, the consequences for Russian industry and for the economy are becoming less and less negligible, whilst on the long term it seems unavoidable the erosion of the Russian oil and gas industry capacity to play an important role on the international market.

By the end of July the US and the EU announced the decision to enforce a new set of economic sanctions aiming at Russia’s energy, financial and defence fields. The West was thus implementing the third wave of economic sanctions against the Russian Federation, as a reply to the latter’s intervention in Ukraine (first Crimea’s annexation, followed by the support offered to the separatists in the eastern part of the country), the decisions becoming effective as of August 1. For the moment, this was the toughest international action.

The US and Europe have agreed to impose restrictions on the trade with equipments for oil and defence fields, accompanied by others for double use technology, for civil and military purposes, by limiting Russia’s access to sensitive technologies, especially the ones in the oil and naval field. Concomitantly, by the same sanctions, Sberbank, VTB, Gazprombank and Vnesheconombank banks were forbidden to contract loans from western financial markets falling due in more than 90 days. From the point of view of the historical evolution and the seriousness of the sanctions, after Russia has unilaterally annexed the Crimean Peninsula, the EU and the US have drawn up a progressive strategy to sanction Russia, initially aiming at certain individuals; to no avail! Later on the sanctions were extended to several Russian companies and the number of persons subject to travelling restrictions and to accessing accounts to European and American banks has increased; also to no avail! Finally, the third wave brings sanctions against certain entities that are in fact the most relevant players in the economic fields most important for the foreign political and economic strategy of the Kremlin; subsequently, it represents more than simple economic and travelling restrictions for some Russian officials, as it was until now.

SANCTIONS TO NO AVAIL?

Are the sanctions imposed by the US and the EU against Russia meant to make the Russian government uneasy? This is a simple and legitimate question (especially after the putting in practice of the third wave of sanctions)... which has no clear and documented answer; there are various opinions, while the arguments in support of the sanctions that are leading to (or will lead to!) consequences, or to combat them... are equally numerous and sound. Hence, the third version has in its turn lots of supporters (the one saying everyone is right, yet with a little ‘but’ on the tail). Such an interpretation means there are two different perceptions determined by the expectations timeframe and by the probability that these sanctions are effective for a certain period of time.

Thus, the first serious arguments in support of the idea that sanctions could have modest consequences (with no real weakening effects on the Russian economy through negative effects on the oil and gas industry) might emerge from the releases issued by the western companies in this field that are doing businesses in Russia; the releases reveal that the EU and the US enforced sanctions haven’t made them revise the plans to invest money and know-how on this market, on the contrary! E.g. right after the second set of sanctions had been implemented (by the end of March), the French company Total SA, the biggest French player in this field, announced the concluding of a partnership with Russia’s Lukoil to develop the Bazhenov shale deposit; according to the US Department of Energy statistics this deposit is one of the biggest of this kind in the world. The two companies plan to extract from this deposit up to 733,000 barrels of oil in 2014 (such a quantity should compensate for the decline of production Lukoil is registering in Siberia), the Russian company officials inform.

FOREIGN COMPANIES STAY IN RUSSIA

In spite of the tensions between the West and Russia, the French group Total seems not to be intimidated. On the contrary, it is consolidating its position in Russia as it is not an outsider; it owns some 16 percent of the Russian company OAO Vovatek’s registered capital (the second biggest natural gas producer after Gazprom); Total already had a significant and active presence on the Russian market. The company’s CEO Christophe de Margeri was saying on the occasion of signing the agreement with Lukoil that it is a business working ‘as usual’ – suggesting in this way that the French company’s presence in Russia is under no circumstances in doubt after the western sanctions. One might say that Total’s decision to conclude the partnership, right after the first set of sanctions was imposed, is placing them even better in a relatively select ‘circle’ – however a relatively extensive circle of western companies that have concluded partnerships for developing and exploiting conventional and unconventional oil and natural gas reserves in Russia. Thus Total joins giants such as: Exxon Mobil, which has already concluded with OAO Rosneft a series of agreements for exploiting great depth deposits in the arctic region and new perimeters of shale deposits; Royal Dutch Shell – having a similar partnership with OAO Gazprom Neft; BP, also present on the Russian market, owning some 20 percent of Rosneft shares, as the Russian company has acquired last year the joint company TNK-BP, the third Russian oil producer; and/or last but not least... the Norwegian company Statoil, which is carrying on a vast programme of exploration in the arctic area with the same Russian giant Rosneft. None of the above mentioned companies has given any sign it could take into consideration the cutting down of its activity and/or of the investments in Russia after the EU and the US enforced sanctions; not even after the third wave of sanctions (implemented by the EU and the US by the end of July 2014) that underlines the ban to supply top equipment and top technologies.

A COMPETITIVE ADVANTAGE

Lots of news shows the real situation: a revealing case is the one of Exxon which, by the beginning of August, right after the third wave of sanctions, announced the commencement of drillings in the arctic region. Let’s note that, at that moment, the Russian President Vladimir Putin was talking about Exxon as ‘an old and trustful friend’.

Within the same coordinates it’s placed the BP positioning, as its officials were reiterating their commitment on long-term in Russia, calling it ‘a competitive advantage’, in a release to the stock exchange on the occasion of issuing the Q2 2014 financial results. BP CEO Bob Dudley was saying that BP has the responsibility to stand by its partners in difficult times. The statement was made on the occasion of the signing of the agreement with Rosneft regarding shale oil deposits’ exploration in central Russia (between Volga River and the Urals), stressing the company’s intention and interest to stay (in spite of the sanctions!) on the Russian market.

Equally relevant in this regard is the stance expressed by the biggest supplier of solutions and services for exploration and exploitation of oil and gas at world level – the US company Schlumberger – whose representatives were saying in a release, right after the enforcement of the third wave of sanctions, that the company will continue to support, in the same conditions and without interruptions, the clients carrying out operations in Russia. Schlumberger is the supplier of technology within the Bazhenov project (western Siberia) developed with Gazprom Neft – the oil production department of Gazprom (company not included on the list of entities sanctioned by the West).

As a conclusion it could be said that the flow of news and information in this regard shows that is very unlikely that the Russian companies will be restricted to access technology and top know-how. Russia’s forceful retaliation, by imposing bans on agri-food imports from the EU and the US (causing important losses for the fruit and vegetable producers in the EU countries)... followed by the announced intention to limit or block auto imports, seem to rather disfavour the West more than Russia. Such reasoning might have made the Hungarian Prime Minister Viktor Orban (a tough objector of the UE sanctions on Russia) criticize the EU, after the first wave of sanctions. “In politics, this is called shooting oneself in the foot,” he said.

AND YET, THE CONSEQUENCES ARE POURING

In contrast with Russia’s tough positioning, the latest months show a different reality; the sanctions implemented by the West against Russia have negative consequences on the oil and gas industry and, implicitly, on the Russian economy, becoming more obvious in the data as well as (extremely important!) in the releases presenting various problems the companies in the field are facing; these releases show, although only slightly developed by the media, that the Russian oil and gas industry is not insensitive to western decisions.

A first clue in this regard could be noticed in a release from Schlumberger, informing along with the intention to continue the cooperation with Russian partners that the sanctions against Russia will lead to decline in the company’s profits in Q3 by some USD 0.03 per share.

A second relevant example is the one coming from BP which, in the release sent to the stock exchange markets on the occasion of issuing the quarterly financial results, was also informing that the western sanctions could negatively influence the business interests and the targets for the Russian market.

By far the most relevant example is the one of Rosneft – the second biggest gas producer after Gazprom. The example is interesting because it affects the industry’s and domestic companies’ access to financing (revealing the importance, as well as the impact the decisions to limit the access of oil companies to big financial banking institutions on the European and American markets have). Rosneft found itself in the situation to request financial aid amounting to EUR 25.2 billion (approx. USD 42 billion) from the Russian government in order to overcome the difficulties to finance investment plans following the ban coming from the US government for American entities and by the EU authorities for European ones to finance Russian companies on the sanctions list for more than 90 days.

RELEVANT DATA

If such information is correlated with the ones regarding the capital outflows from Russia, the importance of the effects coming from western sanctions seems to weight more. According to the Russian Economy Ministry estimates some USD 100 billion are to exit Russia in 2014, an amount significantly higher than the one registered in 2013. The same institution informs the capital outflow was of USD 61 billion. These estimates are rather conservative or even optimist... because, according to the European Central Bank (ECB) President Mario Draghi, the outflows from Russia might be higher. By May, before the implementation of the third wave of sanctions, the ECB President sustained that the capital outflows from Russia could exceed EUR 160 billion. The data revealed by the currency market support his statements! Even though, in the absence of information about the amounts/values traded (information that would have revealed even clearer the amplitude of the movements on the market) the data are incomplete, the evolution of the USD-Rouble exchange rate is a relevant clue of the currency flows; the chart showing the evolution of the national currency against the US Dollar clearly reveals that, after the Russian intervention in Crimea, the movements on the market were in the direction of exiting the Rouble (see the chart ‘Rouble, on an accentuated trend of depreciation’): in less than a quarter the Rouble lost 10 percent of its value against the US Dollar.

At the same time, on the background of the tensions in Ukraine that led to the temporary ceasing of gas deliveries from Russia to the EU states through pipelines, the Russian currency has fallen to the historical minimum as in 2009 against the USD (see the chart ‘Rouble, historical minimum against the USD’).

FALLING SHARES AND STOCK EXCHANGE INDEXES

The evolutions on the currency market are confirmed by evolutions having the same trend – capital outflows – on the stock exchange! As one can see in the chart ‘Falling indexes, the Rouble is depreciating’ that by the end of July – as the first information regarding the imminent third wave of sanctions against Russia surfaced – both MICEX OIL & GAS index (index showing the whole evolution of the oil and gas industry on the Moscow stock exchange) and the MICEX COMPOSITE index (relevant for the entire Russian economy) have registered huge decreases in just a few days. On the other hand, seen on medium and long term, the oil and gas industry on the stock exchange is still very close to the potential maximum levels. At least this is what comes out of the chart showing the evolution of the relevant index during the last ten years (see ‘MICEX OIL & GAS evolution during the last decade’).

More so, in spite of the western sanctions, the trend in this field seems to be upward – at least from the indexes point of view and from the technical analysis (graphic) conclusions.

The paradox is apparent and a fake argument to support the idea that the US and the EU sanctions don’t have the expected consequences! On the contrary, a more profound analysis leads to the conclusion that the sanctions are effective and do have the expected effect!

Hence, the western leaders’ statements reveal that the sanctions were meant to send a credible signal that the continuous support offered by Russia to the insurgents in Ukraine could result in sanctions aimed at creating major imbalances for the Russian economy! The signal had to be sent in such a way that the impact on the economic relations with Russia (of the US as well as of the EU) is as modest as possible. If the intention was to induce difficulties to the pillars of the Russian economy without collateral effects and with no influence over the EU and the US commercial relations (there is no accident that Gazprom is not aimed by the sanctions... while the US exports to Russia have registered significant increase in H1, in spite of the sanctions)... than this is exactly what it turned out. Seen from this angle, the US and the EU sanctions, meant to be first of all a kind of signal and a warning, have attained the objective. Looking at the sanctions more profoundly, the message sent by the EU and the US is much more important; it could aim at effects and evolutions on long and very long term, much more disquieting and dangerous for Russia.

Thus, the major risk Russia is facing in the eventuality of escalating tensions is not coming from the falling values of several oil and gas companies’ shares (be them even bigger!) neither from the capital outflows... however important they might be! The real danger for Russia, the main pressuring instrument the West has in hand over Russia, is related to the fact that the West could block or significantly diminish the amplitude of the process of finding substitutes for drained oil and gas deposits; this is done by rendering more difficult the exploration and exploitation of new deposits, especially the alternative ones (such as shale and huge depth deposits) by restricting the access to new technologies (and to know-how) in the field.

Even if Russia might have solutions for any other kind of challenge, it doesn’t have for now a viable one to the restrictions of access to technology and know-how to exploit new deposits. The danger for Russia is even bigger as the US and the EU decisions on financial, commercial and technological restrictions are followed by coherent and consistent steps to force the downtrend for oil prices on the world market. This means a double blow for Russia: on one hand the fall in prices means lower revenues from the sales of oil and gas for the companies (the price of natural gas is set in accordance with the oil price) and consequently lower revenues to the state budget; on the other hand (even more important and serious for Russia!) the fall in prices is leading to lower interest of foreign companies (the ones having the know-how and capital) in exploring and exploiting new deposits, especially the alternative ones such as shale and great depth deposits. The reason is related to higher costs for exploitation than the ones for conventional deposits... leading to a too sharp decrease of the profit margin following the fall in prices for oil and gas.

Seen in perspective, beyond the negative effects apparently modest for Russia now, the West’s sanctions are more serious than they seem in the context of replacing the traditional oil and gas deposits with unconventional deposits, meaning higher costs and need for top technology.

This unfavourable situation for Russia is amplified by the fact that the energy field is affected by the deterioration of infrastructure, equipments and technology, while the oil and gas field (the main pillar of the Russian energy sector) is ailing in the output, processing and transport areas – for which Russia needs investments. Investments not at all negligible! According to the International Energy Agency (IEA) estimates released recently in the World Energy Investment Outlook 2014, the Russian energy sector would need during 2014 - 2035 investments amounting to USD 2,700 billion for technology updating and improving the infrastructure.

According to IEA more than half of the amount is needed by the oil and gas industry. More exactly, over USD 1,016 billion would be needed for the natural gas industry (some USD 700 billion for the exploring and production sector, USD 300 billion for modernizing the transport infrastructure) while for the oil industry the needed investments reach some USD 850 billion (of which USD 70 billion in the processing sector and USD 28 billion to update the transport infrastructure).

In order to have a comprehensive view over Russian economy needs in order to support the energy sector it has to be said that the same report reads that some USD 614 billion is needed for investments in the electric power production sector.

Drawing conclusions, the need for investments for repairing, modernizing and extending the infrastructure in the Russian energy field in the sectors of exploring, production and transport peak to USD 100 billion per year for the next 20 years; a huge amount, hard to be drawn in an unfavourable context such as the current one, as Russia’s access to resources (financial, know-how, technology) is severely restricted.

The current sanctions are hazardous for Russia on short term as well as on long term and aim much farther than placing Russian finances in distress or than restricting the access to top technologies in the defence field; The EU and the US sanctions are placing in peril the future of Russian industry, Russia’s positioning on the world market... and even Russia’s future as a nation and state, because the state budget is dependent in a 50 percent ratio on the activity in the oil and gas field. As any decrease of revenues leads to cuts in expenditures for administration or social services, Russia may face at any time public discontent and even extensive social movements. This would be one step away from political changes, unconceivable at this moment.

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