Op-ed — by Paul Roderick Gregory
Russian President Vladimir Putin met with the Chinese president Xi Jinping for trade talks in Shanghai. (June 2014)
When I wrote on August 28 that “Western sanctions are strangling the Russian economy,” I had second thoughts about using such strong language. Events of the last two weeks convince me, however, that I understated the case, especially with the introduction of new sanctions on Friday. The Russian economy faces a severe liquidity crisis, collapsing investment and a severe recession. Putin has jeopardized his “safe” European gas market and faces legal problems that he cannot avoid. His sanctions against the West have simply made his own people worse off.
John Maynard Keynes wrote that “in the long run, we are all dead.” Keynes’s puzzle was how long to the long run? We now know that, if Putin’s policies continue, the Russian economy is dead in the long run. When do we reach the long run? That is the question.
The European Union and the United States Treasury and Department of Commerce imposed new sanctions on Russia Friday. These coordinated sanctions close off dealings with major Russian defense manufacturers, further reduce access of Russian banks (including the giant Sberbank) and of energy companies to European and American credit markets (now reduced from 90-day to 30-day maturities), and prohibit the sale of the drilling technology required to develop Russia’s arctic reserves. With the addition of Gazprom Neft, Lukoil, Surgutneftegaz, and Russia’s oil pipeline company, Transneft, to the list, the sanctions now cover the entire energy sector. Although it borrows less from the West than other major banks, Sberbank’s sanction leaves a deep psychological scar. Sberbank was the last Russian bank Russians trusted. Now they read (if it is carried at all in Putin’s press) that the last fortress of safety for their savings has been washed away.
A Kremlin spokesman complained bitterly that Moscow regrets the introduction of new sanctions and considers them illegal. “Today’s actions are completely beyond understanding and explanation amid…Russia’s efforts to facilitate the end of the bloodshed and to ensure a peaceful resolution of the conflict in eastern Ukraine.” Putin assumed a puzzled air a day later: “I do not even understand what these sanctions are related to.” I guess Putin believes no one noticed that the Russian army invaded Ukraine.
Russia’s irate and sputtering response suggests that Putin was caught off guard by the West’s coordinated sanctions. He reckoned he could escape unscathed from his August 26 to August 31 invasion of southeast Ukraine with regular troops, which decimated Ukraine’s army and ended Ukraine’s encirclement of rebels in Donetsk and Luhansk. Although Russian authorities offered their usual fig leaves of denial, NATO satellite images irrefutably show Russian convoys crossing the border and opening a new front in southeast Ukraine. Evidence on the ground includes “lost” elite paratroopers captured inside Ukraine, massive numbers of wounded Russian service men airlifted to Petersburg and Rostov, and a rebel leader confirming thousands of Russian soldiers “on leave” fighting in his ranks. Exclusive Newsweek interviews with unsuspecting Russian soldiers sent to Ukraine to fight (and die in large numbers) against “America” reveal the up-close-and-personal truth behind Putin’s secret war in Ukraine.
Putin had counted on Europe and the United States again to look the other way as he reprised his role of peace maker. After all, he and Ukraine’s president Petro Poroshenko worked hard to hammer out a ceasefire in multiple telephone conversations. And do not the Ukrainians themselvesreport that most (70 percent) of the Russian troops have pulled back across the border! Putin does not mention the remaining formidable Russian troop presence in Ukraine, the Russian troops on the border only an hour or so removed from flash points, or that Russian troops already destroyed the Ukrainian army. They pulled back but only after the carnage was done.
Putin wagered he could barter holding the ceasefire in place for no sanctions. He lost this poker hand. Instead, Europe offers Putin sanction relief if he starts behaving. The shoe is suddenly on the other foot.
The new round of sanctions leaves Russia in increasingly dire economic straits for the following reasons:
Russia counts cost as West tightens sanctions noose.
Sectoral sanctions
While not calling them by name, the West has indeed imposed the sectoral sanctions Russia feared were coming. For all practical purposes, all of Russia’s banking, energy, and defense industries now fall under the sanctions. Only Gazprom’s gas business with Europe remains intact, but it is coming under increasing strain. Russia’s banks, energy companies, and defense companies cannot borrow in Europe or the United States. They cannot buy technology, spare parts, or conduct most normal business activities. Russia is being shunned by a large percentage of the world economy as a rogue state.
Liquidity crisis
Given Russia’s already unsavory business reputation, Russia’s national champion companies could not borrow long even before the sanctions. Hence, they are faced with formidable refinancing challenges now that the spigot has been shut off. Russia must refinance almost $160 billion in foreign debt in 2014 alone, a good portion of which belongs to Russia’s national oil company, Rosneft.
A striking demonstration of Rosneft’s liquidity crisis is its decision to sell one tenth of its biggest production asset, the Vancor fields of Northern Siberia, to China’s CNPC for a miserly one billion dollars. Vancor, a developed field that requires no major investments, is worth some $100 billion (at four times annual revenue of $25 billion). Industry analysts see no reason for Rosneft to sell a major asset at ten cents on the dollar other than a liquidity crisis.
Russian banknotes The Russian stock market and rouble have dramatically fallen from the start of the crisis.
Investment collapse
Russia must raise almost $200 billion abroad just to keep its capital investments at 2013 levels. Foreign direct investment, that used to make up about half of foreign investment, has already collapsed. Russia must look to alternative credit markets, such as in the Emirates or China, and those guys strike hard deals, if at all.
Friday brought additional bad news. ExxonMobil bowed to the inevitable and cancelled its $3.2 billion investment for drilling in Russia’s Arctic Sea in partnership with Rosneft. Other oil majors will likely also pull the plug on their Russian projects. Although ExxonMobil formally left open revisiting the Arctic Sea project in the future, Putin can no longer be trusted to refrain from political adventures that will threaten such investments in the future. ExxonMobil’s shareholders may ask why their company forgot so quickly the stealth expropriation of half of its multi-billion dollar project in Sakhalin. Without ExxonMobil’s $3.5 billion, the cash strapped Rosneft can kiss the billions of barrels of reserves under the Arctic Sea goodbye for a very long time. As for 2014 and 2015 investment, expect huge declines and hence substantial negative growth, perhaps in the neighborhood of the 2008-2009 collapse.
The Yukos $50 billion fine
Putin’s expropriation of Yukos shareholders worldwide in the course of his vendetta against political rival and oligarch Mikhail Khodorkovsky has resulted in an order by a Dutch-based international arbitration court to Russia to pay Yukos shareholders $50 billion for illegally seizing Yukos assets. The court’s judgment is final and not subject to appeal. Insofar as Yukos’s stolen assets were transferred to Rosneft, Rosneft may have to pay all or part of the fine.
If Russia ignores the court’s verdict, it will have shown that any and all arbitration clauses in its contracts with foreign companies are worthless. Risks of investing in Russia are high enough even with binding international arbitration provisions. In the long run, ignoring the court’s order could cost Russia more than $50 billion Yukos fine. To accept it, however, would either deplete Russia’s rainy day funds or bankrupt Rosneft. Neither is a good alternative.
The EU anti-monopoly suit against Gazprom
The European Union anti-monopoly commission initiated a suit against Gazprom in 2012 for abusing its dominant market position to extract extortion prices and to prevent customer countries from diversifying their energy supply. EU law forbids one company from both owning and operating a pipeline. The EU commission is expected to render a decision in the spring of this year.
The international editor of The Economist, Edward Lucas, an expert on the Gazprom suit, predicts: “”I think we are going to see, first of all, a spectacular lump of bad publicity for Gazprom ….then we will have fines, which may be very substantial.” Indeed, if found guilty, Gazprom could face a fine of 10 percent of annual revenues, or some $10 billion, not counting suits from companies that have been overcharged over the years.
Gazprom’s reputation as a reliable supplier
Vladimir Putin and his inner circle have labored to establish Russia’s reputation as a reliable supplier of natural gas to Europe. As Putin stated in late June: “Russia has always been a reliable supplier of energy resources to Europe and is determined to continue fulfilling its contractual obligations.”
The Russian War of Southeast Ukraine threatens to nullify Russia’s reputation as a reliable supplier that has held Europe back from agreeing on a unified energy policy that diversifies its energy sources. Throughout hostilities in Ukraine, Russia has intoned the gas weapon against the EU and states such as Poland and Slovakia inclined to ameliorate Ukraine’s loss of natural gas. Austria, Slovakia, and Poland have experienced unexplained drops in gas deliveries from Russia, which they must attribute to Putin politics.
Europe cannot afford to have its economic growth hostage to the escapades of one Vladimir Putin. For its own defense, the EU is inching towards an external energy policy that unifies the European gas market and diversifies gas suppliers. Gazprom has long dominated the continent’s energy market and ignored its rules. Will Putin’s aggression change all that and what will it cost Russia? Has Putin finally gone too far?
Putin’s retaliatory sanctions hurt Russia more than the West
There may be disagreement on the cost of the West’s sanctions on Russia, but there is a consensus that Putin’s retaliatory sanctions – primarily against Western goods and services – hurt Russia more than their targets and may even loosen Putin’s iron grip on power. Basically, Putin’s sanctions deprive his subjects of the things they wish to buy and raise living costs. This point is so obvious it need not be elaborated. Instead, I quote a message just received from a Russian-American frequent visitor to Moscow:
My first Moscow impressions: things have really gotten worse. There is a lot of fear. Whoever could leave, left. Food sanctions: most European foods have disappeared: I tasted (for the first time in my life) Mozzarella cheese from Belarus. It does not resemble the actual Mozzarella at all and I must tell you this is not an experience I would want one to have. Italian cheese is no longer available. New sanctions offered would refer to clothing, possibly foreign cars, etc. A friend asked me to bring an iPad (much cheaper in the US), I said I will do this next time, they joked, “next time we will have to make a list of what to bring, like jeans or other clothing for instance.” It was a joke but…eight McDonald’s closed in Moscow over the last month. “Sanitary reasons.” At the same time, street stalls/kiosks selling very suspicions Uzbek and Georgian meats are everywhere (speaking of sanitary!) Clearly the closing of eight McDonald’s is a political issue. The main Moscow McDonald’s (formerly the busiest in Europe) is now a dark sealed building in the center of the city and people bring sandwiches from the neighboring places to there and sit in front of it — eating non-McDonalds foods. It is still a meeting place, just closed. When people mention the ongoing war with Ukraine they say it feels like a scary dream. Most my friends want to leave. Not everyone has the opportunity. Basically, I don’t like the atmosphere here at all.
It is too early to decide the winners and losers from Russia’s War of Southeast Ukraine. One winner, however, is clear. China has the cash to pick up Russia’s crown jewels at bargain basement prices. If we look down the road, we must ask: How much of the natural riches of Siberia will belong to China ten or twenty years from now? China probably has a better answer to this question than we do.
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I’d like to thank my colleague Michael Bernstam for his advice and assistance.
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