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by EOS Intelligence EOS Intelligence No Comments

The West vs. Russia: Will Russia Really Survive The Impact Of Sanctions?

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Russia trampled international laws with annexation of Crimea (previously part of Ukraine) to its territory and is reeling under wrath of sanctions imposed by the EU, the USA, Australia, Canada, Norway, and Switzerland, among others. Over a period of time, the sanctions have expanded to inflict economic damage to Russia by targeting its financial, energy, and military sectors. Even though the ball has always been in Russia’s court, the country has only deepened the damage by retaliating with food embargos and standing adamant on its decision to hold on to Crimea against Ukraine’s sovereignty.

The sanctions are intended to limit trading relationships with Russia, which in turn have adversely affected both the EU and the USA. The economic impact is more intensive on the EU member countries and Russia, as they were engaged in high volume and value trading relationship.

Understanding the Sanctions Imposed on Russia

Russia’s economy is suffering under the contracting GDP, growing inflation, capital flight, as well as Ruble depreciation. Economic turbulence has been further intensified with plunge in global oil prices — as Russia’s is one of the world’s largest oil producers, with oil and gas exports accounting for 70% of its export income.

How Are Sanctions Savaging The Russian Economy

The sanctions also had a crumbling effect on the Western companies operating in Russia. Several luxury and consumer goods companies had previously flocked into Moscow to capture the growing middle class market, however, Russia lost its attractiveness and image to being a ‘malignant country’ post Crimea annexation. After the sanctions were imposed, several consumer goods companies shut down their operations — Zara, a Spanish fashion brand, closed flagship store in Moscow in 2014. Wendy’s (an American international fast food restaurant chain), Esprit (China-based clothing brand), and River Island (British fashion shop) are also planning to end their operations in Russia. Consumer spending and retail sales reflect the economic sanctions with retail sales falling 7.7% y-o-y in February 2015.

Western Companies Hit Worst By Russian Crisis

In August 2014, Russia devised a strategy to retaliate against Western countries by banning agricultural import of certain products from the USA, the EU, Canada, Australia, and Norway. Presently, the Russian government is encouraging domestic production to reduce reliance on imports. However, it will take at least five years, if not more, before import substitution starts yielding real impact on domestic food availability and the Russian economy.

Food Embargo Imposed by Russia and Its Impact


EOS Perspective

There is no doubt that sanctions along with falling oil prices have damaged Russian economy. Decline in oil prices strained the availability of domestic liquidity, which could normally be compensated with foreign debt market borrowings. However, borrowing has been prohibited by the ban on Western debt and credit, which intensified the situation and put crushing pressure on the Russian economy.

It is expected that the sanctions are not going to be lifted any time soon, which is projected to bring absence of foreign loans, which in turn is likely to be paired by significantly reduced of foreign investment. This could be a major challenge for Russia, as the FDI tends to be one of the key sources of capital and technologies in emerging nations. With this isolation, Russia might not be able to keep the necessary pace of growth due to lack of capital and limited trading relationships.

Under the pressure of sanctions, Russia can be expected to undergo a transformation to rebalance its economy — with Western companies exiting Russia, their place could be taken by Asian counterparts or domestic companies. For instance, in October 2014, Russia signed 40 agreements with China spanning energy, financial, and technology sectors. Further, Chinese banks agreed to offer credit lines valued at US$ 4.5 billion to Russian banks and companies. These recent agreements clearly show that Russia has been seeking to deepen its strategic ties with Middle Kingdom, intending to improve trade between the two countries to double it to US$ 200 billion by 2016 end.

Sanctions are likely to continue to deeply impact Russia’s key choices in its internal policies as well as the international arena, with expected focus to increase domestic production and choosing Asian allies over Western partners to establish trading relationships.

by EOS Intelligence EOS Intelligence No Comments

Russia’s Energy Economy Sanctioned

A host of countries are of the view that Russia is intentionally trying to destabilize Ukraine by allowing infiltration of arms and ammunitions to support Ukraine’s separatist groups. These countries also believe that Russia desires Ukraine to be a part of the newly formed Eurasian Union and be in its circle of influence. This is pinching more to the western group of countries because they, on the other hand, want to integrate Ukraine with the West and make it a member of NATO. Conflicting interests have resulted in the infliction of sanctions from both sides, Russia being the bigger victim.

In order to dilute Russia’s efforts towards annexing Ukraine, western countries imposed sanctions on Russia which initially followed a route of barring entry of people close to the Russian leadership and blocking their assets in those countries, but this strategy proved futile. The result was a series of new sanctions aimed at Russia’s various sectors in an attempt to further pressurize the country by slowing down its economic growth and deteriorating its investment atmosphere.

Russia's Exports

The latest series of sanctions (those released in July and September 2014) were articulated to weaken Russia’s economy by mainly influencing oil production and its exports (in 2013, exports constituted 28.4% of Russia’s nominal GDP, of which oil and natural gas exports had a share of 68%).

Major Russian energy giants such as Rosneft (integrated oil company majorly owned by the Government of Russia), Transneft (world’s largest oil pipeline company), Lukoil (Russia’s second largest oil company), and Gazprom Neft (fourth largest oil producer in Russia) were directly brought under the purview of sanctions.

The ‘energy sanctions’ prohibit western companies to share energy technologies and invest capital in any Russian offshore oil-drilling projects based out of the Arctic regions, Russian Black Sea, and western Siberia’s onshore. In addition to technology constraint, western companies are debarred from financing Russia’s key state-owned banks for more than 90 days in order to build up financial pressure on Russian energy companies indirectly.


Rosneft and ExxonMobil’s Discovery of Oil at the Universitetskaya-1 Well

One of the major projects under the Rosneft and ExxonMobil partnership was to discover oil and gas reserves in Kara and Black Seas through a joint venture established in 2012. The two companies had also agreed on other projects such as an attempt to conquer the Arctic region’s oil and gas reserves through establishment of the Arctic Research and Design Center for Continental Shelf Development (2013), understand feasibility of developing a LNG facility in Russia (2013), and a pilot project for tight oil reserves development in the shale basin of Western Siberia (end of 2013). Talking about some hard cash involved in research and development activities, Rosneft invested US$250 million while ExxonMobil gambled US$200 million.

In September 2014, the two companies announced their success at discovering oil at the Universitetskaya-1 well in the Kara Sea which became Russia’s second offshore Arctic project. This discovery was a big finding and they initiated drilling activities quickly through the West Alpha rig (originally owned by Seadrill subsidiary of North Atlantic Drilling but under a contract with ExxonMobil till July 2016). Till this time, the partners were under the assumption that they won’t be affected by western sanctions imposed on Russia but to their disappointment, the new sanctions restrained ExxonMobil to cooperate (restricted energy technology transfer) with Rosneft on this project any further. To their dismay, drilling came to a halt in October 2014 as Rosneft could not utilize ExxonMobil’s West Alpha rig.

Rosneft is presently on a lookout for a new rig managed by companies located in the East, China, or South Korea. An attempt to find a new rig and then adjust it at the Kara Sea’s well site is going to be a enormous task and expected to delay things at least till mid-2016. Meanwhile, China (through Honghua Group, for instance) is strengthening its chances of getting positioned as a substitute provider of energy sector technology to Russia, but it is doubtful if it will be able to match the capabilities of western companies. It will be a humongous challenge for Rosneft to find a rig provider which has the expertise to ensure safety operations in such a tough part of the world.

The objective of recent western sanctions appears to not only limit present oil production but harm the future of Russia’s energy sector. 90% of current oil production in Russia comes from conventional oil fields such as West Siberian brownfields which do not require highly advanced western energy technologies, but the problem is that these fields are depleting rapidly. Russia, therefore, faces an urgent need of finding new oil sources to retain its position of being one of the main players in the world’s energy sector (3rd largest crude oil producer – 10.44 million bbl/day, 2013; 2nd largest crude oil exporter – 4.72 million bbl/day, 2013; 2nd largest natural gas producer – 669.7 billion cu m, 2013; largest natural gas exporter – 196 billion cu m, 2013).

Delay of the Rosneft project is slowly fading Russia’s aspirations of increasing oil output as tapping of Universitetskaya well’s oil reserves (estimated to be up to 9 billion barrels) could have added approximately US$900 billion to the government coffer over the next 10-12 years. Similar projects might have led to discovery of new oil reservoirs in the Kara Sea where oil reserves are estimated to be around 13 billion tons (way more than Gulf of Mexico’s and Saudi Arabia’s independent reserves). As per Merrill Lynch, Russia might lose US$500 billion of direct investment and US$26-65 billion of budget revenue during the next 10 years, as energy investors from other parts of the world also become uncertain of Russia’s economic stability.

If western sanctions remain at this level, it would make it difficult for Russia to discover and exploit oil resources in areas like Arctic, as it is primarily western companies (BP, ExxonMobil, Shell, etc.) which have the required expertise and technology to do so. Since the Russian energy sector almost single-handedly drives the country’s economy through exports, impact of the western sanctions, which is already impacting various facets of Russian economy, will be felt heavily in the long-term.

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