<strong>How does Russia export its oil? (4)</strong>

The Group of Seven (G7) countries and Australia have agreed to cap the price of Russian marine crude oil at US$60 per barrel. For some, this limit is too high and will not significantly reduce Russia’s revenues. For others, this cap is too low and could have a negative impact on inflation control. In this fourth article, we will focus on how Russia exports its oil by sea to Asia.

Source: Nakhodka Maritime Services

In the weeks before Russia’s military intervention in Ukraine, less than two-fifths of the crude oil loaded on tankers in Russian ports was destined for Asia. Today, that proportion is two-thirds, with China and India being the two main consumers of this black gold.

In November, Russia pumped an average of 10.9 million barrels per day of crude and a type of light oil called condensate, according to Energy Ministry figures. This is the highest level in eight months.

With the implementation of sanctions, Russia is trying to continue to redirect its crude oil exports to Asia and so limit a possible decrease in its production. Moscow has reaffirmed it will not sell oil below the G7 price cap, as it considers such a restriction unacceptable and contrary to market and World Trade Organization rules.

The country is expected to continue to offer deep discounts to international benchmarks to ensure that its oil finds a buyer. In recent days, discounts for Russian Urals oil have increased significantly, pressured by record freight rates for tankers carrying Russian oil. 

Russian “Ural” grade oil was trading at about US$52 a barrel at the export terminal. This is a discount of US$33.28 vs. Brent. In comparison, the average markdown in 2021 was US$2.85. “We see the price cap is something that benefits China, benefits India, and benefits all purchasers of Russian oil,” U.S. Treasury Secretary Janet Yellen said. 

Indeed, India is not ready to give up its purchases. Its oil minister recently said he had a “moral duty” to his country’s consumers. “We will buy oil from Russia, we will buy oil everywhere,” he added.

 Source: Bloomberg

To circumvent the sanctions, Moscow has been working in recent months to build a logistics network to ensure that its crude continues to flow to global consumers. According to shipping brokers, Russia has assembled more than 100 tankers and spent US$16 billion expanding its fleet.

Traders have indicated that Russia needs more than 240 tankers to maintain its current export flow. Operators linked to Russia are suspected of having purchased as many as 29 supertankers in 2022. Also called VLCCs for Very Large Crude Carriers, they are capable of carrying more than 2 million barrels.

On the insurance side, Moscow has strengthened its own marine insurance company, the Russian National Reinsurance Company (RNRC). It has been recapitalized and has received a guarantee from the Central Bank of Russia (CBR). This gives it “infinite coverage”.

Uninsured ships cannot enter international ports or shipping lanes and some 95% of all marine insurance is issued by London-based companies. Russia is replacing all London-based policies with Moscow-based insurance to avoid sanction measures.

India and Turkey have said they will recognize Russian insurance as a cover, effectively ignoring Western sanctions. China, on the other hand, fears US retaliation and has been more circumspect. The issue of whether or not to accept Russia’s insurance remains highly politicized.

According to the Russian Minister of Transport, Alexander Poshivay, China does not yet recognize all the protection and indemnity insurance and reinsurance certificates issued to shipowners by Russian insurers.

Russia will, therefore, also have to rely on the public or private fleets of buyer countries such as India and China, whose governments have the means to insure them.

Finally, it is interesting to note that Japan is participating in the sanctions on the cap on Russian crude oil, except for that which is imported from the Sakhalin-2 plant. This decision was made by Tokyo to ensure its energy security. 

Japan already imports about 90% of its oil from the Middle East. Last year, it received about 34 million barrels of oil from Russia, accounting for 3.6% of the country’s total supply.

<strong>How does Russia export its oil? (3)</strong>

In 2014, American politician John McCain said, “Russia is a gas station masquerading as a country.” It turns out that the majority of Russian oil shipped around the world is transported by tanker. In this article, we will look at how the country exports its oil by sea to Europe.

Source: Mitsui O.S.K. Lines

Historically, Russia has been a major supplier of oil to Europe and will remain so in 2022. European refiners are scrambling to make deals before EU restrictions on imports and shipments take effect.

At the beginning of this year, Russia was exporting 11 million tons of crude oil by ship to the EU every month. This represented 60% of all Russian crude oil exports by sea, and 30% of EU crude oil imports by sea. 

In the first half of November, Russian crude oil exports by sea to the EU amounted to 3.7 million tons, or 38% of all Russian crude oil exports by sea, and 20% of European crude oil imports by sea.

The International Energy Agency (IEA) predicts that Russian oil production will fall by nearly 2 million barrels per day in 2023 compared to pre-war production, a reduction of nearly 20% due to sanctions imposed by the G7 countries. 

These estimates should be taken with a pinch of salt, since last March the IEA predicted that Russian production would fall by 25% in the first months of the war.

Europeans are compensating for the loss of Russian crude oil volumes by increasing supplies mainly from the Middle East, but also from Africa, Norway, Brazil and Guyana. 

The task of replacing refined products from Russia is more complicated. There is already a severe shortage of refining capacity in the market.

In October, diesel imports into the EU increased by nearly half from pre-war levels, due to strikes at French refineries and seasonal maintenance. According to the International Energy Agency, EU sanctions on Russian diesel exports will increase competition in an already “exceptionally tight” market.

Russia controls some of the largest refineries in the EU through companies such as Rosneft and Lukoil. To ensure its energy security, Germany recently took control of the Schwedt refinery which supplies about 90% of Berlin’s fuel needs. Italy, for its part, is considering buying the ISAB refinery, owned by Lukoil, located in Sicily.

On the other hand, Bulgaria has agreed with the Lukoil refinery located on its territory that it would continue to be supplied with Russian crude oil.  This would constitute a violation of the EU sanctions regime, as Bulgaria imports Russian oil by ship (Black Sea).

Source: Bruegel

Europe imports Russian oil by sea from three main areas: the Baltic Sea (Primorsk and Ust-Luga) in northwest Europe, the Black Sea (Novorossiysk), and the Arctic (Murmansk). 

Before the conflict broke out in Ukraine, about two-thirds of Russian crude oil delivered by ship to Europe left from the Baltic ports of Primorsk and Ust-Luga. The Netherlands, with the port of Rotterdam, was the largest importer of oil from Russia.

At the moment, negotiations on limiting the price of Russian oil are at an impasse. According to the New York Times, opinions within the European Union are currently “too divided”. 

The price cap is a ban on shipping, insurance and reinsurance companies handling Russian crude oil shipments worldwide, unless they are sold at a price not exceeding that set by the G7 and its allies.

The latest news is that the G7 countries are in talks to cap the price of Russian oil at US$65 and US$70 a barrel. Analysts believe that this measure, even if approved, should not have a significant impact on Moscow’s oil revenues. 

The Kremlin has repeatedly stated that Russia has no intention of supplying oil to countries that support a price cap.

Either the G7 countries try to force the Russians to sell oil below the market price and the Russians will stop exporting, which will cause the price of oil to rise. Or the West agrees to buy Russian oil at the market price and they will get the quantity of oil they want.

Western leaders clearly still do not understand why these sanctions are doomed to fail. They cannot control the amount of oil exported by Russia and its price at the same time. They have to choose one of the two. 

Nearly 300 days after the war began and despite countless diplomatic initiatives to stem the flow of dollars to Russia, the country is producing almost as much oil as it did before the invasion. And regardless of the sanctions, Russian oil will continue to reach Europe.

According to Nikkei Asia’s report, ship-to-ship transfers are one of the ways in which sellers and buyers of Russian oil conceal the origin of supplies. This practice allows sanctioned commodities to continue to be traded.

During the first six months of the conflict in Ukraine, 175 transfers took place off the Greek coast involving Russian tankers compared to only 9 transfers during the same period last year.

The second way to circumvent sanctions is to import Russian oil from a third country that does not impose restrictions. As a reminder, the possible sanctions of the G7 countries will not apply to Russian crude oil, imported by a third country and then resold after refining to a European country.

<strong>How does Russia export its oil products ? (2)</strong>

Russia is a major supplier of oil in the world, exporting about 13% of total oil trade. The recent deterioration of Russia’s relations with the West is forcing Moscow to accelerate its pivot to the East. In this second article, we will examine the pipeline infrastructure that the country has to export its crude oil to Asia.

Only 12 years ago, Russia exported virtually no oil to Asia, as all of it was sold to Western markets. Today, the world’s second largest oil exporter sells as much oil to China as Saudi Arabia.

Russia has developed during the last decade significant crude oil export capacity through pipelines to ship large volumes of crude to Asia. This policy is part of an effort to reduce its dependence on European markets and tap into China’s growing demand for crude oil.

In 2012, Russia launched the Eastern Siberia-Pacific Ocean (ESPO) oil pipeline. With a capacity of 1.6 million bpd, this 4,740 km long pipeline transports crude oil to Asian markets such as China, Japan and South Korea.

 Source: IHS Markit (S&P Global)

The ESPO-1 pipelines connect the West Siberian fields (Taishet) to Skovorodino in the Amur region. At Skovorodino, one section of the pipeline is diverted to the Chinese mainland while the ESPO-2 is directed to the Pacific Ocean terminal at Kozmino, near Vladivostok. From there, the oil can be loaded onto tankers for shipment to the Pacific basin. In 2021, Kozmino loaded about 720,000 bpd

According to Nikolay Tokarev, president of Transneft, Russian oil deliveries to Asia have increased and the ESPO pipeline is operating at maximum capacity.

Russia has a second route to supply oil to mainland China via a pipeline crossing Kazakhstan via the Atasu-Alashankou pipeline.Russia’s Rosneft currently pumps 200,000 bpd via Kazakhstan. According the Kazakh Energy Minister Bolat Akchulakov, the capacity of the line in Kazakhstan is 400,000 bpd.

After the outbreak of war in Ukraine, the Russian government ordered a plan to intensify the redirection of energy infrastructure – pipelines, ports and railroads – to the east of the country, but the task remains complex in the near term.

Russia’s infrastructure remains heavily oriented towards the West. The majority of Russian oil is destined for Europe – about 140 million tons via the Druzhba pipeline, compared to about 40 million tons for China via the ESPO pipeline.

Insufficient pipeline capacity limits the amount of additional oil Russia can send to mainland China. This would require increasing the capacity of ESPO by 50%. Expansion of ESPO-2 and the port of Kozmino is also a possibility, but it would involve additional costs and require years of preparation.

Despite the rapprochement between Russia and China, it is not clear that China wants to increase its purchases of Russian oil. Beijing’s energy policy emphasizes diversification and therefore does not want to create too much oil dependence on Russia.

<strong>How does Russia export its oil? (1)</strong>

Russia exports seven million barrels of crude oil and refined products a day. As price cap sanctions are about to take effect, it is time to consider how Russia can continue to export this commodity, crucial for the Kremlin’s finances and for the global economy. In this first article, we will focus on how the country exports its oil by pipeline to Europe.

Since the beginning of the conflict, Russia has often been associated with gas issues. But as far as its finances are concerned, it is oil that generates the most money. In 2021, oil and petroleum products being sold on the global market earned Russia three times more money than gas.

Crude oil is considered the world’s most important commodity as it is the main source for global energy production. After extraction, crude oil is refined and processed into various forms, such as gasoline, kerosene and asphalt, for onward sale to consumers.

As of December 5, the G7 countries will not allow shipping and insurance companies to provide services to tankers carrying Russian crude oil, unless the oil has been sold at a specific price or lower. On February 5, 2023, the ban will also extend to oil products exported from Russia.

Russia is anticipating these restrictions by redirecting its exports to buyers not involved in the sanctions, mainly in Asia. This represents a real challenge for the Russian oil industry. If it is not able to ensure deliveries, it will be forced to close oil fields because the country does not have strategic oil reserve options. This will hurt its production capacity and may drive up the world price of oil.

Today, Russian crude oil is delivered to European consumers by pipeline, via the Druzhba pipeline (which means “friendship” in Russian). Operated by Russia’s state-controlled giant Transneft, it is one of the largest pipelines in the world, with a length of 5,000 km. It has the capacity to transport 2 million barrels per day and was built in 1958 during the time of the Soviet Union to supply the allies of the communist bloc.

Source: Kpler / FT research

The pipeline connects the oil fields of Western Siberia to major refineries in Europe, where the fuel is transformed into diesel, naphtha, gasoline, lubricants and other commodities that are sold both within and outside of the EU.

In Belarus, the pipeline is divided into a northern and a southern branch. The northern branch, which accounts for about two-thirds of the total flow, supplies refineries in Poland and Germany. Even if pipeline shipments from Russia have been excluded from the EU’s recent sixth package of sanctions both countries have pledged to stop purchasing through this channel by the end of the year.

On the other hand, the southern branch, which crosses Ukraine and supplies refineries in Hungary, Slovakia and the Czech Republic, should continue to be used for years to come. As landlocked countries, they have negotiated with the EU for permission to import Russian oil to ensure their energy security.

Hungary and Serbia (which is not part of the EU) recently announced the construction of a branch to the Druzhba pipeline so that Belgrade could receive Russian crude. Currently, Serbia obtains its oil supplies mainly through Croatia and the Adriatic Sea. This link is likely to be severed as soon as the EU implements its sanctions on Russian crude oil deliveries by sea from December.

The European Union will ensure that countries that buy Russian oil cannot resell it with or without processing. Therefore, analysts do not expect an increase in pipeline deliveries via the southern part of Druzhba.

Why capping Russian oil prices is a bad idea?

The G7 countries want to cap the price of oil sold by Russia. The aim is to reduce Moscow’s revenues and lower the world price of black gold. This strategy is risky and will probably have the opposite effect.

Russia is one of the world’s largest oil exporters. Before the conflict in Ukraine began, the country exported more than 10 million barrels of oil per day, or about 9% of global crude exports. Despite Western sanctions, these figures have remained virtually unchanged.

During the first six months of the war, Moscow has earned 158 billion EUR from the sale of oil and gas, according to the think-tank Centre for Energy and Clean Air Research (CREA). Two-thirds of this revenue comes from the export of crude oil and refined products.

The United States and the European Union want to reduce Moscow’s oil revenues by capping the price of its oil. From 5 December, G7 countries will ban banks from financing the purchase and sale of Russian oil, insurance companies from insuring shipments and ports from unloading oil transported by tanker if it is traded above a ceiling price yet to be determined.

The question of the level of the price cap is tricky. If it is too low, it could trigger Russian retaliation by shutting down large swathes of oil production, which would drive up world crude prices and deepen the global energy crisis. If the price is too high, Russia will continue to make large profits and finance its war effort.

According to CREA, 60% of the tankers carrying Russian oil are owned by European companies and nearly three out of four ships are insured or reinsured in Britain, notably by Lloyd’s of London, or Norway. “The proposal seeks to leverage Western dominance in shipping, banking and marine insurance. It amounts to forcing the world into a cartel of buyers,” the Bruegel Institute points out. The embargo on all services related to oil exports is intended to make shipping almost impossible

The US, UK, Canada, Germany, France, Italy and Japan are betting that Russia will need US dollars so badly that it will agree to sell its oil despite the price cap. But the reality could be very much different.

On 7 September, Russian President Vladimir Putin said at the economic forum in Vladivostok that such a move “would be an absolutely stupid decision”. “We will not supply anything at all if it is contrary to our interests, in this case economic (interests),” he said. “No gas, no oil, no coal, no fuel oil, nothing.”

More recently, at an OPEC+ meeting in Vienna, Russian Deputy Prime Minister Alexander Novak reiterated the warning that his country will not sell oil to countries that adopt such a cap. “We believe that this tool is in breach of all the market mechanisms. It could be very pernicious for the global oil industry… We will be ready to cut production (deliberately)”. 

It turns out that other oil producers do not look favourably on the G7 decision to cap Russian oil prices either. According to Bloomberg energy expert Javier Blas, they see the decision as a terrible precedent for consumers trying to dictate oil prices to producers.

This is probably one of the reasons why OPEC+ decided last week to collectively cut oil production by 2 million barrels per day, or about 2% of global oil consumption. Officially, the UAE energy minister said it was a “technical decision, not a political decision”. Saudi Arabia added that the production cut was justified by market conditions amid fears of a global recession.

In fact, this OPEC+ decision could mark the beginning of the US losing control of the global oil market. As a reminder, US President Joe Biden visited Saudi Arabia in June to ask for an increase in oil production, but without real success. “There’s going to be some consequences for what they’ve done with Russia,” Mr. Biden told CNN’s Jake Tapper in an interview broadcast on Tuesday night.

Finally, the success of a Russian oil price cap would require a united front from all global buyers. It is unlikely that China and India, and even Turkey, will agree to submit to these sanctions. Since the start of the war, India and China have made up for most of the decline in Russian shipments to Europe.

Russia would then send more barrels to these countries using mainly Russian, Chinese and Turkish flagged vessels. Russia would continue to offer discounts, but not up to the ceiling set by the G7.

On 5 October, Patrick Pouyanné, CEO of TotalEnergies, told at the Energy Intelligence Forum that a cap on Russian oil prices would benefit Russian President Vladimir Putin.

“I think it’s a bad idea because it’s a way to give the leadership back to Vladimir Putin and I would never do that.”

“What I am sure is that if we do that (cap), then Putin will say that ‘we don’t sell my oil’ – and the price will not be at $95, it will be at $150.” Pouyanné said.

Japan is facing an energy security crisis

The supply of liquefied natural gas to the world’s third largest economy is in jeopardy. While Japan is participating in Western sanctions against Russia following its military intervention in Ukraine, Moscow has made it clear to Tokyo that its participation in the Sakhalin II project is not a given.

Japan is the fourth largest exporting country in the world after China, the United States and Germany. Its economy is heavily dependent on its access to abundant and cheap energy to manufacture vehicles, machinery and electronic equipment.

Like all developed nations, Japan’s energy policy attempts to balance access to cheap energy, security of supply and the reduction of GHG emissions. 

Japan’s energy security is fundamental because as an island, the country has limited natural resources and lacks international pipelines and electrical connections.

According to the International Energy Agency, the country produced 30% of its electricity from nuclear power until 2011. The Fukushima nuclear disaster led to a total suspension of the nuclear fleet. The latter has only partially restarted and now produces less than 10% of the country’s electricity, making Japan more dependent on fossil fuels.

Dependence on imported fossil fuels reached 94% of energy supply in 2014. Several factors such as the restart of nuclear power, the expansion of renewable energy and the decrease in energy demand have reduced this share to 88% in 2019. This is still the worst self-sufficiency rate among IEA member countries after Luxembourg.

Natural gas plays a critical role in energy supply in Japan, representing the largest energy source in electricity generation. With domestic production being limited, Japan imports nearly all of its natural gas in the form of liquefied natural gas (LNG). 

Japan is the world’s largest LNG importer, accounting for 22% of global trade in 2019. About 10% of LNG imports come from Russia, specifically from Sakhalin 2.

Japan’s total primary energy supply by source

The Sakhalin-2 project

The Sakhalin-2 project, located on the Sakhalin Island is one of the biggest integrated oil and LNG projects in the world. It also represents the first offshore gas project and the first LNG plant in Russia. 

Before the military operation in Ukraine, the project was operated by Sakhalin Energy Investment Company Ltd, a joint venture between the Russian state-owned Gazprom (50%), the British company Shell (27.5%), and the Japanese companies Mitsui (12.5%) and Mitsubishi (10%). 

The project infrastructure includes three offshore platforms, an onshore processing facility, 300 kilometres of offshore pipelines and 1,600 kilometres of onshore pipelines, an oil export terminal and a liquefied natural gas plant.

The LNG plant was officially inaugurated on February 18, 2009 and the first cargo began its journey to Japan in March 2009. The project produces 10 million tons of LNG per year, or 4% of the current global liquefied natural gas market, of which six million tons are shipped to Japan.

The Sakhalin-2 project is of great importance to Tokyo, particularly because of its geographical proximity. While LNG tankers can take more than two weeks from Qatar and three weeks from the United States to reach East Asia, Sakhalin LNG tankers can arrive in a few days.

The Sakhalin-2 project supplies LNG to the Asia-Pacific region

  Source: Sakhalin Energy

Tensions are rising between Moscow and Tokyo

In late February, Shell announced its intention to withdraw from the project following the Russian military intervention in Ukraine.

For their part, Japanese companies Mitsui and Mitsubishi have maintained their stakes in the gas project while Japan participates in Western sanctions against Russia by banning the export of goods that could support the development of Russian industry.

Recently, the country also openly discussed with the G7 to cap the price of Russian oil exports at half the current rate, which of course irritated Moscow.

On June 30, Russian President Vladimir Putin signed a decree to transfer all assets and rights of the Sakhalin project from foreign to Russian jurisdiction. A Russian limited liability company will be formed to control all assets of the project. The foreign shareholders have one month to decide whether they will remain in the project. If so, they will join the capital of the new company with the same shareholdings. Otherwise, they will lose their assets.

Putin’s decision caused shares of Japanese companies Mitsubishi and Mitsui to fall 6% immediately after the news broke earlier this month. The Japanese government has openly asked Japanese companies to make the transfer. 

Currently, it is very difficult to replace this gas. Neither Qatar, Australia nor the United States currently have significant volumes of LNG available. Liquefied natural gas is a scarce commodity and finding consumers is not a problem.

Reuters reports on July 19 that Japan’s Nippon Steel Corp, the world’s second largest steelmaker, has purchased a cargo of LNG at the highest price ever paid in the country.

The signal sent by Moscow seems clear: Tokyo must stop imposing ever more sanctions on Russia if it wishes to maintain its energy security.

Vladimir Putin signs the decree to create the new company

Source: Kremlin

DISCLAIMER: The statements, views and opinions expressed in this article are solely those of the author and may not necessarily represent those of Equinox.

Winter is coming to Europe

In the midst of an energy crisis, the gas issue has become one of the main topics of tension between Russia and Europe. On July 11, the Nord Stream 1 pipeline commenced a ten-day maintenance program, completely interrupting gas deliveries to Europe. Many commentators already see this as the end of Russian gas deliveries. If this is the case, it would be a disaster for the Old Continent. 

“Everyone should know that by and large we haven’t started anything yet in earnest. At the same time, we don’t reject peace talks. But those who reject them should know that the further it goes, the harder it will be for them to negotiate with us.” These are the words spoken by Vladimir Putin on July 7 at a meeting with parliamentary leaders.

The Russian president has remained ambiguous in his threats against the West, but everyone is guessing that gas is now at the heart of the economic war.

France’s Minister of Economy recently warned that Russia is likely to totally shut off its sale of natural gas to Europe. “Let’s get ready for a total shutdown of the Russian gas supply,” he said. “This is the most likely event”.

Nord Stream 1 is the main route for Russian gas to Germany, providing 55 billion cubic meters (bcm) per year. Since Russia reduced the capacity of Nord Stream 1, the European benchmark price of gas (Dutch TTF) has doubled to 170 EUR per megawatt hour, an increase of 145% since the beginning of the year.

Gas is already eight times more expensive in EU than in the US

Europe’s heart is under attack

Energy is vital to an economy, and Russian gas is crucial to Europe’s largest economy, Germany. It is used to heat the majority of households and to power the country’s industrial export machine.

In recent months, gas volumes from Russia have fallen to about 40% of their usual level. Moscow attributes this drop in throughput to the sanctions it faces, claiming that these have hampered its access to spare parts.

Economy Minister Habeck fears a social breakdown in the event of an energy shortage. “Companies would have to stop production, lay off their workers, supply chains would collapse, people would go into debt to pay their heating bills,” he said.

Germany is already suffering from rising energy prices. For the first time since 1991, the country recorded a negative trade balance of less than one billion EUR in May.

The economic research institute Prognos published a study in June explaining that, in the event of a complete shutdown of Russian gas, Germany’s gas reserves would run out after four weeks.

While households and social services would continue to be supplied with gas, the shutdown would particularly affect the steel, chemical and glass industries. Forecasts indicate a 50% drop in their production volume.

Europe’s leading economic power is crumbling

The Eurozone is in Crisis

The single currency recently fell to parity with the US$ for the first time in nearly 20 years.

The decline of the EUR against the US$ is mainly due to the restrictive monetary policy of the U.S. Federal Reserve, which combines interest rate increases and quantitative tightening. Rising energy prices and the collapse of German industry are adding to this dynamic.

The weakness of the EUR is driving up the price of imports, especially energy, at a time when policymakers are already struggling with record inflation.

The European Central Bank is in a very difficult position. If it does not raise interest rates, the EUR is likely to continue to plummet against the US$, which will continue to fuel a rise in inflation driven by higher energy prices. 

But if it raises interest rates, it risks causing a recession that will be very hard on southern Europe and could cause fragmentation within the Eurozone.

A country like Italy, with a debt of about 150% of its GDP, could quickly be strangled by the need to refinance its excessive debt burden. 

Recently, the spread between Italian and German 10-year bonds has widened. This indicates that investors are beginning to doubt the ability of the Italians to meet their payments relative to the Germans. It reached 2.52 percentage points on June 14. 

Europe will probably again face a systemic risk related to the sovereign debt of its member states.

Confidence in the Eurozone is eroding

DISCLAIMER: The statements, views and opinions expressed in this article are solely those of the author and may not necessarily represent those of Equinox.

Sanctions against Russia – a fiasco?

Responding to Russia’s military intervention in Ukraine, the West introduced major sanctions against Moscow. The objective was to inflict maximum pain on the Russian economy to encourage a change in Moscow’s policy. Now, with the conflict more than four months old, it is time to make a first assessment on the effectiveness of Western sanctions.

“One of the great mistakes is to judge policies and programs by their intentions rather than their results”. Following Milton Friedman’s philosophy, we will try to put aside moral considerations to focus on the impact of sanctions, and, for the sake of simplicity, we will group the main sanctions into four categories according to their objective.

1. Generate a crisis of confidence in the Russian economy

As revealed by the French Minister of Economy Bruno Le Maire, the initial purpose of the sanctions was to “cause the collapse of the Russian economy.” The most important measure in this regard was the freezing of the assets of the Russian central bank. The idea was to prevent the country from being able to use its foreign currencies in US$ and EUR to support a potential massive depreciation of the ruble. 

Despite a sharp decline at the beginning of the war, the Russian ruble has now recovered much of its value against other world currencies, made possible by government capital controls and a steady flow of payments for the country’s oil and gas exports. As a result, Russian confidence in their economy has actually increased, while the IMF believes that the freezing of Russian assets has weakened the position of the US$ as an international currency. Russia has now set up ruble payment systems that the West has no choice but to follow.

2. Cut Russia’s income stream

On May 31, Europe’s leaders agreed to boycott 90% of imports of crude oil and refined petroleum products from Russia by the end of the year. Presented as a powerful demonstration of solidarity with the Ukrainian people, this decision is probably the most counterproductive one ever taken by the Europeans. 

Oil and gas are inelastic commodities, so their price can vary considerably without affecting the quantity demanded. By trying to reduce the volumes of Russian oil sold on the markets, the West is driving up the price per barrel. To lower its price and resulting revenues generated by the Russian state, they should be doing exactly the opposite and increase their oil supplies as much as possible 

“With higher crude oil and product prices globally, Russian oil export revenues are estimated to have increased by US$1.7 billion in May to about US$20 billion,” the International Energy Agency said in its monthly oil report.

3. Isolate Russia from the rest of the world

On March 2, 2022, less than a week after the Russian invasion began, the United Nations General Assembly passed a resolution demanding that Russia immediately end its military operations in Ukraine. Of the 193 UN states, 141 states voted in favour of the motion, 35 countries abstained and 5 states voted against. 

On April 7, 2022, a new motion was proposed to exclude Russia from the UN Human Rights Council. Still symbolic, this measure was more restrictive than the earlier one and provoked quite different reactions. 93 states voted in favour, 58 countries abstained and 24 countries voted against. 

Barely a month after the beginning of the conflict in Ukraine, the world was already divided into two camps. On one side, developed countries including the United States, Europe, Japan, Australia and New Zealand were seeking to maximize sanctions and the isolation of Russia for geopolitical reasons, and, on the other, emerging countries such as China, India, Mexico, Brazil, South Africa, the Middle East and a good part of Africa were wanting to abstain or refuse the isolation of Russia for geo-economic reasons

The West’s inability to mobilize more states to isolate Russia is a major contributor to the failure of sanctions.

4. Limit Russia’s imports

The measures most successful at affecting the Russian economy are those that are limiting its imports of high-tech manufactured goods and its access to high-tech services. As soon as the war began, Moscow stopped publishing monthly data on exports and imports. To estimate Russian imports, we would need to calculate exports to Russia from its major partners.

We find that exports to Russia from so-called “unfriendly countries” have fallen by 60%, compared to average levels from the second half of 2021. Interestingly, exports from “friendly countries” have also fallen by 40%. But Russian imports still remain significant and the West may introduce tougher secondary sanctions to ensure that their technologies and goods are not re-exported to Russia by “friendly countries”. 

China is the country to watch – it is able to replace a large part of Russian imports which were coming from Western countries before the war. According to the Peterson Institute for International Economics (PIIE), since the invasion, Chinese exports to Russia have dropped by 38%. This suggests that Chinese companies may be afraid of retaliatory measures that the Americans might impose if they support Russia too openly.

It is still too early to measure the full impact the collapse of imports will have on the Russian economy, but, given the experience the country has accumulated since 2014, it is highly likely that it will be able to circumvent them.

According to the European Union: By aiming to undermine the Kremlin’s ability to pursue the invasion, sanctions are contributing to restoring peace in Ukraine and the region. Together with other EU policies, sanctions are a concrete means to uphold the EU values of human dignity, freedom, democracy, the rule of law and human rights.” 

If Western sanctions against Russia are based on noble intentions, in terms of effectiveness, after four months of conflict, they are a fiasco. And this fiasco could have fatal consequences for the rest of the world. Historian Nicolas Mulder recently published a history of sanctions in which he convincingly demonstrates that sanctions often precipitate the wars they are supposed to prevent.

DISCLAIMER: The statements, views and opinions expressed in this article are solely those of the author and may not necessarily represent those of Equinox.

Research & Insights #24

Foreign Debt. According to the White House, Russia defaulted earlier this week on its international obligations. Some bondholders reported that they had not received interest and that the grace period of 30 days had expired. Moscow rejected these claims and accused the West of having pushed it into an artificial default. Indeed, Russia has the money to make payments thanks to oil and gas revenues but is unable to make the transfers because of sanctions on its financial system. The payments in question are for US$100 million in interest on two bonds, one denominated in U.S. dollars and the other in euros. The default is symbolic because Russia cannot borrow internationally at the moment and does not need to do so. The markets did not react to this default. Russian president Vladimir Putin signed a decree this week setting out a new mechanism to make upcoming payments in rubles and then allow investors to convert them into foreign currencies.

Oil Sanctions. The West’s latest sanctions idea is to cap the price of Russian oil imports in order to limit Moscow’s revenues and drive down the price of black gold. As we explained in a recent article, sanctions are a double-edged sword. By banning Russian oil imports by the end of the year, the Europeans have succeeded in driving up the price per barrel, increasing the revenue of the Russian state and allowing countries like China and India to buy oil at a discount price. The G7 and the EU have not indicated where the price cap would be set, but have suggested that it could be higher than Russia’s cost of production – but not too high – in order to maintain its incentive to export. Of course, for the measure to be effective, as many international partners as possible would have to participate in the new sanctions. Some oil executives are sceptical about the feasibility or effectiveness of such a measure.

NATO Expansion. Turkey has finally lifted its veto on Finland and Sweden’s application to join NATO. The decision ended a weeks-long drama that tested the unity of the allies. The decision comes just before the start of the NATO summit in Madrid. Helsinki and Stockholm will be able to move forward with their membership application and make the biggest change in European security in decades. Finnish and Swedish membership would give the Western military alliance superiority in the Baltic Sea, where Norway, Denmark and the three Baltic states are already members of the organization. Officially, Turkey opposed the two Scandinavian countries’ application because of their links to Kurdish militants considered terrorists by Ankara. Some analysts believe that the Turkish president sought to negotiate the lifting of arms bans imposed on Ankara by the United States and many European countries, as well as to play hardball in the run-up to elections in Turkey in a year.

Gas Supply Shock. European leaders are growing increasingly concerned about the possibility of a full shutdown of gas supplies from Russia. Gazprom has reduced its gas flows to Europe by about 60% over the past few weeks. Europe, which receives roughly 40% of its gas via Russian pipelines, is trying to rapidly reduce its reliance on Russian hydrocarbons. “Russia is diminishing the supply of gas little by little — to some countries [by] almost 100%; to others, cutting 10, 15%,” said Josep Borrel, the European Union’s foreign policy chief. The reduction in gas flows has heightened fears that the EU is on the verge of a difficult economic period. The International Energy Agency said the continent should prepare for a complete shutdown of Russian gas exports this winter. In the long term, the EU wants to use more renewable energy, but there is not enough time to add significant capacity before winter. Germany, Austria and the Netherlands have already announced an emergency restart of coal-fired power plants.

DISCLAIMER: The statements, views and opinions expressed in this article are solely those of the author and may not necessarily represent those of Equinox.

“The End of a Unipolar World Order”

Last week, Vladimir Putin gave an “extremely important” speech, according to the Kremlin, at the St. Petersburg International Economic Forum (SPIEF). It was the Russian President’s first major appearance before an international audience since the launch of the military campaign in Ukraine. Below are some excerpts from his speech on the main economic and geopolitical issues of the day. Click here to read or listen to his entire speech.

A New World Order is Emerging

When I spoke at the Davos Forum a year and a half ago, I also stressed that the era of a unipolar world order has come to an end. I want to start with this, as there is no way around it. This era has ended despite all the attempts to maintain and preserve it at all costs. Change is a natural process of history, as it is difficult to reconcile the diversity of civilisations and the richness of cultures on the planet with political, economic or other stereotypes – these do not work here, they are imposed by one centre in a rough and no-compromise manner. 

After declaring victory in the Cold War, the United States proclaimed itself to be God’s messenger on Earth, without any obligations and only interests which were declared sacred. They seem to ignore the fact that in the past decades, new powerful and increasingly assertive centres have been formed. Each of them develops its own political system and public institutions according to its own model of economic growth and, naturally, has the right to protect them and to secure national sovereignty. 

These are objective processes and genuinely revolutionary tectonic shifts in geopolitics, the global economy and technology, in the entire system of international relations, where the role of dynamic and potentially strong countries and regions is substantially growing. It is no longer possible to ignore their interests. 

Denial of the Western Elites

[…] the ruling elite of some Western states seem to be harbouring this kind of illusions. They refuse to notice obvious things, stubbornly clinging to the shadows of the past. For example, they seem to believe that the dominance of the West in global politics and the economy is an unchanging, eternal value. Nothing lasts forever.

Our colleagues are not just denying reality. More than that; they are trying to reverse the course of history. They seem to think in terms of the past century. They are still influenced by their own misconceptions about countries outside the so-called “golden billion”: they consider everything a backwater, or their backyard. They still treat them like colonies, and the people living there, like second-class people, because they consider themselves exceptional. If they are exceptional, that means everyone else is second rate.

Thereby, the irrepressible urge to punish, to economically crush anyone who does not fit with the mainstream, does not want to blindly obey. Moreover, they crudely and shamelessly impose their ethics, their views on culture and ideas about history, sometimes questioning the sovereignty and integrity of states, and threatening their very existence. Suffice it to recall what happened in Yugoslavia, Syria, Libya and Iraq.

Sanctions will not change the course of History 

The idea was clear as day – they expected to suddenly and violently crush the Russian economy, to hit Russia’s industry, finance, and people’s living standards by destroying business chains, forcibly recalling Western companies from the Russian market, and freezing Russian assets.

This did not work. Obviously, it did not work out; it did not happen. Russian entrepreneurs and authorities have acted in a collected and professional manner, and Russians have shown solidarity and responsibility.

Step by step, we will normalise the economic situation. We have stabilised the financial markets, the banking system and the trade network. Now we are busy saturating the economy with liquidity and working capital to maintain the stable operation of enterprises and companies, employment and jobs.

Within just three months of the massive package of sanctions, we have suppressed inflation rate spikes. As you know, after peaking at 17.8 percent, inflation now stands at 16.7 percent and continues dropping. This economic dynamic is being stabilised, and state finances are now sustainable. 

On the European Economy

Sanctions as a weapon have proved in recent years to be a double-edged sword damaging their advocates and architects just a much, if not more. 

According to experts, the EU’s direct, calculable losses from the sanctions fever could exceed US$400 billion this year. This is the price of the decisions that are far removed from reality and contradict common sense.

The growing outlays of European companies and the loss of the Russian market will have lasting negative effects. The obvious result of this will be the loss of global competitiveness and a system-wide decline in the European economies’ pace of growth for years to come. 

Such a disconnect from reality and the demands of society will inevitably lead to a surge in populism and extremist and radical movements, major socioeconomic changes, degradation and a change of elites in the short term. 

The attempts to keep up appearances and the talk about allegedly acceptable costs in the name of pseudo-unity cannot hide the main thing: the European Union has lost its political sovereignty, and its bureaucratic elites are dancing to someone else’s tune, doing everything they are told from on high and hurting their own people, economies, and businesses.

On the Global Economy

Surging inflation in product and commodity markets had become a fact of life long before the events of this year. The world has been driven into this situation, little by little, by many years of irresponsible macroeconomic policies pursued by the G7 countries, including uncontrolled emission and accumulation of unsecured debt. These processes intensified with the onset of the coronavirus pandemic in 2020, when supply and demand for goods and services drastically fell on a global scale.

So, they printed more money, and then what? Where did all that money go? It was obviously used to pay for goods and services outside Western countries – this is where the newly-printed money flowed. They literally began to clean out, to wipe out global markets. Naturally, no one thought about the interests of other states, including the poorest ones. They were left with scraps, as they say, and even that at exorbitant prices.

The European Union is building up imports even faster. Obviously, such a sharp increase in demand that is not covered by the supply of goods has triggered a wave of shortages and global inflation. This is where this global inflation originates. In the past couple of years, practically everything – raw materials, consumer goods and particularly food products – has become more expensive all over the world. 

Global Foreign Exchanges Reserves

According to the UN, in February 2022, the food price index was 50 percent higher than in May 2020, while the composite raw materials index has doubled over this period.

Under the cloud of inflation, many developing nations are asking a good question: why exchange goods for US$ and EUR that are losing value right before our eyes? The conclusion suggests itself: the economy of mythical entities is inevitably being replaced by the economy of real values and assets.

According to the IMF, global currency reserves are at US$7.1 trillion and 2.5 trillion EUR now. These reserves are devalued at an annual rate of about 8 percent. Moreover, they can be confiscated or stolen any time if the United States dislikes something in the policy of the states involved. I think this has become a very real threat for many countries that keep their gold and foreign exchange reserves in these currencies.

According to analyst estimates, and this is an objective analysis, a conversion of global reserves will begin just because there is no room for them with such shortages. They will be converted from weakening currencies into real resources like food, energy commodities and other raw materials. Other countries will be doing this, of course. Obviously, this process will further fuel global US$ inflation.

As for Europe, their failed energy policy, blindly staking everything on renewables and spot supplies of natural gas, which have caused energy price increases since the third quarter of last year – again, long before the operation in Donbass – have also exacerbated price hikes. We have absolutely nothing to do with this. It was due to their own actions that prices have gone through the roof, and now they are once again looking for somebody to blame. 

On Global Food Shortages

Not only did the West’s miscalculations affect the net cost of goods and services but they also resulted in decreased fertiliser production, mainly nitrogen fertilisers made from natural gas. Overall, global fertiliser prices have jumped by over 70 percent from mid-2021 through February 2022. 

Unfortunately, there are currently no conditions that can overcome these pricing trends. On the contrary, aggravated by obstacles to the operation of Russian and Belarusian fertiliser producers and disrupted supply logistics, this situation is approaching a deadlock. 

It is not difficult to foresee coming developments. A shortage of fertiliser means a lower harvest and a higher risk of an undersupplied global food market. Prices will go even higher, which could lead to hunger in the poorest countries. And it will be fully on the conscience of the US administration and the European bureaucracy.

I want to emphasise once again: this problem did not arise today or in the past three or four months. And certainly, it is not Russia’s fault as some demagogues try to declare, shifting the responsibility for the current state of affairs in the world economy to our country. 

On Russian Food Supplies

The current priority of the international community is to increase food deliveries to the global market, notably, to satisfy the requirements of the countries that need food most of all.

As a priority, we will supply the countries that need food most of all, where the number of starving people could increase, first of all, African countries and the Middle East.

At the same time, there will be problems there, and not through our fault either. Yes, on paper Russian grain, food and fertilisers… Incidentally, the Americans have adopted sanctions on our fertilisers, and the Europeans followed suit. Later, the Americans lifted them because they saw what this could lead to. But the Europeans have not backed off. Their bureaucracy is as slow as a flour mill in the 18th century. In other words, everyone knows that they have done a stupid thing, but they find it difficult to retrace their steps for bureaucratic reasons.

As I have said, Russia is ready to contribute to balancing global markets of agricultural products, and we see that our UN colleagues, who are aware of the scale of the global food problem, are ready for dialogue. We could talk about creating normal logistical, financial and transport conditions for increasing Russian food and fertiliser exports.

DISCLAIMER: The statements, views and opinions expressed in this article are solely those of the author and may not necessarily represent those of Equinox.