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.

Research & Insights #23

Semiconductors. On May 30, the Russian government decided to limit its exports of noble gases such as neon. Noble or inert gases, such as neon, argon or xenon, are essential to the semiconductor manufacturing process. Semiconductors compose the significant part of electronic devices (computers, tablets, smartphones) critical to the industry 4.0, aeronautics or automotive sector. Restricting these Russian exports could exacerbate the supply shortage on the global market. Ukraine was one of the world’s leading suppliers of noble gas until it suspended production at its plants in the cities of Mariupol and Odessa in March. According to ministry estimates, Russia accounts for 30 percent of the world’s supply of three noble gases: neon, krypton and xenon. After the European Union banned the export of semiconductors, machinery and other equipment to Russia in April, Moscow wants to remind the “unfriendly countries” that they also depend on Russian exports in the field of semiconductor manufacturing.

Oil & Gas. China and India have increased Russian oil purchases, allowing Moscow to secure export revenue. According to Refinitiv data, China imported 800,000 barrels of Russian oil per day by sea last month, which is a 40% increase in volumes compared to January. Russian seaborne oil imports by India have also risen from zero in January to nearly 700,000 barrels per day in May. China and India are taking advantage of the drop in Western demand due to the embargo on Russian oil to buy it massively at good prices. Russian Urals crude is currently trading at around US$90 a barrel compared with Brent, the international benchmark for crude, at around US$125. While Asia is buying more and more Russian crude, the European Union recently decided to block most of it by the end of the year.

Russian stock market. The possibility for non-residents to trade their securities on the Moscow Exchange (MOEX) in a special session is under discussion. According to Interfax, the largest exchange in Russia plans to launch a separate trading session for non-residents at the end of June. They could then buy and sell Russian securities for rubles. Since the crisis in Ukraine and the sanctions taken by the West, the Russian authorities have banned the sale of securities on behalf of non-residents as one of the first capital controls. For its part, the U.S. Treasury Department has just prohibited U.S. fund managers from buying any Russian debt or equity on the secondary markets. Until now, Americans were still allowed to trade hundreds of billions of dollars of assets already outstanding on the secondary markets. 

Food Crisis. While Ukraine and the West accuse Moscow of weaponizing food, Russia blames the situation on international sanctions against its economy and mining Ukrainian ports. Indeed, the main Ukrainian port, Odesa, is currently blocked. The Russian Foreign Minister is in Turkey to discuss unblocking grain exports from Ukraine. Opening a safety corridor for ships carrying grain is at the heart of the negotiations. The United Nations is also working on plans with Kiev and Moscow on how to restart grain exports. Russian Defense Minister Sergei Shoigu said two major Ukrainian ports on the Sea of Azov seized by Russian forces (Berdyansk and Mariupol) were ready to resume grain shipments. The Russian offensive in Ukraine has disrupted shipments of wheat and other commodities from both countries, raising concerns about the risk of food shortages and famine worldwide.

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

Will the coming food crisis put globalisation at risk?

Recent globalisation has been marked by innovation and falling international trade costs. Both factors have led to an explosion in global production, consumption and trade. With Covid, and now the war in Ukraine, globalisation has never seemed so threatened. The disruption of agricultural supply chains and its consequences should change our positive perception of an interdependent world.

Russia is using food supplies as a weapon with global repercussions, acting the same way it does in the energy sector, European Commission President Ursula von der Leyen said on May 24, at the World Economic Forum (WEF) in Davos, Switzerland.

“In Russian-occupied Ukraine, the Kremlin’s army is confiscating grain stocks and machinery (…) And Russian warships in the Black Sea are blockading Ukrainian ships full of wheat and sunflower seeds,” she added. 

Since the start of the conflict in Ukraine, wheat and maize prices have increased by 41% and 28% respectively. Russia and Ukraine account for about a third of global wheat and barley exports and a significant share for maize and sunflower oil.

According to the International Fertiliser Development Centre, Ukraine also provides one-fifth of the world’s supply of fertiliser nutrients, while Russia and Belarus supply 40% of the potash used as a crop nutrient. In fact, the Ukrainian crisis has pushed up the price of the three most important items for agriculture: feed, fuel and fertilisers.

About 25 million tonnes of maize and wheat are currently stored in Ukraine. Farmers are unable to export their agricultural product via the Black Sea ports which are either under Russian control or blocked by its navy. Thus, farmers are trying to export their grain by road, river and rail. 

A global food crisis seems inevitable if Russia maintains its blockade, a Ukrainian agriculture ministry official told Reuters last week. Vladimir Putin said that if sanctions were lifted, then Russia could “export significant volumes of fertilisers and agricultural products.” 

Major agricultural powers are tempted to impose restrictions on food exports as the outlook for food security continues to worsen. India has already banned wheat exports, citing a food security risk, partly because of the war in Ukraine but also a heat wave that has reduced domestic production and pushed local prices to record levels.

The first direct victims of the impending food crisis will be the countries of the Middle East and Africa, where millions of people depend on subsidised bread. It is still too early to know what the indirect effects of higher food prices will be, such as social unrest or waves of migration.

Globalisation could be the ultimate victim of the coming food crisis. 

Covid has made many Western countries aware of the drawbacks of relying on Chinese industry to produce something as simple as protective masks. The war in Ukraine should now make many countries aware of the importance of ensuring their own food sovereignty.

“We are shifting from a world in which economic considerations determine how resources are allocated to a world in which ideologies and politics determine how resources are allocated. Ideological and political wars lead to much less cost-efficient resource allocations, which is inflationary” said Ray Dalio, the billionaire founder of Bridgewater, recently.

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 #22

Central Bank. The Russian ruble continued its strong recovery, falling below 60 rubles to the dollar again this week. In theory, the ruble is the world’s best performing currency with a 30% rise since the beginning of the year. However, the exchange rate is artificial as the Central Bank of Russia has put in place strict capital controls following the imposition of sanctions by the West. Most experts believe that the national currency is currently overvalued. Russian authorities will continue to take measures in the coming weeks to ease the pressure on it. On 24 May, the Ministry of Finance reduced the mandatory sale level of export earnings from 80% to 50%. On 26 May, the Bank of Russia cut interest rates by 3%. A simple way to prevent the ruble from strengthening is to ensure now that Russian companies can pay their foreign debt in foreign currency, to stimulate foreign currency purchasing. Current EU and US sanctions make such transactions difficult.

Foreign debt. Once again, Russia is moving closer to a potential default on its foreign currency debt. The US will not extend the General License 9A (GL9A), which allowed the Russian state and its companies to service their debt in dollars to international investors. This could lead to a cascade of defaults, the US Treasury Department’s Office of Foreign Assets Control (OFAC) said on 24 May. Without this licence, it will be very difficult for the state or companies to pay, forcing them to default. Russia has some US$75 billion in outstanding debt, of which 15% is foreign debt. With an estimated current account surplus of some US$200 billion in 2022, the government has enough money to cover its bond obligations. It seems that that the US would rather force Russia to default than allow the country to pay its US creditors.

NATO. Following Russia’s military intervention in Ukraine, Sweden and Finland have officially applied to join NATO. Traditionally neutral, these two states have recently seen their public opinions rapidly shift in favour of joining the politico-military alliance. Seventy-six percent of Finns are now in favour of membership, compared to 12 percent who are against it. Moscow has warned against the move, saying it would damage relations and that Russia would retaliate. Turkish President, Recep Tayyip Erdogan, said he opposed the alliance’s expansion, citing concerns about the presence of “terrorists” in Finland and Sweden. Turkey has set several conditions for accepting Sweden’s application for NATO membership. Sweden must lift sanctions against Turkey, including the arms export embargo, end “political support for terrorism”, eliminate sources of funding for terrorism and stop supplying arms to the PKK and its armed Syrian wing, the YPG.

Food crisis. Wheat prices have reached record levels in the last two months and have risen by more than 60% since the beginning of the year. The surge has been triggered by the conflict between Russia and Ukraine, which supply almost a third of global wheat exports, and by droughts around the world. Major producers such as Russia, Kazakhstan and India have already restricted exports to protect their domestic markets. There are currently 20 million tonnes of wheat blocked in Ukraine. Usually, the country exports five million tonnes of grain per month. Currently, Kyiv can only export a fraction of its production, between 200,000 and one million tonnes per month. For its part, Moscow is seeking to strengthen control over its grain exports. According to the Russian daily Kommersant, it wants all members of the Eurasian Economic Union to introduce quotas and duties on grain exports to third countries, fearing that Russian grain will be re-exported to other markets.

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

Should the West acknowledge Russia’s security interests?

On 12 May 2022, the Munk Debates organised a debate on the war between Russia and Ukraine. With this conflict becoming a major risk to global security, the organisers brought together the most brilliant thinkers of our time to reflect on the biggest issue of the day.

What is the best way to resolve the crisis between Russia and the West?  Should the West continue to punish, isolate and weaken Russia, or should its security needs be recognised? Four guests were invited to debate and discuss these questions. John Mearsheimer, from the University of Chicago, and Stephen Walt, professor of international affairs at the Harvard Kennedy School, tried to defend the idea that the West should take into account Russia’s security needs. Opposite them, Radosław Sikorski, MP, former Minister of Foreign Affairs and Defence of Poland, and Michael McFaul, former US Ambassador to the Russian Federation, argued the contrary.

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

Why is the EU struggling to ban Russian oil imports?

Since the beginning of the conflict in Ukraine, Brussels has been putting pressure on Moscow by introducing sanctions to damage its economy. The aim is clear: to deprive Russia of its main sources of hard currency income. But the European Union is having trouble agreeing on its sixth sanction package. Initially, the EU had planned to ban the import and transport of crude oil from Russia. Due to a lack of consensus among Member States, this plan could now be watered down.

Oil is essential for all economies to create wealth. When the price of oil rises sharply, countries without oil pay the equivalent of a tax or levy to countries that produce it. A massive change in the price of oil leads to a massive transfer of wealth in a global economy.

This is the difficult situation that President of the European Commission, Ursula von der Leyen, is currently facing. By seeking to stop importing oil from the world’s largest producer, the European Union risks above all paying more for its much-needed energy. 

Will this policy inflict more pain on Russia than on the old continent? Nothing is less certain. What is certain is that this measure is not unanimously supported by the EU Member States.

Hungary, which has until now largely supported EU sanctions against Russia, is the main opponent of the suspension of Russian oil imports. Prime Minister Viktor Orban has said that stopping Russian oil purchases would be an “atomic bomb” for the Hungarian economy. “Fuel prices in Hungary will rise by 55-60%. Their growth will be followed by a surge in prices for all goods”, said the Hungarian Minister of Foreign Affairs. 

Given their dependence on Russian crude oil, Slovakia and the Czech Republic would also want to benefit from special conditions if an agreement can be reached on new energy sanctions.

According to Bloomberg, the EU is considering banning the transport of Russian oil to third countries by EU-owned ships. This time, it is Greece that is lobbying to drop this provision in the next round of sanctions. Its economy is heavily dependent on maritime transport. 

Greeks own more than a quarter of the world’s oil tankers by capacity. The share of Greek tankers shipping oil from Russian ports has risen from 37% before the war to 55% since. 

EU member states could, however, agree to sanction Russian oil exports through European insurers. To transport oil using tankers, oil companies collectively insure their ships against risks, including oil spills.

Targeting marine insurance is a powerful tool as the largest specialist insurers in this sector operate mainly in Western countries. This option still needs the UK to be persuaded to adhere to EU sanctions as it plays a crucial role in the insurance market.

“I can assure you that Europe will move out from Russian oil and Europe will move out from Russian gas. The only thing is it cannot be done overnight,” said Alexander Schallenberg, the Austrian Minister of Foreign Affairs

The paradox is that by promising to phase out Russian oil imports, the EU is helping to create uncertainty about future supplies. This in turn drives up the price of oil today and helps to increase Russian state revenues.

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