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reflections

Sep 16, 2015 | 22:18 GMT

7 mins read

Russia Begins to Buckle Under Sanctions Pressure

(Stratfor)
It can be difficult to separate the important from unimportant on any given day. Reflections mean to do exactly that — by thinking about what happened today, we can consider what might happen tomorrow.

Low energy prices and economic sanctions are taking their toll on the Russian economy, so much so that the Kremlin is putting sanctions relief at the forefront of next year's policy agenda. The Western sanctions are in large part designed to affect the Russian economy down the road — for example, energy sanctions target long-term development projects like Arctic oil and gas deposits. But Russia is getting to the point where delays in key projects, along with financing constraints on Russian companies and Western firms doing business in Russia, could cause irreparable harm to the economy in the not-too-distant future. In addition, there are increasing signs that the global economy is about to enter a downturn and that oil prices, which have dropped by more than half since the Ukraine crisis began, will remain low for the foreseeable future and possibly go lower.

Simply put, Russia is starting to realize it cannot weather the sanctions much longer, particularly because the next five years will already be a difficult time for the Russian economy.

The sanctions have delayed long- and medium-term projects. On Sept. 15, an Energy Ministry official noted that the ministry does not expect drilling to return to the Arctic Sea until 2020 at the earliest. ExxonMobil and Rosneft began drilling in the Kara Sea last August, but the United States ratcheted up sanctions the following month, forcing ExxonMobil to pull out of the project entirely. Pushing back the development timetable by six years likely means that the first oil from the project will not come online until the second half of the 2020s, if not later, instead of during the crucial 2020-2025 period. Moreover, sanctions somewhat inhibit access to technology for shale oil and gas development. As many of Western Siberia's Soviet-era fields decline, Russia needs reinvestment, redevelopment and the discovery of new resources just to maintain its current production levels. 

Limits on financing have also affected several key medium-term projects. Novatek's Yamal liquefied natural gas facility has been barred from using long-term dollar-denominated loans. Thus, the project stakeholders — Novatek (60 percent), Total (20 percent) and China National Petroleum Corp., or CNPC (20 percent) — have had to turn to more Chinese financing than they had originally intended. Novatek finally agreed to sell a 9.9 percent stake to the China Silk Road Fund on Sept. 3 during Russian President Vladimir Putin's visit to China. But as China's own economy has slowed, Beijing has been more stringent in its overseas investment strategy, thus limiting Russia's ability to turn away from the West and toward China to offset sanctions blowback. Gazprom's 2014 deal with CNPC on natural gas supplies through the Power of Siberia pipeline has also been difficult to move forward because of China's hesitance to prepay for gas; Gazprom needed the prepayment funds to help finance the construction of the project.

Sanctions are also affecting the Russian financial system. By no means were sanctions the only cause of the Russian ruble's decline and the Russian banking sector's difficulties, but they add enormous weight to what was already a major burden from low energy prices. Because oil prices are largely out of Russia's — or anyone's — control, Moscow must do what it can. In theory, a country with ample financial reserves could use them to offset the decline in government revenue stemming from lower oil prices, as Saudi Arabia and other major oil producers have. But the uncertainty about the duration of sanctions on the Russian financial system has made the Kremlin a miser, holding on to its reserves in case Russia's economic situation grows even bleaker in the future. Therefore, Moscow will likely scale back some of its long-term development plans, such as its military modernization or massive energy projects such as Turkish Stream, Nord Stream II and the Power of Siberia pipeline.

Russia has limited ability to respond to Western sanctions in kind. Russia's counter-sanction options are either very drastic, such as energy cuts to Europe, or very small, such as embargoes on European fruit. They offer no sense of proportionality in response and thus have been ineffectual. Now Russia is trying to create circumstances in which sanctions could be removed, relaxed or suspended, even if that turns out to be a slow process. 

In Ukraine, a cease-fire between Ukrainian forces and Russian-backed separatists has held relatively well for the past two weeks, and last week's meetings between the foreign ministers of Russia, Ukraine, Germany and France indicate that officials will soon reach a deal to withdraw heavy weapons from Ukraine. The next important date in the negotiations on Ukraine is Oct. 2, when Normandy format talks between Putin, Ukrainian President Petro Poroshenko, German Chancellor Angela Merkel and French President Francois Hollande will be held (though the leaders instead may meet early, during the U.N. General Assembly next week). France — and to a certain extent, Germany — has begun considering the eventual easing of sanctions on Russia, though nothing is imminent. Russia is laying the groundwork to appease the two most important EU heads of state in hopes that if the Europeans ease sanctions the United States may do likewise. 

At the same time, Russia is becoming even more involved in Syria. Although propping up Bashar al Assad and prolonging his government's resistance to rebel movements seems counter to Western interests, it actually supports U.S. and EU positions to a degree, because Russia's support gives Syrian government forces more resources to fight the Islamic State. But Moscow is also trying to bolster its position in the Syrian crisis to potentially gain leverage with the United States. Moscow has few bargaining chips with Washington, but Syria may be enough to bring the United States to the table.

Although discussions between Russia and the United States — whether about Ukraine, Syria or sanctions — have largely broken down, U.S. Secretary of State John Kerry and Russian Foreign Minister Sergei Lavrov are still communicating. Over the past two weeks, Russian officials have said daily that Putin is interested in a meeting with U.S. President Barack Obama but that the Americans are sending mixed messages. This week the White House said Obama would speak with Putin only "when it would advance our (the United States') interests."

However, Moscow is thinking of its own interest, namely, negotiating with the United States for an eventual easing of the sanctions. Next week's U.N. General Assembly in New York could indicate how open the United States is to moving quickly on a dialogue with Russia. Kerry and Lavrov are set to meet, but the big question is whether the Russians can convince Obama to sit down with Putin.

Moscow's key objective for 2016 and 2017 is getting relief from the sanctions, and it will use whatever it can — Ukraine and Syria included — to present itself as a willing partner. Theoretically, the European Union could remove some restrictions as early as January, when EU sanctions are set to expire. Russia now aims for the removal of U.S. sanctions sometime in the next two years. 

Even with Moscow intent on sanctions removal, it will not completely bend to Washington's demands. Russia must maintain its influence in Ukraine's eastern region and rebuff NATO's attempts to contain Russia. The sanctions are finally starting to bite Russia, and Moscow is trying to use its limited tools to find some relief where it can, but there are still some concessions Russia will not make. 

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