EU divisions delay sanctions on Russia, likely to focus on Rosneft

The EU last night finally reached an agreement on the latest round of sanctions on Russia, although the members agreed to delay implementation for a "few days" to allow time for the ceasefire to take hold and to reconsider the sanctions on the basis of whether the ceasefire holds or not.

This is despite the fact that by almost all accounts fighting has continued in Eastern Ukraine over the weekend and into today. However, for now, all those involved seem keen to maintain the ‘ceasefire’ and suggest the deal agreed on Friday remains in place.

First a couple of thoughts on why both sides are so keen to keep the deal in place, despite seemingly flagrant violations:

Ukrainian government: Kiev is keen to push for stability for a couple of reasons. The upcoming election is weighing on thinking and if it is ever to be seen as viable and legitimate it must take place during a calm environment. Kiev may see the ceasefire as first steps towards this. Furthermore, it seems unlikely to be a coincidence that Ukraine found a renewed vigour for the ceasefire just as the IMF warned that the prolonged fighting could lead to another $19bn bailout for the country next year. Lastly, Ukrainian forces had been suffering heavy losses as Russian forces became more involved and bolstered the rebels – this ceasefire allows Kiev to regroup and plan how to deal with this new resistance.

Russia and the pro-Russian rebels: The ceasefire came at a perfect time for Russian President Vladimir Putin – right in the middle of EU sanctions negotiations and NATO meetings – and played on divisions within the two groups. It turned attention away from what was happening on the ground in Ukraine and the potential Russian influence. It allowed the rebels to regroup and prepare to take back some more of the land they had lost in previous weeks. There also seems to have been an increasing shift towards Mariupol which looks to be a new strategic objective for the rebels.

From the EU perspective, while the official line is that they want to give the ceasefire time, the more likely influence is the concern around the economic impact of sanctions and the potential Russia retaliation. The talks over the past week have reportedly seen the reemergence of significant divisions within the EU over sanctions (although they never really went away).

While the official details are yet to be released, the sanctions have been widely reported. We discussed the options in detail here, but the key points are:

• Ban European financing with a maturity of over 30 days to Russian state-owned oil and defence firms. This will include Rosneft, Gazprom Neft and Transneft (the main oil pipeline operator). A large number of Russian defence firms are state-owned but few, if any, look externally for funding.
• Ban European companies from providing services to Russian firms which are associated with oil exploration and production (be it deep water, Arctic or shale).
• Expand the list of banned high-tech energy and dual use goods which cannot be exported by European firms to Russia.
• Reduce the allowed level of financing to Russian state-owned banks from 60 to 30 days.
• One option which is not entirely clear is a potential limit to the syndicated loans to Russian state-owned entities. This would essentially limit loans given by groups of banks (a fairly common practice used to spread the risk of lending over many parties).

Our initial feeling is that this will be a modest increase in the current sanctions. They remain very specific and targeted on a few state-owned firms, and particularly their access to European capital markets. They also remain only forward looking. Below are a few stats to give a feeling of the impact.

Above we have updated a graph we produced previously, which now shows which Russian state-owned banks, defence and oil firms have issued shares on the London Stock Exchange. In this instance, there is only one issuance to be added – the $10.65bn listing by Rosneft in 2006. Let's not forget that Europe gets around 35% of its oil from Russia, and while the global oil market remains much more fungible and varied than the gas sector, hitting Rosneft is probably the main story of these sanctions.

A quick peak at Rosneft’s latest financial statement also hints at why they are so concerned by potential sanctions that they have asked the Russian state for a loan of $42bn (around RUB 1,550bn). Out of RUB 2,179bn ($58.8bn) in loans and borrowings, around RUB 1,536bn ($41.5bn) is in the form of long term bank loans in dollars and/or euros. A significant portion of this is likely to have been provided from foreign banks, meaning Rosneft could face issues rolling over these loans. Furthermore, the amount they have requested almost exactly corresponds to their net debt levels (show in the chart below) with Rosneft even admitting that the main motivation for asking for assistance from the Russia state is to help finance its net debt amid the US and EU restrictions on its market access.

One final point to note here is that the sanctions on syndicated loans could be particularly important for a company such as Rosneft, not least because it is an instrument it has used previously, for example to help finance its purchase of TNK-BP.

 

As with all these sanctions while the direct impact could be limited it will further add to the indirect freezing of business between the West and Russia. Furthermore, Russia looks set to retaliate once again – with the idea of banning commercial flights from the West from Russian airspace being reheated. All of this could of course be offset by positivity if the ceasefire holds – but that remains a big if at the moment.

The UK manages to water down the EU's north sea power grab - to Scotland's benefit

MEPs yesterday voted on a new safety regime for offshore oil and gas platforms. And what do you know, it appears that the UK has managed to come up with an acceptable solution.

Fears that the Commission's original plan to push its plans via a regulation (which have direct effect) have not materialised and it is now to be done via a directive, giving states some leeway, and through careful negotiation the final outcome is similar to the existing UK rules.

This is interesting on a number levels. Firstly it is a good example of the UK successfully pushing its case in the EU. It is also a good example of how the UK can use its weight to influence MEPs and the Council of Ministers - and for the benefit of an industry based primarily in Scotland.

One interesting question is whether an independent Scotland within the EU would have the same potential to succeed (This is of course if they were in the EU at all.)

A crude agreement

On Monday Brussels announced an EU-wide ban on oil contracts between Iran and member states. The hope is that these sanctions will choke the Islamic republic’s finances, and prevent its nuclear programme from progressing further. However, as with countless other EU foreign policy objectives, the goals look to have been undermined by the lack of consensus between EU member states.

Diplomats admitted that negotiating the embargo had been difficult. Quite an understatement given that the enforcement of the embargo has been delayed six months just to ensure that an agreement could be met. The key dispute comes from the fact that Greece, Italy and Spain are far more dependent on Iranian exports than their Northern neighbours. Greece imports up to a third of its oil from the Islamic state, with which it has negotiated a favourable rate. Italy and Spain buy 10% of their oil from Iran.

Forcing these countries to source such a large percentage of their oil from another producer in such a short time frame will undoubtedly put additional costs on their economies (not to mention the potential for higher prices which we discuss below). This seems slightly counterproductive to say the least when they are already struggling to stay afloat in the storm of the eurozone crisis. Not that you can abandon all policy goals on the basis of economics, but it highlights the breadth of impact which the eurozone crisis will continue to have until a lasting solution is found.

That said, fears of an impending energy crisis are alarmist. For one, Saudi Arabia has assured European governments that it will increase its production capacity to replace Iranian imports, which represent a fairly small share of overall EU oil consumption. Gaps in supply can also be met by Libya, which is set to boost exports after a year in remission.

A massive price hike is also unlikely, with refineries taking the hit more than consumers. Providing it does not switch to other Middle Easter suppliers, China will become the biggest consumer of Iranian oil, creating a monopsony through which it can drive down prices. Iran has shown itself willing to sell oil under the market price during previous embargoes. An interesting side effect then is that China could end up benefitting most from this ban by sucking up the excess Iranian supply at low prices. Not the EU’s fault, but it seems to undermine any prospect of the embargo having a huge financial impact on Iran.

Will Europe’s energy future be unaffected then?

Possibly, if two conditions hold:

- First, Iran must not blockade the Strait of Hormuz, through which Europe accesses Saudi oil. This seems unlikely since doing so would likely cause a full scale military conflict as the US has vowed to defend EU cargoes.
- Second, Iran must not throw a spanner in the works by cutting off oil supply immediately (something which Europe could not cope with as the delayed start of the embargo shows).

Will any of this bring Iran ‘back to the table’?

As EU High Representative on Foreign Affairs Catherine Ashton outlined, the aim is to “bring Iran back to the table”. It’s not clear this will be the case - Iran has survived previous embargoes, some of which have even hardened support for the regime. Without China and India joining the embargo (highly unlikely) Iran may not feel much of a squeeze. Even if they did, oil prices would skyrocket creating even more problems for the eurozone.

All in all then, this embargo has been a bit of a mess. Whether or not the aims are valid, it has once again highlighted the disparities in foreign policy goals within the EU, and therefore the limits of a combined foreign policy. It also brings home that, despite its size, the EU’s power is to some extent dwarfed by that of China and the US. Ultimately, their decisions will make or break this embargo, not the EU’s.