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What I Plan to Tell China Tonight About an 800 lb. Russian Gorilla

by | published July 24th, 2014

Around 8:30 tonight, I’ll be live on Chinese national TV again, just before the markets open in Shanghai and Hong Kong.

This audience is usually larger than the entire U.S population, and the anchors always give me more time than any other outlet in the world.

It’s a good thing, too…

Because tonight the topic is the new European Union sanctions against Russia set to be announced today.

In the wake of the shoot-down of Malaysian Airlines flight 17, the continuing (and accelerating) Russian arming of separatists in civil war-torn Eastern Ukraine, and a new stiffening of resolve in Brussels, these sanctions are going to be harsher than any instituted thus far.

And for the first time, they are likely to target the energy sector.

That guarantees that all hell may be about to break loose…

An Economic “Nuclear Strike” on Moscow

Now there has been, and continues to be, a noticeable rift among EU members in how quickly such a “nuclear strike” should be introduced.

The simple fact is that Europe is not unified on the subject of potential sanctions.

Given the concerted trade and economic connections between Europe and Russia, tougher sanctions will result in some immediate reprisals that are certain to create problems for the continental market.

But to date, EU moves to sanction Moscow have been quite indirect and of little genuine value.

True, a broad three-part strategy had been agreed to early on, but EU countries have hardly been on the same page on either the implementation strategy or even the intention of the moves.

The first phase was rather straightforward, but had little teeth. It involved cutting bilateral talks on various “diplomatic” matters like revisions in travel visa regulations and removing Russia from the G8 meetings of major world economies.

Phase two targeted individuals in both Russia and Ukraine considered directly connected to the insurrection and/or the leadership in Moscow. To date over 70 individuals have been placed on a travel ban to Europe and have had their European-based assets frozen. These moves resulted in a tit-for-tat exchange by the Kremlin to no effect (mirroring the situation of similar bans by the U.S.).

However, the third phase promises to be the heaviest of them all, designed to strike at Russia economically. It will include attacks on three separate elements: arms sales, financial institutions, and the energy sector. This is where the divisions among the EU have surfaced, preventing the unanimous agreement that is needed before sanctions can be levied.

And until flight MH17 came down, with the overwhelming majority of its fatalities European, the real sanctions fell victim to national interest.

France is opposed to an arms embargo because of a huge pending naval ship sale to the Russian navy. The U.K. would feel the brunt of moves against Russian financial institutions, especially within its financial district, the “City” in London. And Germany would suffer the most from any steps taken against Russian energy supplies.

In fact, Moscow has been counting on these divisions in national interests to keep Brussels from introducing any serious sanctions.

Well, in the wake of the MH 17 shoot-down, everything has changed.

A lot of pressure is now building from below to do something significant. Democracy tends to have such an effect in situations like this. Meanwhile, heavy prodding from Washington has also been thrown in for good measure.

Bracing for a Potential Firestorm in Europe

But whether there is consensus among the 28 nations in the EU remains the issue.

Further restrictions on Europeans buying bonds issued by Russian banks is almost a certainty, and there is now added pressure to hit at least some of the technical requirements in the Russian energy sector.

Both of these would hit Moscow where it is weakest – financially.

But the real 800 lb. gorilla in the room has yet to be addressed. The problem is Gazprom (OGZPY), the largest natural gas company on the face of the earth, by far Russia’s biggest company, and the largest single contributor to the Kremlin’s budget.

Due to its international exposure, Gazprom remains Russia’s soft underbelly. Yet an attack on Gazprom would unleash a firestorm and put current European gas delivery contracts in the crosshairs. Even after working to diversify their energy sources, Europe still relies on Gazprom for about 25% of its daily gas needs.

Of course, the legal ramifications of impeding trade contracts would be a difficult enough hurdle itself. But it’s Moscow’s response to a direct attack on Gazprom that is keeping some diplomats in Brussels up late at night.

Realistically, a frontal attack on Gazprom’s contracts would mean all hell would break loose.

A “War of Degrees”

There is, however, another way to sanction the energy giant so that it would really hurt Moscow without attacking the current contracts.

According to my policy and intelligence sources in Washington, London, and Brussels, the target under consideration is Gazprom’s main international trading arm – Gazprom Marketing & Trading (GM&T). GM&T’s primary office is at 20 Triton Street in London. Other GM&T offices are in Manchester, Houston, Paris, Singapore, and Zug (Switzerland).

In this case, restricting Gazprom’s access to international dollar-denominated banking would create major problems for the company in two areas: pre-financing export volume and budgeting for things like their huge new Chinese pipeline initiative.

The combination of the likely restrictions on buying bonds issued by Russian banks (one of which is Gazprombank, Gazprom’s banking arm) along with restricted access by GM&T to capital markets (remember, gas and oil are traded worldwide in dollars) would require Gazprom to fund exports based on the value of the contracts themselves.

This could be done. But it would require that capital intensive investments rely on Russian government sources in the future.

As a result, the Kremlin would respond in kind – and forcefully.

In fact, I expect there to be pressure on major Western banking houses doing business in Moscow, as well as the likes of Exxon Mobil Corp. (NYSE:XOM), Chevron Corp. (NYSE:CVX), and BP plc (NYSE:BP) in regard to their Russian projects.

Chevron already is receiving grief in Moscow over its (now postponed) shale gas deal in Eastern Ukraine. This is going to be a “war of degrees” as the sanctions on both sides move closer to creating some serious market consequences.

So despite not being the direct target of previous sanctions, Gazprom is now in trouble.

As discussed in an earlier issue, the EU already applied pressure on Bulgaria to suspend onshore construction of the South Stream pipeline, which is essential to move Gazprom gas into Europe. At stake is the likely loss of nearly $30 billion in pipeline building alone.

Meanwhile, Gazprom is already under the weight of poor management, an inefficient and bloated corporate structure, and an accelerated decline in domestic field reserves.

And the more difficult moving Russian gas west becomes, the greater the Chinese pressure will be to adjust prices lower on their recently negotiated pipeline deal, which still has most of its details in the “to be addressed” category.

So anybody who believes for a minute that energy issues are not basic to just about any geopolitical controversy ought to take heed from this one.

Soon, we may experience a very different kind of warfare.

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  1. Fred Pulver
    July 24th, 2014 at 16:39 | #1

    Insightful, cogent, timely and well-written.

  2. Jo-Anne M
    July 24th, 2014 at 16:40 | #2

    For those of us that own Gazprom stock ( OGZPY), should we hold?

  3. July 24th, 2014 at 16:56 | #3

    Very well done Dr. Moors and good luck tonight on the Chinese broadcast.

  4. laurel
    July 24th, 2014 at 17:03 | #4

    I am confussed , so USA applies pressure for Russia to give China better pipeline deal?
    Is this a backdoor way to force china to use USDebt as currency of exchange?

  5. SS
    July 24th, 2014 at 18:05 | #5

    Are you serious that you think Russia didn’t anticipate any of this when it started this whole game? First of all nobody knows who did what in regards to the Malaysia flight. It all conjecture at this point. To say russia/Putin is directly to blame is overstepping at this point.

    I believe this is all American hype to protect their precious dollar and their unlimited debt accumulating machine. The Russians and the rest of the BRICS are moving away from the dollar. So I don’t think they really care what they do. But Europe and America sure do and they really want they rest of the world to fear Russia to protect themselves. This is a lot of political grandstanding for for reasons mostly unknown to the rest of us.

  6. CHRISTOPHER BOWEN
    July 24th, 2014 at 19:00 | #6

    No one considers or discusses the other side of the coin. Russia depends on sales of gas to Europe as much as or more than the reverse. Where else will Russia sell gas as profitably? Russia buys from abroad with money earned abroad. Europe can replace Russian gas eventually, possibly sooner, but China certainly will not take up the slack in sales to Europe to Russia’s advantage. Despite the official mouthing of friendship, Chinese basically despise Russia and russians and are likely in this century finally to recapture Siberia, an area stolen from Russia in China’s time of weakness. Putin is a fool, and he is leading Russia into the mouth of the Dragon.

  7. Gaz
    July 24th, 2014 at 19:59 | #7

    The question from an individual and day trader like me would be what companies in particular we should focus to make money out of this deal?? Cheers!

  8. Clean Coal
    July 24th, 2014 at 20:32 | #8

    Maybe Putin and the Germans want to kill the Euro. Germans and some others are sick of bailing out the Greeks Spain and Italy. No wonder the US has to spy on Germany.

  9. jerry morel
    July 25th, 2014 at 05:53 | #9

    do i hold or sell gazprom ?

  10. July 25th, 2014 at 06:32 | #10

    When will the Russians consider cutting off their palladium exports to the West? Given that their mines are being depleted, it would seem that this approach would serve them well. Does any of this impact the value of PAL?

  11. July 25th, 2014 at 07:04 | #11

    “This guarantees that all hell may be about to break lose.” Kind of hedges your bets does it not?

  12. Ken
    July 25th, 2014 at 10:22 | #12

    So what is going to happen when the real truth comes out, as it is starting to? Why has the new, EU/US-installed “democratic” Prime Minister of Ukraine resigned, together with his party in the coalition. Is it because the Russians are about to prove with real evidence, that the Ukraine air force shot down the Malaysian aircraft?
    Next winter, when most of Europe is sitting in the dark and cold, they may be saying to each other, “…but O’Barmy told us to do this and all would be OK”

  13. Ken
    July 25th, 2014 at 10:33 | #13

    @CHRISTOPHER BOWEN
    wishful thinking Christopher. What do you think will happen when China says to the USA, “we have $UStrillions, and we would like to cash them in, because we now have all these deals to trade with other countries and we are not using your devalued, newly-printed dollars”

  14. Sig Skaley
    July 25th, 2014 at 12:14 | #14

    Very interesting. Since the USA is now a major producer of oil & gas, could they not ship some of it to Europe and ease the pressure?

  15. August 3rd, 2014 at 21:25 | #15

    The Russians and Chinese need each other, even though they may not like each other…

    They and the other members, just agreed to deposit $20billion each into a kitty to prop up the BRICS, so that they can avoid using the IMF or the World Banks in a currency crisis.

    I suspect that someone will “recommend/advise/suggest” that the Bank has at least some – SOME precious metal backing 10% – 20%, and that $10-20billion would be enough to spike the PM market if they wanted delivery in a timely manner, and THAT would sink the dollar.

    Now, who was the instigator of this idea? I don’t know, but I have some ideas…

  16. DH
    August 5th, 2014 at 17:47 | #16

    Nobody really asks WHY is all this happening?

    What did the US wanted to achieve by “initiating” the regime change in the Ukraine ? It did not work the first time (Orange Revolution) and it will hardly work this time, because the Ukrainians involved in running the show now, want to primarily fill their own pockets and then retire abroad (Timoshenko, Jushchenko and the likes). To steel 50 millions Dollars by high ranking individual is nothing out of the ordinary.They hardly works for “the good of the people”.

    What is the goal in this war from Kiev on ethnic Russians who have been living in eastern Ukraine for ever? They did not like each other before and they will hate each in the future even other more now.

    Slovakians and Czech’s hated each other too. However they managed in a civilized manner to divorce and are doing great now in two successful individual countries. Why cant the Ukraine do the same ? Maybe the Oligarchs have something else on their mind? How could the US put itself on the level of those crooks? If you had nothing in 1992 and now you own $ 15 bln dollars while all your fellow countrymen are still at the poverty line, is such legally possible ?

    Should the Russians have to bleed because of the EU sanctions they will do so with patriotism. Putin’s popularity soared. If the gas for Europe will increase by $ 500, the elected simple minds in Brussels will feel all that heat, that people in Europe can’t afford to put ion their homes any longer. Unfortunately they do not understand the gas business a bit. With all the fracking you can do, it will take 15 years to develop meaningful quantities and they will still be more expensive than the piped gas from Russia.

    Russia has another option up its sleeves. Export oil and gas in Ruble and make everyone buy ruble to pay their import bills. This could boost the ruble significantly and together with Brazil, China and India the green back may become some problems. Could that bee in the interest of the US ?

    Lets not forget that Russia has less than 10% of its GDP in debt, a balanced budget every year since 1999, a general flat tax of 13%(!), 500 bln foreign currency fund and still pays on its bonds 5% to 8%. For some reason the Government does not want us to buy such bonds any longer.. do they fear we will become too rich?

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