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