Tag Archives: Ukraine Crisis

The Russian Economy: Why Natural Resources Are Its Only Hope (Part 2)

This is a continuation of my previous post about the adverse effects that the Russia/Ukraine conflict has had and will continue to have on the Russian economy. I will elaborate on two more of these negative effects and argue that Russia’s natural resource industry is one of the only bright spots in an otherwise grim view of the future for the Russian economy. As a recent Economist article, “From Bad to Worse,” emphasizes, the three most notable negative effects of the Russia/Ukraine conflict are: (1) Sanction tightening, (2) a cut off of foreign lending + investment into Russia, and (3) a fall in the value of the ruble. Having examined sanction tightening in the last post, I will take a closer look at the last two effects in this post.

2.    Cut off of Foreign Lending + Investment into Russia

Political instability in Ukraine is causing foreign investors to doubt whether or not their investments and loans to Russian firms are safe bets. As I have discussed numerous times before in previous posts, availability of credit drives business cycles (both short and long term), so a credit tightening in Russia would have many unfavorable consequences including plummeting asset prices, a drop in productivity, and decreased incomes. Unfortunately, these potential effects are already becoming realities. As the article states,

With capital flight hitting $60-70 billion in the first quarter of this year alone, investment in domestic production—what the spluttering economy needs most of all—will be even harder to come by.

It is worth noting that the main concern is not about existing investments and loans, but new ones. Many of the investments into Russian firms are under long term contracts, which make them difficult to get out of, but new financing is unlikely to come rushing in after the conflict in Ukraine. Although Russian banks have expressed enthusiasm in replacing the role of their foreign counterparts, their ability to do so is doubtful because many of these banks rely on western loans. If further sanctions and investor doubt forces these western loans to stop flowing in, Russian banks may be in an even worse position than the Russian firms relying on foreign imports (discussed next).

3.    Fall in the Ruble

The ruble has plummeted as a result of the conflict in Ukraine. Although there is some argument about whether or not a weak ruble is good or bad for Russia, I would argue that the costs clearly outweigh the benefits. A weak currency makes imports more expensive, and with many Russian firms not only relying on foreign loans, but also on foreign imports of supplies, a weak ruble is not something to celebrate.

In conclusion, I have laid out a detailed summary of some of the negative consequences the Ukrainian conflict will bring upon the Russian economy (sanction tightening, cuts in foreign lending, and a fall in the value of the ruble). Furthermore, I have argued that Russia’s natural resource industry will likely survive these troubles because of two reasons– Europe’s dependence on natural gas and the prospect of new, long term deals between Russia and China.

The Russian Economy: Why Natural Resources Are Its Only Hope (Part 1)

In my last two posts I discussed Europe’s dependence on Russian natural gas and I argued that it is unlikely that this dependence will disappear anytime soon. By focusing on Russia’s prospering natural gas and oil industry I think that the past two posts downplayed the negative effects that the Russia/Ukraine conflict has the potential to bring upon the Russian economy. In this post and the next one I will elaborate on some of these negative effects and argue that Russia’s natural resource industry is one of the only bright spots in an otherwise grim view for the future of the Russian economy. As a recent Economist article, “From Bad to Worse,” emphasizes, the three most notable negative effects of the Russia/Ukraine conflict are: (1) Sanction tightening, (2) a cut off of foreign lending + investment into Russia, and (3) a fall in the value of the ruble.

1.    Sanction Tightening

Although the sanctions placed on Russia as a result of the Ukraine conflict have been minimal (mostly because gas-dependent Europe refuses to risk endangering its natural gas supply), their potential negative effect is magnified by what Alexander Kilment of Eurasia Groups calls the ‘scare factor.’ The scare factor is essentially the idea that trade sanctions cause investors to expect further sanctions and trouble in the future. Shares of Russian companies that do business abroad, especially shares of those with administrative officials whose names are on the sanctions list, have fallen greatly. What makes this even worse is that the effects of the scare factor have been hitting the Russian economy where it hurts most: its energy companies. As the article states,

Shares in Novatek, a gas producer, fell sharply when the restrictions were announced, on fears it might struggle to do deals with foreign partners or raise capital abroad because Gennady Timchenko, a friend of Vladimir Putin’s named on the American sanctions list, owns 23% of the company and sits on its board.

The article suggests that this effect could spread to other large Russian energy firms such as Rosneft (an oil company) if the American government sanctions Igor Sechin, Rosneft’s current boss.

Even given these potential drops in shares, however, I have confidence that Russian energy firms will thrive. Apart from the European dependence reason I have discussed in previous posts, another key international player has entered the Russian energy game as a result of the sanctions: China. China is taking advantage of the sanctions by urging Russian firms to sign long term trade contracts that would quell some of China’s ever-growing natural resource demand. Gazprom, for example, is on the cusp of signing a deal to sell gas to China. In the next post I will elaborate on the other two negative effects: cuts in foreign lending and a drop in the value of the ruble.

Europe’s Thirst for Russian Gas: An Addiction Unlikely To Wane (Part 2)

This post is a continuation of my previous post about Europe’s dependence on Russian natural gas. After reading a recent Economist article, I am convinced that Europe’s addiction to Russian gas will remain strong in both the short and long term. The combination of (1) an already developed infrastructure, (2) a lack of viable alternatives, and (3) a growing European demand for gas reveals that a large enough economic incentive can successfully overshadow political conflict. Having analyzed the infrastructure point last time, I will elaborate on points 2 and 3 in this post.

2.    Poor Alternatives

Even if European leaders were to overlook the infrastructure problem and tap into all the alternative sources of natural gas at their disposal, they would only have enough to cover about half of Europe’s gas demand. In order to see this more clearly I will elaborate on the main alternative sources Europe could use and the problems associated with each one:

  • Gas from other European countries (i.e. Norway, Netherlands, Britain): Although Norway and the Netherlands combined have enough gas to provide about one eighth of Europe’s yearly gas demand, environmental concerns (carbon emissions and earthquakes) and negative public opinion create domestic political barriers.
  • Shale Gas from European countries: Although tapping into local supply provides an effective hedge from international political risk, the problem with local shale gas is, once again, environmental. Many countries, such as France, the Czech Republic, and Bulgaria have banned shale gas extraction.
  • Gas from Africa (i.e. Libya, Algeria): These sources have generally been unreliable due to political unrest and increased local demand. As the article points out: “Italy’s imports from Libya, once a reliable supplier, were down by 11.9% in 2013; supplies from Algeria (where local demand is booming) were down by 40%.
  • Liquefied Natural Gas (LNG): The main problem with LNG is its inelastic supply. Due to the cost of the plants that liquefy the gas and the steadily growing demand from China and Japan, Europe would not be able to attain the LNG for a reasonable price.
  • Shale Gas from America: The lack of U.S. export facilities means that there would be large startup costs to begin importing, and even once the facilities were built, Europe would have to compete with the high prices China will be offering for the shale gas.

An interesting statistic to conclude and drive the point home: if Europe were to employ all of these alternative sources it would not only be short about half of its demand, but it would also spend $50 billion more on gas per year!

3.    Growing European Demand For Gas

The final argument is a short, but important one– European demand for gas is expected to grow for the next ten years: According to AT Kearney, a consultancy, imports are set to climb from 327bcm today to 413bcm in 2020.” A growing demand for gas would mean that gas from alternative sources would be even more expensive, making Russian gas that much more attractive.

In summary, the past two blog posts have developed a detailed argument for why European dependence on Russian gas will remain strong despite political concerns in Ukraine. The already developed infrastructure between Russia and Europe, the unjustifiably high cost of alternative gas sources, and a growing demand for gas has put European leaders in a tough position– a strong and expanding Russia is not in their best interest, but Russia’s cheap gas has chained Europe’s leaders onto the political sidelines until an economically viable alternative is found.

Europe’s Thirst for Russian Gas: An Addiction Unlikely To Wane (Part 1)

The Russia/Ukraine conflict has been a topic of growing concern for the Western World in the past month, especially for Europe. Vladimir Putin has discovered a chink in his western neighbors’ armor and is now exploiting it to his advantage. Europe’s severe dependence on Russian natural gas, a majority of which is supplied through the Brotherhood pipeline that runs through Ukraine, has allowed Putin’s annexation of Crimea to go largely unpunished. If Russia were to suddenly cut off the supply of gas to Ukraine, European gas prices would skyrocket, hurting households and firms across Europe– a risk that European leaders are unwilling to take. Even though Putin has little incentive to cut supply off in the long term (the EU’s purchases of Russian gas make up 3% of Russia’s total output), it is not stopping him from using it as an effective short-term threat while the conflict with Ukraine unfolds.

In a previous post, I discussed some of the potential long-term effects of the crisis, predicting that Europe will make an effort to rely less on Russian gas in the future by increasing demand from alternative sources (Norway, Algeria, and LNG). However, after reading a recent Economist article,  “Conscious Uncoupling,” I am convinced that Europe’s addiction to Russian gas will remain strong in both the short and long term. The combination of (1) an already developed infrastructure, (2) a lack of viable alternatives, and (3) a growing European demand for gas reveals that a large enough economic incentive can successfully overshadow political conflict.

1.    The Infrastructure Problem

The transportation of gas from one region to another requires a significant amount of infrastructure. Everything from pipelines to processing plants to storage facilities need to be built and then maintained regularly. An already developed natural gas transportation infrastructure between Europe and Russia is the primary reason Europe will continue to buy Russian gas. It is simply too costly for European countries to stop using the already built pipelines, especially when, as is the case for Lithuania, Estonia, and Latvia, these pipelines are the country’s only source of natural gas:

natural_gas1

Adding to the infrastructure argument is that even if Russia were to completely cut off supply to the Brotherhood pipeline, its workload would likely be redirected to other pipelines that run from Russia to Europe. As I mentioned in my previous post on this topic, the Nord Stream pipeline through the Baltic Sea to Germany and the Yamal pipeline through Poland and Belarus offer the EU alternative methods of importing gas from Russia.

Furthermore, many alternatives to Russian gas, such as American shale gas, face infrastructure concerns as well. As the Economist article points out, investors may be wary of the large, potentially unjustified startup capital necessary to begin importing shale gas into Europe:

Private-sector investors may be chary of putting money into costly terminals that risk not being used if Europe slips back into accepting more cheap Russian gas.”

And even if European demand for shale gas was guaranteed, lobbyists in the U.S. government could attempt to stop the export of shale gas in an effort to keep domestic prices low.

In the next blog post I will analyze two other reasons for Europe’s long term dependence on Russian gas: a lack of economically viable alternatives and a growing demand for gas in general.

What would be the future outcomes of Ukraine Crisis?

Recent havoc which Russia deploying military troops near Ukraine boarder is act of invasion which the World should not tolerate their action. However, it is not easy to impose any sanction to such a strong nation. I really hope that Russia to pull back their troops and leave Ukraine. It seems to me that Russia thinks they have right to intervene Ukraine’s sovereignty due to their similarity in historical and geological backgrounds with Russia. It is true that many Ukraine speaks Russians and shares similar religion backgrounds, like Orthodox Christianity, but this does not mean Russia can consider Ukraine as “Little Russia” and boss them around. NBC NEWS article, Seven Reasons Why Russia Wants to Keep Ukraine All to Itself, includes a succinct summary about break out of the Ukraine Crisis.

It is unlikely to happen if any serious military action will be place at the Crimea, yet more serious damage will be done by Russia is imposing export restriction on natural gas to European countries. WSJ article, Energy Seriousness for Europe, summarized its impact on European economy as most of European countries are totally depend on Russian Natural Gas imports.

Lithuania, Finland, Estonia, Latvia and Bulgaria are almost completely dependent on Russia for their natural gas. Poland, Slovakia, the Czech Republic, Austria and Greece source more than half their gas from Russia. Germany gets more than 30%.

 2014-03-29 14;52;05

I have downloaded a map which shows the supply of natural gas pipe lines from Russia. By simply looking at the map above, it is convincing that without Russia’s natural gas supply, this will immediately negatively effect on many European countries’ economics. Of course, the United States is well aware of this situation and tries to minimize the influence. As a result, President Obama is discussing rules and regulation to make ease for U.S. natural gas exporter to export their products to European countries, yet I am not sure how much this can help out European countries’ demand for natural gas. Another WSJ article, U.S. Gas Exports Unlikely to Ease Tensions Over Ukraine, discusses possible delay in increasing exports of natural gas to European countries, and it does not look that well promising how U.S gas export can help European countries to meet their demand even after including the prosperity effect of recent shale gas boom. Lessening the U.S. export regulation on natural gas will however benefit more of Asian countries rather than European countries. For example, Korea and Japan have been paying premiums for the supply of natural gas. So they will be benefited from the lower costs of export price due to competitions among U.S. exporters. It is somewhat strange how misfortune of a country can turn out to be a good thing for some countries.

Natural Gas prices are relatively stable at this point, yet when Ukraine’s tension gets hotter the price will surely fluctuate more and create unwanted outcomes for many countries, thus we all needs to watch closely how U.S. and Russia compromise their different stances. If both do not find a peaceful solution, I am afraid that the world has to walk into the wrong direction which no one will be pleasant.