EU sanctions will hit Russia hard

The stern sanctions imposed on Russia by the EU are a damaging blow to the country's oil and gas sector. But will economic pain induce Moscow to change its tack on the conflict with Ukraine?

LONDON -- In the 12 days since Malaysia Airlines’ flight MH17 was shot down over Ukraine, Russia has played a double hand: talking tough on the horror while backing a rapidly deteriorating situation in Ukraine. On the world stage Vladimir Putin has decried an international tragedy; at home Russia is keeping a steady stream of ammunition flowing to the rebel soldiers in the Ukraine, with which it is closely tied. For three days, the violence has kept international investigators from the crash site. 

But Europe has also, for much of the past two weeks, indulged in somewhat more talk than action towards Russia. Until last night, formal disciplinary measures were unchanged in the wake of the crash. Stressing the need for peaceful resolution, they remained focused on sanctions against individual entities, and a suspension of new European Investment Bank financing in Russia. 

That dynamic shifted sharply in the early hours of this morning, with the European Union’s announcement of sector-wide economic sanctions from August 1. In the most severe measures taken against Russia since the Cold War, they ban Russia’s state-owned financial institutions from accessing EU capital markets, prohibiting transactions on any financial instruments with a maturity exceeding 30 days.

The measures prohibit exports of equipment and technology related to deep water oil exploration and production, arctic oil exploration or production and shale oil projects in Russia. And they ban all EU-Russia arms trade and exports of any goods with dual military use. Far beyond squeezing Russia’s military support in the Ukraine, they apply a sharp sting to the country’s nervous system. 

And the crackdown comes with far sterner words of warning. “When the violence created spirals out of control and leads to the killing of almost 300 innocent civilians in their flight from the Netherlands to Malaysia, the situation requires urgent and determined response,” President Jose Manuel Barroso and President Herman Van Rompuy said. 

“We cannot pursue [a] positive agenda when Crimea is illegally annexed, when the Russian Federation supports armed revolt in Eastern Ukraine, when the violence unleashed kills innocent civilians… Destabilising Ukraine, or any other Eastern European neighbouring State, will bring heavy costs to its economy. Russia will find itself increasingly isolated by its own actions.” 

For Russia, which has yet to respond, the sanctions, which are expected to be reviewed after several months, will bite harder than any measures in the past 20 years. They strike at the heart of the country’s multi-billion-dollar oil and gas sector, which accounts for around 50 per cent of federal budget revenues and around 70 per cent of exports, according to Bank of America-Merrill Lynch. And they come at a time when traditional reserves are shrinking and investment demand is growing rapidly, along with the need for technological investment to exploit Arctic shelf and other new reserves. In addition, EU fuel standards are forcing the upgrade of processing facilities by 2016. 

The crackdown brings Europe closer to the US stance, which now includes prohibition on trade with Russia’s three biggest state-owned banks. But it will be far more painful for Europe, which counts Russia as its third-largest trading partner, receiving around €120 billion ($US161.12bn) worth of goods per year. (The EU is also Russia’s largest trading partner, importing goods worth over €200bn per year). 

And the economic costs will be unevenly distributed among European Union members. London’s financial services industry, a major thoroughfare for Russian funds, will take the biggest hit. But in a Downing Street statement, a spokesman for Prime Minster David Cameron said England may support even stricter sanctions in the future. “[Mr Cameron] noted … Europe must be willing to pursue further tough measures if Russia does not change course,” the spokesman said. 

Meanwhile, the timing of oil giant BP’s earnings report throws the materiality of the new sanctions into sharp relief. In its second-half earnings report overnight, the $US89.40bn major said its 20 per cent stake in Russian-owned Rosneft had contributed $US1bn towards its $US3.6bn net profit for the half (including an after-tax dividend payout of $690m) -- sharply up from $220m in the previous corresponding half. BP, a key company for British pension funds, warned investors that any sanctions could hurt both its income and reputation. 

Highlighting the ripples beyond targeted sectors, Renault, which also handed down first-half results overnight, warned on falling sales in Russia, which it expects to slow further in coming months. 

But it’s clear that others’ pain, economic or otherwise, is not a primary consideration for Russia. Whether Moscow will be willing to unclench its fist to soothe its own situation remains to be seen.

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