Russia’s energy sector: the cumulative effects of Western sanctions

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Following Russia’s 2014 annexation of Crimea and the incursion into eastern Ukraine, the West imposed targeted sanctions on Russia’s energy sector, the most revenue-generating part of the Russian economy. The sanctions have highlighted the main vulnerabilities of the energy sector – a heavy reliance on borrowing in the Western capital market and a heavy reliance on Western technology.

Russia’s largest state-owned banks and energy companies, including Sberbank, VTB, Rosneft and Novatek, have been barred from any new debt financing. A ban on technology transfer for the exploration and production of deepwater, arctic offshore and shale oil projects has been imposed on Gazprom, Gazpromneft, Lukoil, Rosneft and Surgutneftegas and their subsidiaries.

In response to Western sanctions, Russia initiated a policy of import substitution and attempted to diversify into Asia. As part of a recently launched edited book Russian energy strategy towards Asia-Pacific: implications for Australia, I reviewed Russia’s strategy for adapting to energy-related sanctions and assessed the effectiveness of these measures after seven years.

The effectiveness of sanctions is best measured against their objectives. By design, Western sanctions were not aimed at limiting the current supply of energy exported from Russia, but aimed at increasing costs for Russia to develop its long-term and technologically difficult projects. The technology-related sanctions targeted unconventional oil projects slated for exploration and development in 2030. The short-term effects of the sanctions were likely modest. Uncertainty and lack of interest from domestic and foreign investors were the main factors that impacted Russia’s energy sector during the initial phase. The unexpected drop in oil prices in 2014 had a more devastating impact on Russia’s GDP growth than the effect of the sanctions.

Due to the EU’s green deal, oil and gas imports are expected to decline by 50-70% from current levels.

Halfway through, a combination of financial and technological sanctions began to produce cumulative effects and increasing pressure on the energy sector. The sanctions have exacerbated already existing problems – heavy reliance on Western borrowing and advanced technologies, and an unfavorable business climate.

The Russian government was quick to introduce concerted measures to soften the impact of the sanctions, mainly through currency devaluation, lavish tax breaks and favorable bailouts. Russian energy companies have sought to adapt, by resorting to the policy of import substitution and by turning to Asia. But the adaptation triggered the securing of the economy, which was costly.

After seven years, the results of import substitution showed mixed results: some equipment could be supplanted, but the dependence on advanced technologies remained high. Progress in import substitution has been slow and hampered by uncompetitive prices and poor quality products. Novatek’s Arctic Cascade technology is a good example. The company has tried to develop its in-house LNG technology to minimize dependence on foreign suppliers. After long delays and technical problems, Novatek replaced it with technology from German Linde AG. Partnership with foreign companies and product localization have become a new solution. For example, to compensate for the lack of technological expertise, the Zvezda shipyard led by Rosneft, presented as the leader in import substitution, associates with General Electric and Samsung Heavy Industry to fill its long list of orders, including LNG ships, drilling rigs and offshore platforms.

The unexpected drop in oil prices in 2014 had a more devastating impact on Russia’s GDP growth than the effect of the sanctions (Carsten ten Brink/ Flickr)

Tapping into Asian capital markets and sourcing Asian technology has become a crucial part of Russia’s strategy to ease the pressure of sanctions, but far from a panacea. China has taken advantage of Russia’s inability to procure Western equipment to test and improve its own technology at the expense of Russian manufacturers. Breaking the Western monopoly, Chinese engineering companies supplied 80% of the LNG equipment for Novatek’s Yamal LNG. With the help of Chinese offshore platforms, Gazpromneft and Rosneft made important discoveries off the east coast of Russia in the Sea of ​​Okhotsk and north into the Kara Sea. Wary of Washington’s reaction, Japan and South Korea played a limited role.

The pivot to Asian capital markets has proven to be an urgent, but costly, alternative. Lukoil CEO Vagit Alekperov gave a appropriate description about Chinese lenders at the time – “These are the most expensive loans in the world. We are not going for such a loan ”. Chinese loans are the most expensive in the world and his business will never use them. China’s desire to take advantage of Russia’s isolation came as a shock to Russian businesses in 2014-2016. Companies have adapted to Chinese lending practices (financing is usually tied to the use of Chinese technology and labor), but issues remain. The participation of the Asian private sector without government assurances was less than guaranteed. Novatek struggled to secure external financing from Chinese private banks and was forced to restructure loans worth US $ 12 billion with the Chinese state-owned Silk Road Fund, the China Development Bank. and the Export-Import Bank of China.

As the long-term effects of the sanctions loom, another factor is expected to significantly influence Russia’s energy sector after 2030: decarbonization. External changes are coming from both the West and the East and are expected to cloud the outlook for Russia’s energy exports. Due to the EU’s green deal, oil and gas imports are expected to decline by 50-70% from current levels. With the introduction of the carbon adjustment tax at the borders, depending on the scenario, Russia is to lose from $ 3 billion to $ 60 billion per year, or up to 10 percent of its total domestic export earnings.

The eastward pivot would also be problematic, as China, South Korea and Japan have announced their own climate neutrality plans. Responding to changes in the energy landscape, in addition to the pressure of sanctions, will require substantial structural reforms and diversification of the economy away from hydrocarbons.

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