17/7/2014: More Russia Sanctions, Same Pains, Same Strategies

Another set of sanctions and another tumble in Russian shares. This time around, sanctions have impacted major Russian companies with significant ties to the global economy. However, no broad sectoral sanctions were introduced.

The following companies are hit:

• Rosneft - largest oil producer in Russia
• Gazprombank - largest bank in Russia outside retail sector
• VEB - Vnesheconombank 
• Novatek - largest independent natural gas producer
• Federal State Unitary Enterprise State Research And Production Enterprise Bazalt, 
• Feodosia Oil Products Supply Company (in Crimea)
• Radio-Electronic Technologies Concern KRET 
• Concern Sozvezdie
• Military-Industrial Corporation NPO Mashinostroyenia  
• Defense Consortium Almaz-Antey
• Kalashnikov Concern
• KBP Instrument Design Bureau
• Research and Production Corporation Uralvagonzavod 

Full list here: http://www.treasury.gov/ofac/downloads/ssinew14.pdf

The U.S. Treasury Department said that under new sanctions, the U.S. companies are only prohibited from dealing in "new debt of longer than 90 days maturity or new equity" with the listed non-defence firms. There are no asset freezes, no prohibitions or restrictions on export/import transactions. The sanctions do not impact U.S. and other multinationals' work in Russia, unless Moscow retaliates with such measures (which is unlikely).

This contrasts with previous sanctions under which sanctioned companies were prevented from conducting any transactions, including export/import and clearing with the U.S. firms.

So we are having a clear attempt to undercut some Russian companies' access to the U.S. debt and equity markets, while preserving their ability to trade.

VEB will unlikely feel the pinch. The bank converted the National Wealth Fund deposits into capital recently, so it can offset the shortfall on foreign funding.

Gazprombank is a different issue. Last month, Gazprombank raised EUR1 billion at 4% pa in the foreign markets via a bond sale on the Irish Stock Exchange. Gazprombank has one of the largest exposures to international funding markets of all other Russian financial institutions - it has 78 outstanding eurobond issues demented in a number of currencies. So the real problem with the sanctions is that they may open the way for EU to follow, which can shut Gazprombank from the Euro-denominated debt markets too.

When it comes to Rosneft, sanctions are weak. The U.S. simply cannot afford shutting flows of Russian gas and oil to global markets. Reason? Imagine what oil price will be at, if Rosneft was restricted from trading. The company is responsible for roughly 40% of the total Russian oil production which runs at around 10.5-10.9 million barrels per day. Get Rosneft supply access cut and you have an equivalent of entire Iraq's 2013 output (that's right - total output of Iraq is lower than that of Rosneft alone) drained from the global production. Rosneft pumps more oil than Canada and more than double the output of Norway.

You can read on geopolitics of Russian oil & gas here: http://trueeconomics.blogspot.ie/2014/07/1772014-geopolitics-of-russian-gas-oil.html

The real target of the sanctions are pre-paid contracts that Rosneft and Novatek have on future supplies of oil and gas. These are de facto forward loans, repayable with future oil and gas supplies. Rosneft exposure to these currently sits at around USD15 billion. Another target: long term funding for energy companies. Rosneft raised USD30 billion in two loans in 2012 and 2013, in part to co-fund buyout of TNK-BP which cost Rosneft USD55 billion in 2013.

In reality, while short- and medium-term borrowing costs for two Russian energy companies is likely to rise, the effect in the longer term will be to push more and more trade and finance away from the U.S. dollar and U.S. markets. Plenty of potential substitutes are open: Hong Kong and Singapore being the most obvious ones. London is a less likely target. For example, in June partially state-owned UK Lloyds Bank cancelled a USD2 billion prepayment facility with Rosneft. The loser is, of course, Lloyds as it foregoes substantial revenues, while Rosneft can secure (albeit also at a price) similar funding from any number of larger trading companies it deals with, e.g. Glencore, Vitol or Trafigura.

Bloomberg covers some of the immediate reactions in corporate debt markets here: http://www.bloomberg.com/news/2014-07-17/rosneft-bonds-sink-most-on-record-as-sanctions-shut-debt-markets.html

All in, there is still ca USD60 billion worth of maturing corporate debt that Russian companies need to roll over before the end of 2014. This is a bit of a tight spot for Russian economy going forward, but it can be offset by releasing some of the liquidity accumulated on Russian banks balance sheets in 2013.


There is a bit of a silver lining for Russia from the U.S. sanctions too. To-date, higher oil prices worldwide (primarily driven by the Middle East mess, but now also with a support from the latest Russia sanctions) pushed up Federal Budget surplus to 1.4% of GDP (see latest arithmetic here: http://trueeconomics.blogspot.ie/2014/07/1772014-geopolitics-of-russian-gas-oil.html) over January-May 2014. This means Moscow can afford a bit more of a stimulus this year, offsetting any sanctions-related adverse effects on its economy in the short run.

On another positive side, sanctions have triggered renewed interest in Moscow in developing domestic enterprises with a view of creating a buffer for imports risks (http://en.itar-tass.com/world/741073). Imports substitution is a norm for Russian economy during strong devaluations of the ruble. This time around, we can expect a push toward more domestic investment and enterprise development to drive imports substitution growth to compensate not for Forex changes, but for the risks of deeper and broader sanctions in the future.


So I would re-iterate my previously made call: 

1. Russian economy is in a short- medium-term decline in terms of growth
2. Growth slowdown is compounded by rising borrowing costs and adverse news flow
3. With correct course of actions (monetary & fiscal policies and potentially some regulatory changes), Moscow can steer the economy into recovery in 2015
4. Ukraine crisis abating during the rest of 2014 is likely to support (3) above

All of the above suggest the markets will be oversold by the time Russian equities corrections hit 8-10% mark, assuming, of course, no further escalation in Ukraine (both with and without Russian influence, Ukraine's internal problems have now been firmly pushed by the EU into Russian domain).

There has been no cardinal change in the Western strategy with respect to Ukraine (support at any cost of Poroshenko push East) and with respect to Russia (blame at any opportunity for anything happening in Ukraine). The latest sanctions are simply a replay of the previous ones, which means that the U.S. is relatively satisfied with the progress in Ukraine, while the EU has moved to the back seat, having finalised the association agreement and unwilling to expand on this.


As a side note: there are implications building up for Western companies, relating to the U.S. and EU sanctions:

• Bloomberg reports (http://www.bloomberg.com/news/2014-07-16/as-ukraine-heats-up-exxon-to-airbus-eye-growing-risks.html) on Exxon Mobil Corp, Airbus Group NV and Daimler AG risks;
• ITAR-Tass covers the cases of Caterpillar and Bombardier: http://en.itar-tass.com/world/741083

On political front, here is an interesting report on President Putin approval ratings: http://en.itar-tass.com/russia/740817. I have not seen the original study cited in the report, yet.