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Energy Shares Plunge As Oil Rally Stalls

Energy Shares Plunge As Oil Rally Stalls

Energy shares were hit hard…

Nicholas Trickett

Nicholas Trickett

Nicholas Trickett currently works at a think tank in Washington D.C. He is finishing an M.A. in Eurasian studies through the European University at St.…

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More U.S. Sanctions On Russia Would Be Counter Productive

Hoping to push back against Russia and prevent president Trump from changing current policy, the Senate has produced two new sanctions bills: the Defending Elections from Threats by Establishing Redlines (DETER) Act and the Defending American Security from Kremlin Aggression Act (DASKAA). Both would create a new set of harsh sanctions designed to significantly increase pressure on Russia’s economy, namely firms in the energy and metals sectors given their central role in providing tax revenues and employment in Russia. But the bills’ energy sector provisions as currently written threaten national interests rather than advance them.

DASKAA is the larger of the two current bills in committee. The bill in its current form would automatically place sanctions on any American energy firm working with a Russian parastatal – a state-owned or private firm advancing state interests –on a project worth more than $250 million located outside of Russia. Firms will be frozen out of countless international projects if Russian firms participate. The DETER Act would block U.S. firms from using railway carriers in Russia that supply energy projects in countries such as Kazakhstan and Azerbaijan.

Unfortunately for U.S. policymakers, it would be difficult to convince the European Union (EU) to commit to similar measures. There’s little need, given the effectiveness of existing sanctions and Europe’s energy needs. Production of natural gas in the EU is structurally declining. While U.S. LNG exports may increasingly flow to Europe, Russia will remain a key trade partner; liquefied natural gas is more expensive than piped gas. Europe’s import dependence is only going to grow, but the EU has been largely successful in limiting the risks posed by Russia’s attempts to politicize European gas markets.

The U.S. Treasury sanctions imposed in 2014 and those implemented by Congress last summer are effective precisely because they focus on altering the Russian energy sector’s long-term ability to produce tax revenues for the Kremlin. Russian firms now face considerable pressure internationally as a result. Their lack of access to Western energy technology, difficulty raising loans from western banks, and generally worse corporate standards make them less competitive. The technology gap continues to grow, making Russian firms less able to enter technologically demanding projects or else developing their own shale production domestically. Nikolai Patrushev, the head of Russia’s National Security Council, admitted to news service Interfax in early August that technology sanctions were taking a heavy toll on Russia’s energy sector. Related: The Biggest Risk In Today’s Oil Markets

Russian firms collectively relied on imports for up to 70 percent of their technological needs when sanctions were put in place in 2014. So far, Russia hasn’t adequately replaced imports at home or with gear made elsewhere. Even a few years’ delay in investments or the adoption of technology has large structural effects on the Russia’s oil output since its largest fields are aging. Gas production is steady, but much less lucrative.

Evidence shows firms like Rosneft and Lukoil aren’t terribly rosy about their long-term plans within Russia. A 2016 report from the Russian energy ministry’s projections showed that Russian oil production will begin to decline structurally by the early 2020s. The question is by how much. Per the same, companies suggested Russian production would drop nearly 50 percent by 2035. Though Russia’s oil production has been resilient the last four years, newer deals with China are also beginning to strain its ability to maintain its share of the market in Europe while increasing its sales to China and the Asia-Pacific.

Though its production looks strong for the long-term, Gazprom in particular has seen its bargaining power in Europe erode due to legal decisions, business negotiations, and the EU’s energy strategy. Congress’ attempts to exert greater pressure will stoke divisions with key partners while creating unintended, negative consequences for U.S. foreign policy.

By forcing companies out of any project with the participation of a Russian parastatal worth more than $250 million, firms like Rosneft, Lukoil, and Gazprom can do their best to bid for even insignificant stakes to freeze out western competition from important finds. Firms like Saudi Aramco, CNPC Indonesia’s Pertamina, and even privately-owned firms from elsewhere can then coordinate with Russian firms to exploit DASKAA. They could then acquire large stakes in strategically important projects. Instead of restricting Russia, these proposals ironically create a new means to pressure the West and enable Russian firms to compete despite their limitations.

Denying U.S. firms the ability to import needed equipment for projects in Kazakhstan will threaten tens of billions of dollars of existing investments in an important market. Chinese and Russian companies would be able to supplant American businesses, reducing Astana’s ability to play off different interests. That would increase Kazakhstan’s dependence on Russia and China, and weaken Washington’s role in Central Asia. Neither is a net positive for the U.S. Related: Oil Prices Inch Higher On Crude, Gasoline Draw

The reality is that the U.S and EU have gone as far as possible sanctioning Russia’s energy sector without damaging transatlantic relations. Rather than add sanctions, Washington would be wiser to rely on the competitiveness of Western companies. Enhancing western energy ties with Russia’s neighbors and partners across the Asia-Pacific is a more effective means of countering Russia’s energy strategy. Natural gas prices are expected to slowly converge between different regions by the 2030s as more gas is traded globally. Gazprom is losing its political power over prices as well as market access over time.

Current sanctions have already had a significant impact on Russia. Allowing Western businesses to continue to compete with their Russian counterparts from an advantageous position would be better than handing Russia a means of explicitly undercutting U.S. oil and gas interests abroad using its parastatals. There are limits to sanctions. Washington needs to better learn them.

By Nicholas Trickett for Oilprice.com

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