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What is Putin’s plan?

This article appeared in Vol. 11, No. 5 - 2014

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Vladimir Putin. Motivated by a desire to divert attention from his bid for premiership till 2024? (Source: Presidential Press and Information Office)

How on earth did this happen? How, in less than a year, did East and West get themselves back to a state of cold war? Last winter there were mass demonstrations in Ukraine rejecting a corrupt government and seeking greater alignment with the EU: this was followed by the annexation of Crimea, a summer-long bloody conflict in Donetsk and Lugansk provinces and the downing of the Malaysian airplane MH17. Almost 3,000 are now dead and the occupation is frozen. Putin knew there had to be a western reaction: it has come in the form of ‘smart sanctions’: step by step targeting of Putin’s inner circle, restrictions on access to western capital markets, a stop to transfers of technology, and specific sectoral sanctions. Now the unexpected slide in oil price is pouring salt into the economic wounds. The analogy of a slow-motion train crash seems shockingly apt as the rouble sinks, oil and gas exploration is put on hold and Russian consumers face budget cuts, high interest rates and inflation.

Still the west – and, it seems, many in the east – puzzle at Putin’s motives and wonder just how far he will push this conflict. Why was the threat of  a less corrupt, westward leaning Ukraine just too much? Would a more responsive, transparent Ukrainian government have inspired demands for less corruption in Moscow? Do territory and alliances really matter in an interdependent world where power is more often derived from economic strength and the ‘soft power’ of culture and diplomacy? Ukraine is a vital conduit for oil and gas to the European market, and Ukraine itself is the biggest single purchaser of Russian gas. So is the problem rooted in the historical relationship between the two countries, that Russia simply doesn’t recognise Ukraine as an independent sovereign state? Or is Putin simply playing the nationalist card, rallying popular support to divert attention from an undiversified economy and criticisms of his bid for premiership till 2024?

Sanctions ‘blowback’

Undoubtedly sanctions are hitting the west too. Western companies that provide much of the essential technology for exploration and production in Russia’s shale and Arctic have been forced to pull out – ExxonMobil’s ten joint ventures with Rosneft, signed 2011-2013, are all on hold; similarly, Shell’s project with Gazprom Neft and Total’s with Lukoil. BP owns 20% of Rosneft so will be feeling the damage. Smaller companies supplying specialist services – the drilling bits, high pressure engines, data analysis - have been forced to pull back. The UK has rejected €5bn of investment for the North Sea – Russian money, though apparently unconnected to Putin.

Restricting Russian access to capital markets also holds risks for the west. Russian corporations and government are estimated to have over $130bn of external debt due for repayment by the end of 2015, mainly to western banks: Russia needs a lot of refinancing. Nobody is talking about defaults, but nothing looks good for such an interconnected – and still weak - banking system.

In addition, Russia has imposed its own sanctions on the west. Perhaps most hard-hitting is its ban on agricultural imports. Although Europe has feared a winter disruption to gas supplies, this appears to have been averted with an eleventh hour gas deal struck with Ukraine (the conduit for over half of Europe’s demand from Russia).

But on balance, with a sliding oil price, this looks like a game of chicken that Putin is not winning. Russia’s budget is 50% reliant on its oil and gas revenues and the latest draft budget for 2015-17 had assumed a price of $100. The low price is putting pressure on the rouble: it is believed that in October the central bank spent more than $15 bn supporting the currency and much more will be required before the currency's flotation, scheduled for early 2015. A further downgrading by the credit rating agencies could bring the rouble to junk status.

However, perhaps the biggest threat to Putin’s plan is the west’s renewed focus on infrastructure that will create long-term independence from Russian fuel supplies. Europe as a whole gets a third of its gas from Russia, and for many east European states it’s 100%. Several have, this year, had reductions in supply and threats of cut off should they sell Russian gas to Ukraine. Despite the fact that Russia remains the most economic supplier of fuel, with 85% of its current gas reserves in western Siberia, Europe is showing new determination to introduce LNG infrastructure, domestic fracking, energy corridors and expanded reserves. Gazprom has a lot to lose here since it is already challenged by the prospect of a developing spot market and new competition from Australia and the US. The $400bn pipeline deal to China has, apparently, not been finalised and the Chinese are, reportedly, foot-dragging.

There seems to be no immediate solution. Putin is challenging the west with air incursions into NATO territory, the abduction of an Estonian agent  and statements that all ethnic Russians are entitled to Moscow’s protection. The west is relying on a withdrawal of support for Putin, from his own inner circle and from the public at large. The risks are that this will only come with widespread economic collapse and more bloodshed. At a time when many in Europe are advocating a ‘dash for gas’ to supplant coal and nuclear, a move that should really cement the west’s dependence on Russia, Putin is forcing his main market to run for cover. We’re all watching the train crash and wondering why.

Nikki Jones,

Bristol

November, 2014

To read more articles and find further analysis visit http://www.exploringoilandgas.co.uk/

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