Oil and Gas in the Capitals

	Vol. 231 No. 7
JACQUES SAPIR, CONTRIBUTING EDITOR, FSU

Russia and the eurozone crisis: Problems and opportunities

Russia was just emerging from the depths of the 2008–2009 financial meltdown when the euro crisis became apparent. The ongoing tumult in financial markets since the last days of April has been clear testimony that the crisis is not over. Of course, public and private debts are very high in the “eurozone”—the 16 European Union member nations that have adopted the euro as their sole currency. The solution that has been adopted—implementing a stricter fiscal regime and curtailing expenditures—could throw the whole zone into a new recession.

For Russia, the current crisis is both a predicament and an opportunity. With nearly 60% of Russian imports coming from the EU and nearly 50% from the eurozone, the potential economic impact of the crisis is obvious. Already, the euro exchange rate has dropped back to its 2006 level, depreciating from 46 rubles to less than 38.

Meanwhile, it is quite probable that European imports of Russian commodities (natural gas, oil and metals) will be stagnant in 2011 and perhaps even in 2012. Europe has been and still is the primary market for Russian exporters. Thus, it is quite understandable that the euro crisis is having a disquieting effect on Russia.

However, at the same time, this crisis can be seen as an opportunity. The very weakness of the euro, which is causing trouble for Russian producers, is also lightening the weight of reimbursement on the shoulders of indebted Russian enterprises, which had resorted to borrowing in European markets as a result of the very high domestic interest rates generated by the policies of the Central Bank of Russia. With a weaker euro, both the principal of these debts and the interest on them is likely to be much less onerous.

Could the downward plunge of the euro be a good thing for Russia? Theoretically, the debt issue could balance the trade effect. However, in practice, less than 15 Russian enterprises have borrowed large amounts from European lenders. These companies are essentially commodities exporters, among which Gazprom and Rosneft have borrowed the largest amounts. If they see their debt lightened, it will not significantly increase their exports to Europe; at best, the current situation would mean a draw for them.

But commodities exporters are not the only industrial enterprises in Russia. Domestic producers, be they in the food production sector or in car making, will be seriously hit by a weaker euro. With stagnant export revenue, the potential increase of imports is not a good thing. Of course, the Russian government could increase import tariffs. However, this would wreak havoc on the country’s current negotiations within the World Trade Organization regarding the extension of protections to some of its industrial sectors.

Another approach is to diversify the country’s exports by accelerating the turn toward Far East markets. The demand for energy and metals is booming in these markets and will continue to grow for years to come. However, going east is not going to be easy. First, infrastructure needs to be built. So far, oil and natural gas pipelines mostly go from east to west—a legacy from Soviet times. Building new pipelines would be very costly at a time when Russia is already committed to two major westbound projects: Nord Stream, already under construction with a capacity of about 5 Bcfd and a price tag estimated at US$9 billion, and South Stream, still in project but now in the closing phase, with a capacity of about
3 Bcfd and a price tag that is projected to fall between $22 billion and $30 billion.

Of course, developing LNG facilities would provide another way to get natural gas to the east. The Russian energy strategy to 2030, approved in August 2009, is expecting Far East countries to receive 12% of Russian gas exports by 2020 and up to 20% by 2030. LNG is expected to represent 4% of total gas exports in 2020 and up to 15% in 2030. So far, only the Sakhalin-2 facility is in operation, processing gas from Lunskoye and Piltun Fields. There is another facility planned near Vladivostok to process natural gas originating from Chayanda Field, but construction is still years away.

It is quite clear that the eastward turn forecast by the Russian Federation’s energy strategy to 2030 will imply considerable investments. No less than US$80 billion of investment has been planned. Improving upon the 20% of gas exports that Russia hopes to send to the Far East by 2030 would require even greater investment.

But the problem is not just one of finding the money required by these huge projects. There is also a strategic dimension. If Russia would expands its trade ties in the Far East to the expense of Europe, the economic repercussions for the European Union could leave Russia without a strong partner to counterbalance an ascendant China—sacrificing a longstanding geopolitical policy of Moscow.

What courses of action are open to Russia in the face of the current European crisis? The EU has so far kept Russia at arm’s length. This is slowly changing, but the pace of change is not consistent with the current crisis, and more radical measures are needed in order to prevent Europe from entering a new recession. Increasing Russia’s integration into the EU would allow the implementation of currency swaps between Russia and the European Central Bank that could help stabilize the situation, a proposal that has been discussed at the Central Bank and Russia’s Finance Ministry. Moscow, for its part, would certainly welcome increased integration into the EU. This would be an interesting turn of fate for observers who remember Russia’s situation from 1996 to 1998, when it was very dependent on Western finance leading up to the country’s default.

The EU’s ability to accept increased involvement with Russia is now open to question. Some unexpected signs point to the affirmative, such as the recent warming of Polish-Russia relations. It is still to be seen how such a proposal on an issue as hot as the European currency will be received by eurozone members. In any case, it is quite clear that the current crisis in Europe is opening political opportunities for Russia.  WO