MOSCOW BLOG: Recalibrating for the economic war with Russia

MOSCOW BLOG: Recalibrating for the economic war with Russia
MOSCOW BLOG: Recalibrating for the economic war with #Russia #UkraineWar #UkraineInvasion #bne #EmergingMarkets / wiki
By Ben Aris in Berlin March 9, 2022

ED: This article first appeared as the blurb in bne IntelliNews’ EDITOR’S PICKS, a daily email digest of the best articles from the last 24 hours delivered free to your inbox. Click here to see the back issues and to sign up.


OK people. It’s time to recalibrate. The war between Moscow and Kyiv in Ukraine just went global. It’s now a full blown economic war between East and West.  

As bne IntelliNews has argued, the West has hit Russia with the most damaging sanctions it could think of, which was a declaration of economic war. Russian President Vladimir Putin has now hit back with Russian counter-sanctions that will ban exports of commodities until the end of this year. They will create chaos on the commodity markets. Brent has already touched $140 this week and opened at $128.3 this morning. Gas prices also spiked to double their peak of last year and are currently 16 times higher than usual. And it could get much worse: the Kremlin warned of $300 oil as a result of the slugfest that has just begun.

We have already had to recalibrate our understanding of Putin, who has been taking unexpectedly extreme steps at each escalation of this crisis, choosing to go for the maximum option at each stage. No one (including me) was expecting a full-scale invasion of Ukraine after the diplomacy of January and February failed. However, we should not be surprised at the ban on commodities, as it is more of the same.

Maybe the West is surprised that Putin is willing to effectively cut Russia off from its own best revenue earners, but given Putin’s recent form I think this has become entirely predictable. He needs to see this conflict end as soon as possible, as Russian popular dissent is a ticking time bomb at home and he can’t sustain a long war in Ukraine and he definitely can’t occupy and hold Ukraine for any length of time, as it will clearly turn into another Afghanistan. He is using extreme measures to bring forward conclusive peace talks as fast as possible. And when I say “peace” I mean that Ukraine conceding to all his demands.  

On that note there seems to be some progress. Kyiv has more or less said it is giving up on its Nato aspirations as Ukrainian President Volodymyr Zelenskiy is bitterly disappointed that Nato has refused to come Ukraine’s rescue in its hour of need and close the skies above Ukraine. And in an interview with the US media yesterday he suggested that the status of the Donetsk and Luhansk regions was also up for negotiations. Recognition of Russia’s sovereignty over Crimea is going to be really hard, but hopefully they can find some “agree to disagree” formula that allows a compromise over this one. A fourth round of talks is due any day.

In keeping with my step-by-step model with pauses for talks, it is important to point out that the counter-sanctions are only supposed to run until the end of December, when there is yet another pause for talks. They have a timeline, unlike the western sanctions which are open-ended. Putin is clearly inflicting massive damage on the global economy (and his own) – this is maybe the first time that the great powers have imposed sanctions on a country that is able to retaliate in kind – but the timeline also suggests that the Kremlin wants talks to end this so that the sanctions will not be renewed in January next year. Expect a demand for the West to lift its sanctions on Russia. Putin will continue to play hardball.

And a deal is possible. As far as I know the US sanctions have been imposed by presidential executive order, which means the authority to impose them and lift them remains under US President Joe Biden's personal control. If the sanctions had been imposed by House legislation then they become impossible to unwind. This mechanism is the easiest to implement but it also gives Biden a powerful negotiating tool. I’m not sure the intention was to signal there is a way out of this clash, but the effect is the same.

The details of just what is on the list and what sort of exemptions there are will be released in the coming days or weeks when we will have a better idea of the damage this will cause. But you can be sure they will cause a lot of damage.

Here is another place you need to recalibrate: Russia has become a global commodity and agricultural superpower with significant clout in the international markets. While the economy is relatively small, as it plays such an important role in the supply of so many key commodities it has the power to wreck many industries as well as push global inflation up dramatically and cause real pain for everyone’s economy.

As I have been arguing for years, the past two decades of demonising Putin have always been based on the assumption that you can do so at no cost, as the West has so few investments in Russia and commodity sales continue unaffected by politics, as that’s how commodity markets work – more or less.

Notably the one country that does have significant business with Russia is Germany – Germany has literally ten times more companies working in Russian than any other European country – and that is also the country that had been most dovish on Russia right up to the last moment with its support of Nord Stream 2.

For most of the last two decades Putin has tolerated this set-up, where on the one hand he developed Russia’s business ties with the rest of the world, and on the other hand pursued his political agenda of poisoning spies and arresting Navalnys. The West has also been happy to play this dual game; in Putin and German Chancellor Angela Merkel’s meetings they would always talk about international problems like Syria but at the same time clear away obstacles for things like the construction of a new BMW factory in Kaliningrad or a Siemens investment.

That stopped in 2020 during European Union top diplomat Josep Borrell’s visit to Moscow just after anti-corruption activist and opposition politician Alexei Navalny was arrested and he was personally humiliated by Russian Foreign Minister Sergei Lavrov.

At the starting point of the active phase of the clash that has now reached its apex, Lavrov said very clearly that the Kremlin would no longer tolerate this dual policy of doing business with one hand but slapping on sanctions with the other in his new rules of the game speech that February.

According to my reckoning, Putin had been preparing for this clash for a dozen years as I think he believed this clash was inevitable, as I recently wrote in an op-ed “Has Putin gone mad?” Lavrov set the bar to zero and implicitly linked Russia’s business to the politics of sanctions, which has now been triggered. That means Putin is willing now to forego the income from commodity exports for the sake of his political goals, which is brand new.

People have long said that Russia uses gas as a political weapon and bne IntelliNews has long argued that while the gas business is a foreign policy tool, as the Kremlin is most interested in establishing long-term gas supply contracts it never uses it as a weapon. Well, that just changed. Now one of the possible bans is the nuclear option of cutting off Europe’s gas supplies, which would have catastrophic consequences.

In a related piece I took a deep dive into how the war in Ukraine could affect gas supplies to Europe. I imposed a map of the current territories under occupation over a map of Ukraine’s pipeline and gas storage tank distribution. It shows that the Russian army is not occupying the territory where the gas pipelines run, and that the storage tanks in the east of the country, half the total capacity, are also still in government-controlled territory.

Cutting off the 40 bcm per year of gas that flows through Ukraine would by itself cause an energy crisis in Europe, but if Russia took over half of Ukraine’s storage capacity as well, as these tanks are close to the occupying forces, then there would be a crisis on a crisis.

Russia sent about 180 bcm to Europe last year, which has a total storage capacity of 161 bcm. Ukraine’s storage is the biggest on the continent with 33.6 bcm of capacity, or about 20% of the total. But that means Europe doesn't have enough storage capacity on its own to get through the winter, even if it could fill it with LNG (which it can’t). In an emergency Europe would have to restart its coal and nuclear power stations. But Europe is as reliant on imports of Russian coal as it is on gas, and the decertified nuclear power stations apparently need at least a year to be restarted.

So it appears that Putin is in a position to cause a major energy and economic crisis in Europe if he follows through on the most extreme version of the commodities ban, although he can do little damage to the US other than indirectly by driving up oil prices and stoking international inflation, which will be bad enough in itself.

Like I say, it's time to recalibrate, as this could all get far worse than it is at the moment.


And I highlight one more piece on our site: as a result of the war Russia’s best and brightest tech workers have fled the country en masse. The thing with these workers is they are extremely mobile. As there are world-class tech companies in Russia the reputation of Russian software engineers is very good and they can easily get jobs anywhere in the world they like.

Russia has already gone down the road travelled by Belarus' President Alexander Lukashenko, who destroyed Belarus’ flourishing tech sector where thousands of engineers and tech companies just left the country when the protests started two years ago.

This will cost Russia heavily as it stymies its long-term development. And that is what Putin has done: his fiscal fortress may be strong enough to withstand the current sanctions onslaught and he may be able to reorientate Russia’s economy away from Europe to Asia and the other EM markets, but by cutting Russia off from the top technology and losing his most active and entrepreneurial workers – and not just from the tech sector – he has doomed the Russian economy to underperform. The growth potential of Russia was only 2% a year before the current crisis started, which is the real cost of the previous sanctions. Now it must have been cut to nothing and that means Russia is probably doomed to stagnation for the rest of Putin’s life.

My Russian staff this week are telling their children they need to leave the country and find a career overseas, as Russia no longer has a future.

There is plenty more coverage of the Ukraine war on our premium service and this is a great time to sign up for the free two-week trial to PRO here.