Russia plays a weak hand in battle with West over sanctions

“Kto kovo”, as Lenin said, “Who whom?” Expressing the Bolshevik principle of which political class would dominate, his words also apply to the escalating economic warfare between the West and Russia over the Ukraine crisis.

Because indeed, Russia appears to be sanctioning itself. The West, borrowing from its Iran playbook, has imposed sanctions on the Russian energy sector, including on the long-term financing of oil companies and on advanced technology used in shale oil production and offshore drilling.

In response, Russia banned food imports from the United States, European Union, Norway, Canada and Australia. From the US$43 billion of agricultural products it bought last year, $25bn are now banned. This may revive old memories of empty Soviet supermarkets, and spur inflation, seen at about 7 per cent this year.

Russia’s shift to retaliatory sanctions shifts the battleground from its strengths in covert warfare, diplomatic intimidation and dissimulation, to its weak point – the economy. Russia’s GDP is just 6 per cent of Nato’s and it was running into economic trouble even before the current crisis.

Growth averaged 7 per cent annually from 1999 to 2008, driven by rising oil prices and solid macroeconomic policies. But the economy suffered in the global financial crisis and has expanded only slowly in the past two years despite continuing strong commodity prices. Inflation has risen; the labour force is shrinking, ageing and unhealthy; and Soviet-era infrastructure is decrepit.

The economy’s three greatest weaknesses are throwbacks to the USSR’s downfall. The market economy built so painfully in the 1990s has partly been reversed into state capitalism, dominated by lumbering giants in supposedly “strategic” sectors – notably Gazprom and Rosneft in petroleum – and grandiose, uncommercial Potemkin projects.

Corruption is pervasive – indeed, it has become the system – fostering cynicism and deterring innovation and foreign investment.

And Russia has reverted to a petrostate, dependent on exporting oil, gas and metals. Gazprom’s key European market is shrinking, prices falling and the global liquefied natural gas market is becoming more competitive. Russia’s workhorse West Siberian oilfields have performed better than most expected, but are increasingly mature.

New Arctic, shale and East Siberian fields, required to sustain output, are expensive and reliant on tax breaks that reduce earnings to the treasury. The EU and US sanctions are still quite mild, and have not stopped ExxonMobil from starting to drill a 9 billion barrel prospect in the remote Arctic Kara Sea, in its joint venture with Rosneft. Russian companies will adapt, but stiffer measures will gradually stifle investment and access to technology.

Of course, instability in the Middle East offers Russia a get-out. Coincidentally – or not - the long-frozen conflict between the Russian protégé Armenia, and Azerbaijan, a major oil and gas exporter, has just flared up again.

Such conflicts such as those over Iran, Iraq and Libya keep the oil price high. They also hamper Europe and, more recently, China from finding alternatives to Russian gas. That, as well as Mr Putin’s reflexive opposition to the US, explains why the Kremlin should never have been regarded as an honest broker in mediation over Syria or Iran.

The recent supposed deal to facilitate 500,000 barrels per day of Iranian oil exports in return for Russian equipment is full of holes. There is no physical way to transfer that much oil to Russia – a major exporter itself – and Russian entities trading the crude would be hit with US sanctions. But it has a political logic, to increase both countries’ leverage in their respective tussles with the West.

Sanctions hurt both sides. Indeed, that’s part of their logic – to show how much pain one can endure. But if we ask whose form of coercion is stronger, if this becomes an economic war, the odds favour the West.

Robin Mills is the head of consulting at Manaar Energy, and author of The Myth of the Oil Crisis

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