Sanctions and their hard-to-judge effect

There's a very long history of financial sanctions.  Apartheid-era South Africa and Rhodesia suffered for years, but somehow got by (and a lot of oil traders got rich).   It can't have done them any good, though.   The West managed against OPEC in 1973-74, but hardly emerged unscathed.  Cuba also got by, but hardly thriving by the standards of the hemisphere where it lies.  North Korea gets by, after a fashion, and scrimps together enough surplus resources to mount a nuclear ballistic missile development programme.  Iran hasn't obviously been brought to its knees.  Most societies only really prosper with a basic level of efficiency in day-to-day commerce, import/export etc.  Undue friction eventually wears things down.  *Eventually*, however, is to be measured not in months, but in years or even decades.

So what will be the impact of sanctions on Russia? (- imperial Russia, that is: oligarchs will just have to mourn their yachts in private.)

On the one hand, we gather Putin laid in quite substantial foreign currency reserves (and gold?).  Russia is probably OK for food, and obviously awash with energy (Germany's perpetual strategic weakness).  It seems - and this is truly remarkable, even granted the well-known long-term demographics - they are short of manpower for the fray, drafting in Syrians, Chechens, and the assorted orcs and dregs of the mercenary world: but sanctions don't really affect that kind of import.  Equally astounding, it seems they are also short of military supplies; but China can make good, if minded to do so.

Where's the short term pressure-point, then?  Or even medium term?  The only compelling answer I've read is that Russian manufacturing - such as it is, i.e. not much to write home about** - is wholly dependent on western imports for vital higher-tech components, and will rapidly grind to a halt without them.  Where will this bite?  (a) They'll need to import more or less everything from China & India eventually; and (b) their efforts to open up more remote oil provinces will be stillborn.

(b) is an interesting one for the long strategic haul.  "Upper Volta with rockets" is the traditional insult, but more recently I've heard Russia pithily described as "the oil exporter that ran out of cheap oil".  Yes, exporting oil is just as important to Russia as gas - and a lot more flexible when it comes to dodging boycotts and embargos, as those Swiss-based oil traders will helpfully confirm.  But, they're coming to the end of the cheaply-produced reserves.  The next few decades depend on opening up some much more difficult oil patches, which will be beyond them (and probably China, too) - this is the province of prime US / UK expertise.

(a), however, bites a lot more quickly, and equates to the severing of Russia from the modern world.  Do they care?  Well, Putin probably has his populace where he wants them: either patriotically onside, or thoroughly suppressed - and with a near-infinite capacity for suffering privations, let it not be forgotten.  And there's always the China trade, energy-for-stuff.  Surely that's not even remotely satisfactory, for Putin or anyone else in Moscow?   But is it sufficiently intolerable to be a deadlock-breaker, via something like a putsch, or a resort by Russia to massive escalation? ++

I really don't know the answer.  Never a good idea to place too big a bet on who can hold their breath the longest.  But it seems we may be limbering up for a contest of that sort.

ND

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** Obviously, there are some areas of remarkable strength: I gather Russia's titanium industry is second to none.  But that's just a North Korea phenomenon.  Their trucks (for example) are utter crap: as related here before, when the Chinese were first in the market for gas, Russia tried to make them buy a bundled offering, gas + trucks.  The Chinese laughed in their faces.  Either gas on its own - and deeply discounted, too - or nothing, comrade! 

++ Which can surely only mean tactical nukes, which turns out to be the only military thing Russia still has that impresses anyone.  PS, I'm willing to bet most of them won't work, either, if it comes to it.  But you might only need a couple ... 

Hitting back at China - imports ban and trade war?

 Following on from the last post, suggesting we try a worldwide bond default to de-stabilise China if it continues to deny its involvement in allowing Corona to escape into the global population, another way would be trade sanctions. 

China thrives on trade, this is why it invests so much in its Belt and Road programme to connect it to the world to allow its goods to flow. These goods generate the hard currency needed to keep improving its economy. 

Of course, China produces a huge amount of the key goods for the world and even though is viewed as short of commodities, has a strong market on key elements such as rare earths - hence dominating mobile phone production for example. 

But we could also use our 'Green Agenda" to stop say importing hard plastic products or things like steel that we know are produce using high energy processes. This may hurt the UK economy in some ways, but there are other suppliers and some domestic businesses could step in. 

China's reaction is unlikely to hurt us more, we export so little to them really. Burberry might not like it. However, US and Germany may not be so supportive of this stance as it is a bigger proportion of their GDP in exports. 

China won't like the 'war' that occurs as it will deeply damage its image so it still remains a good shout, not like hitting them in their pocket directly though perhaps.  

How Long the Dollar as World Currency?

BTL in a recent post, Anon asked for views on how much of the present ME unpleasantness is explained by US desire to maintain the dollar as the currency in which the world buys oil?   Anon went on to mention that Gaddafi head been mooting a barter scheme to circumvent dealing in dollars before his demise.

This is quite a long post so I'll summarise here: not really plausible, IMHO. 

It's not an academic response, nor does it contain any quantified macro-economics (my being in neither profession): but after a career in pragmatic multinational micro-economics - the energy business - I do have a number of practical observations.

*   *   *   *   *   *

1.  Liquidity / critical mass is vital in every sector.  Nothing stymies business worse than non-fungibility and non-convertability.   Needless to say, if anything that has "currency" today is doing a halfway satisfactory job in the market, that militates strongly against the adoption of anything else.  The intertia / barriers to entry & exit are great.

2.  There have long been plenty of national-pride-based attempts to drag the commercial world away from Anglo-US dominance of the instruments of liquidity.  In my own sphere: many countries hate having their oil priced against Brent (which almost all crude oil is, except US production), let alone in dollars; and there have been attempts to establish marker-prices for other blends, and to have them traded in other financial centres.  Kuwait Blend; Urals Blend, Dubai ... they come along, they get reduced to a basis-differential against Brent, and the world carries on.  And this despite apparently formidable technical difficulties in maintaining "Brent" as a marker (due to terminally declining North Sea production).  But the clever chaps in London cunningly keep extending the definition of the blend and - thus far - they've had total success.

Likewise, and to Anon's question, lots of folks have dreamed of having oil - even just their own local production grades - priced in their own currencies.  You might justly argue that provided there is full FX convertability between those currencies and USD, what's to stop them?  Answer: nothing - except it would be entirely empty.  The whole business world speaks English (and reads the FT), not Russian or Mandarin.  Arbitrage ensures "their" price would always be (Brent USD +/- basis)*FX.

As regards barter schemes ... well, money was invented, partly because there are distinct, nay fatal limitations as to what barter can achieve.  So I don't think Gaddafi represented any kind of threat to dollar oil trade.   BTW, the Russians have tried to sell gas to China in complex packages with industrial equipment - but the Chinese are having none of it!  Cash on the nail, so far as they are concerned.

3.  Some things do change & evolve: but typically only for very good reasons (which do not include national pride).  Example: the first natural gas trading hub in Europe was the UK's "NBP", and European gas prices for many years were given as NBP (+/- basis).  How logical was this, when the UK isn't remotely the centre of gravity of European gas movements, and the Eu deals mostly in EUR?  Very logical indeed - when only the UK's gas market was truly liquid.  However, over time, unsurprisingly several other hubs emerged as the rest of the EU belatedly caught up on gas trading (well, sort-of), one of which - the Dutch TTF -  was very much closer to the continental centre of gravity than our peripheral island market.  A German hub would have been just as likely a candidate: but the Germans genuinely don't understand how markets work, and screwed up their market design.  The Dutch are much better at it: and so today the TTF is more usually given as reference point for "the gas price in Europe".  (By the way, NBP and TTF trade at incredibly high correlations and the basis differential is always easily rationalised - as you'd expect, because they are both liquid, and generally inter-connected physically.)

4.  So: given that things can change over time and with good fundamental reasons, who's to rule out everything coming under Chinese hegemony in the long run, when their economy becomes dominant?  Well, in the very long run, maybe.  But right now they don't really understand markets either, nor indeed quite How The World Works.  Case in point: they'd spent years cultivating Gaddafi (for his oil), and were gobsmacked when "the West" just did away with him one day.   WTF?, you could hear them saying.   And, to their disgust, right now large & mainstream Chinese firms are obliged to, errrr, kowtow to US sanctions on Iran, much as they'd like to exploit the situation commercially. 

Of course, they hate this stuff and have every intention of supplanting it.  One day.  And who knows, maybe Trump will so overplay his hand, he'll help them accelerate the process.

Then again, the French have long hated the use of the English language everywhere - and most specifically in the organs and councils of the EU.  Tough titty, mes braves; not even Brexit is going to change that. 

No lengthy post is complete without an army anecdote.  All army vehicles come with a comprehensive toolkit.  But as I quickly discovered when becoming responsible for a troop of 30 vehicles, there's only one item out of a dozen or so that's ever taken out of the box, and which is permanently going missing - the Spanner Adjustable.  

Yes: some things turn out to be Really Useful.  The English language, the Brent oil contract, and the Almighty USD are excellent examples.  The clever Chinese will need to come up with something even better if they want any of them to be superceded.

ND

EC Iranian Sanctions-Busting? Won't Work.

Now this is a headline to make anyone pay attention:

EU, China and Russia in move to sidestep US sanctions on Iran: Special Purpose Vehicle aims to keep Iran in 2015 nuclear deal with barter system

Federica Mogherini, the EU external affairs chief, said the SPV was designed to facilitate payments related to Iran’s exports – including oil – and imports, so long as the firms involved were carrying out legitimate business under EU law. The aim is to make the SPV available not just to EU firms but to others ... it could underpin a sophisticated barter system that can avoid US Treasury sanctions ...  without any funds traversing through Iranian hands or the banking system. A multinational European state-backed financial intermediary would be set up to handle deals with companies interested in Iran transactions and with Iranian counter-parties. Any transactions would not be transparent to the US, and involve euros and sterling rather than dollars. The proposal is additional to a blocking statute passed by the EU in August that theoretically makes EU companies immune from sanctions imposed by the US in pursuit of its Iran policy.

Well.  The technology exists, for sure (the City can do this stuff standing on its head, as I've often said whenever the EC claims it will "ban London from dealing in Euros").  A total return swap (TRS) is a clever, flexible device with many uses in creative hands.  It's quite interesting that anyone's even trying, on such a scale.

But.  The fact is, no company I've ever met will trifle with US sanctions in any way, however much is is intended to be "not transparent to the US".  Case in point: I was involved in a deal over the summer where a particular asset was in play.  The asset is in Europe; the main parties concerned are a very big UK co, a very big French co, and an Iranian player (this is all energy stuff).  There are several Eu banks and miscellaneous smaller Eu parties.

Not a single one would cross any line the US authorities choose to draw - not by an inch.  Energy, see?  It's international.  Everyone will be travelling to the States one day.  It's very effective self policing.  CU has made this point before.

So good luck with your SPV, fellahs.  But be it ever so technically sound - it ain't gonna work.

ND
    

Iran shows how the US calls the shots

It is quite interesting, perhaps more to those not au fait with financial markets, how America can use its power to end trading relationships with a Country, globally.


The US will re-instate its sanctions on Iran shortly, on the same terms as they were before the Obama deal.


What this means is that all companies that have any US customer so subsidiaries will have to stop trading with Iran. Take Airbus for example, an order for 100 new planes from Iran Air.


But, Airbus trades with US too of course, so they can be sued in the US by the Government for sanctions breaking.


More critically this applies to Banks, if you have a US subsidiary then you can get fined for any kind of lending or transaction servicing for any deal to do with Iran or where there is an Iranian Party.


In 2014, BNP Paribas got a $9 billion fine from the US for 'sanctions busting' Of course in the US no BNP entity had broken sanctions it was a third party transaction between French and Iranian companies.


So US Sanction end a countries ability, thank to these extraterritoriality rules, to trade in effect with any Western Bank, but also most banks full stop. Iran will have to look for finance to Russian banks or other odd third-world banks. Without finance oil trading is very hard. One thing I have seen this week is the gold price increasing, gold can be used here as a form of finance, I have heard alleged that this is how Turkey manages to buy the ISIS oil and now Iranian or illegal Kurdish oil and avoid sanctions.


Anyway, all the posturing by Europe will come to nothing, America is the ruler of global finance and if it says stop then tough on you!

Conspiracy Corner: the French in Russia

A ghastly but typical Russian tragedy - the death of Total's CEO in a 'drunken snowplough' incident, straight out of a Robert Harris novel.  But what was he doing there in the first place?

Total is a pretty good company in my experience - far superior to unlamented, scandal-ridden Elf-Aquitaine which it gobbled up in 2000.  (One of the dodgiest business meetings I ever attended was in the horrible Elf office in La Défense:  made my excuses and left, as they say.)  But like most big French concerns, part of its identity is that of an arm of the French state, much as BAe (or in former times BP) is of HMG.  Its operations in Algeria, for example, have never really skipped a beat through decades of turmoil in that country.

Here's a basic account of Total's activities in Russia, which also cites M. de Margerie as being outspokenly opposed to sanctions over Crimea / Ukraine.  No surprises there: Total has long been a go-to company whenever Russia needed some fancy oil & gas technology, and its Russian interests are significant.  So he'd every reason to be doing the rounds in Moscow.

But here's Ambrose EP telling us that Russia is being squeezed to a devastating degree by sanctions, not least of which he reckons relate to oil & gas technology.  We seem to be playing the game, in a passive sort of way.  It is to be imagined the Americans are.

We know, however, that German industry really hates this lark, having big capital interests as well as very large export flows in Russia.  We also know that sanctions never really stopped South Africa getting oil, or Iran plodding on with its quietly expansionist plans - it just costs more, that's all.  Several of the big commodity trading houses ensure the wheels of global trade keep turning...

This is quite a significant dividing line.  USA, UK and the eastern EU countries against France and Germany ?  Note that Barroso's rebuke to Cameron was couched in terms of 'losing friends in Eastern Europe'.

EU politics are always complex: is there any hope that Hammond is equal to the task ?  Have a nice weekend !

ND