ExxonMobil’s Russian partner in the Kara Sea was finally hit with economic sanctions by both the U.S. and European Union on Friday as Moscow has shown its inability to cool anti-Kiev militants in eastern Ukraine.
Rosneft, Russia’s biggest oil state-owned oil company, was banned primarily from financial transactions within the United States, the U.S. Treasury Department laid out yesterday. The European Union’s sanctions were similar. This latest round of sanctions now makes it more difficult for U.S., European and Russian companies to conduct business without first consulting a lawyer.
Exxon is spending over $700 million in a joint venture deal with Rosneft to drill for hydrocarbons in the cold Kara Sea in Russia’s Arctic Circle. That deal will face careful scrutiny by Treasury, if it is means to enforce sanctions on the true titan of Corporate America.
Russian oil companies have been in the cross-hairs of Washington and Brussels since March. That’s when Russia annexed the Crimean peninsula, once an autonomous region of Ukraine located in the Black Sea. Early sanctions targeted individuals — mostly wealthy businessmen believed to be funding or providing other forms of support for pro-Russia separatists in Crimea and, later, in Eastern Ukraine.
A second round of sanctions began targeting privately held companies and later this summer, Europe and the U.S. began punishing big banks and oil firms. The U.S. banned the exchange of fracking technologies. The E.U. banned exports of equipment used for exploration and production.
It got worse on Friday. And now Exxon will be hard pressed to escape Washington’s latest punishment against the Russians.
This latest round targets all the major energy names in Russia. ExxonMobil, along with BP — a shareholder with a 20% stake in Rosneft — will be impacted. Just how remains unclear.
Exxon’s corporate office was unavailable for immediate comment on Saturday. Exxon’s Moscow office was closed at the time this article was published.
Although the language of the sanctions against Rosneft stuck to financing,Treasury did impose full-sector sanctions that banned the export of goods, services and technology used in exploration and production of Russian deepwater, Arctic offshore, and shale projects “that have the potential to produce oil”. This is smack dab in the middle of the Exxon-Rosneft wheelhouse.
It also impacts Gazprom, Gazpromneft, Lukoil, Rosneft, and Surgutneftegas.
Financial sanctions only apply to Novatek, Gazpromneft, Transneft, and Rosneft.
“The situation is getting very bad for Russian companies and for foreign subsidiaries in Russia,” said Andrey Goltsblat, head of the Moscow law firm of Goltsblat BLP. “Companies are afraid to break the sanctions. Everyone involved wants them to be removed.”
The language of the European and U.S. sanctions is not consistent, noted Barclays Capital analyst Michael Cohen in a commodities team research note to clients on Friday. Each uses a different clause in describing deepwater. Europe specifies deep water oil while the U.S. refers to bans on deep water and Arctic oil exploration and production, and shale projects that have the potential to produce oil.
Cohen wrote, “the language adds uncertainty for companies involved in the production of both oil and gas in Russia.”
U.S. Senator John McCain, never one to hide his anti-Russia viewpoint, once referred to the country as one big gas station. That’s because the energy sector drives Russia’s economy and is responsible for its surpluses and high foreign exchange reserves of around $460 billion.
Sanctions do not bode well for the Russian energy sector. Economists will be re-rating their Russian GDP forecasts next week. Holders of the Market Vectors Russia (RSX) exchange traded fund will have to hold their noses for a while. This ETF is going to stink.
Meanwhile, Barclays’ oil forecast once assumed Russian oil production of around 10 million barrels a day would decline slightly by 20,000 barrels daily next year because of the sanctions.
They now think the latest round will reduced plans to expand the offshore Kara Sea fields and the Sakhalin fields, both dependent on Exxon drilling technology.
New sanctions now point to a gloomier outlook for output next year, said Cohen.
“The impact on service companies and other foreign companies may be temporary until they reassess their supply chain and determine what can still be provided within country,” he said.
Derivative Impacts
Oil and gold markets will respond to Friday’s sanctions, which were announced after market hours.
Russia no longer plays a prominent role in adding to non-OPEC supplies, but a decline has the potential to drag down non-OPEC oil output, Barclays Capital warned. This will push oil prices higher in the near-term.
In the medium term, joint efforts between Russian energy firms and Exxon to explore and delineate shale oil prospects and complete Arctic LNG projects will likely to be delayed as corporate lawyers interpret Washington’s orders.
The fact that sanctions now encompass a wider universe of Russian oil companies will give pause to multinational European and U.S. oil service companies as well and will add further headwinds to Russian efforts to keep onshore production elevated.
Commodity prices will be volatile
Markets have been paying close attention to the Russia-Ukraine variable. When the recent cease fire deal was announced between pro-Russia separatists in Eastern Ukraine and the Ukrainian Army, gold prices fell and the MSCI Emerging Markets Index rose. We are now going in the opposite direction, said Vladimir Signorelli, president of Bretton Woods Research, an independent market research firm in New Jersey.
“It’s unclear at the moment, but it’s possible that the rise in the junk bond and investment grade credit spread since June is connected to economic growth concerns given the rising threat of a trade war between the West and Russia,” said Signorelli.
News of additional sanctions on Russia will be negative for global growth in general, Europe and Russia in particular. Europe is dependent on foreign oil and gas imports from Russia. Moreover, Russia will likely announce retaliatory sanctions next week. One should not be surprised if Russian firms threaten deliveries to Europe as cooler weather sets in.
The Baa-Aaa credit spread has been highly correlated to Russian politics, said Signorelli. The ruble began its recent slide after Ukraine’s president Petro Poroshenko terminated Kiev’s cease-fire on July 1.
