Russia, Ukraine War - It’s Time to Play the “Gazprom Card”

By: Money_Morning

As the situation in Ukraine continues to unravel, the West is certain to develop another round of sanctions against Russia.

Unlike the first set, these new sanctions will almost certainly have a more direct bearing on the energy sector.

And now that Russian gas behemoth Gazprom (OTC: OGZPY) has once again threatened to cut off the gas supply to Ukraine if Kiev doesn’t pay what it owes, worry has begun to creep into the European Union headquarters in Brussels.

Cutting off the gas to Ukraine will have a knock on effect, disrupting pass through deliveries to the rest of Europe. That wasn’t a big problem in June… but now it’s almost September.

Unlike the low demand period in which the crisis has been moving through thus far, natural gas storage in advance of winter becomes the main objective as the season moves later into the fall.

And Europeans remember all too clearly two weeks of freezing during a dreadful winter in 2009, the last time Russian gas was interrupted crossing Ukraine.

The key to avoiding this impending crisis is the way the West decides to deal with Gazprom…

Here’s why.

Gazprom is the largest single contributor to the Russian central budget. Curbing Gazprom’s ability to sell its gas would be a direct and heavy sanction, creating an immediate economic consequence to the Kremlin.

In fact, consensus is forming among my policy contacts that the latest Russian direct incursion into Southeastern Ukraine requires a heavier response, and Gazprom is now in the crosshairs.

However, any frontal attack preventing Gazprom’s current sales to Europe would both impair the obligation of existing contracts and create some significant hardships for both European countries and energy companies.

And that brings us back to a recommendation I made several months ago.

Putting Gazprom in the Line of Fire

As of this morning, Washington will almost certainly extend sanctions against a widening number of Russian armament exporters. It will also place further restrictions on access to western capital by Gazprombank (Gazprom’s financial institution, which is also a top five Russian commercial bank in its own right), VEB (a primary banking channel for Russian export finance), and other Russian banks.

This will be achieved by limiting or cutting their access to dollar-denominated bank exchanges internationally. In concert, the EU will put greater weight on similar sanctions.

Yet, in addition to these banking-related sanctions we may see the first sanctions against Gazprom operations. This is the point I made in discussions more than a month ago, and it will have to traverse a veritable political mine field to occur.

But the pressure to act is growing and the possibility of genuine sanctions – short of military intervention – are becoming fewer and fewer.

Of course, the West has already been successful in prompting Bulgaria to have a change of heart on the South Stream pipeline. (I discussed that move earlier in OEI : The West Has Gazprom in its Crosshairs). South Stream is an essential conduit for additional Russian gas moving into Europe, and Bulgaria is the lynchpin of that throughput.

But an even better approach promises to seriously impact Gazprom’s more immediate needs.

Targeting the 800 lb. Gorilla

The plan calls for an initial round of sanctions against Gazprom Marketing & Trading (GM&T), Gazprom’s main avenue for financing exports. These sanctions would limit GM&T’s access to financing only existing contracts, not new ones.

This could be applied immediately against the GM&T office in Houston. The main location is in London (20 Triton Street), a location I’ve been to several times in the past. Others are in Manchester, Paris, Singapore, and Zug (Switzerland).

In this case, both the UK and France would support the move, since it does not impair existing delivery contracts. Those contracts are multi-year, usually spanning two decades, and require the pre-financing of each monthly delivery. Under this plan, those would continue.

But direct pressure could now be directed toward Russia’s Achilles heel – Gazprom – or what I have previously referred to as “the 800 pound gorilla in the room.”

The intent of these sanctions is to hurt Moscow financially, not destroy Gazprom. But the inability of its international trading arm (GM&T) to access working capital puts several major projects in jeopardy — including the building of the ground breaking new Chinese pipeline.

That pipeline project was the “big news” several months ago. But they have yet to finalize how much it will cost (or for that matter what the gas pricing will be or even how that price will be determined).

Here is the most important point to remember in all of this: Moscow must sell additional gas abroad, otherwise its budget will collapse. To do that Gazprom must have the ability to operate freely.

Simply maintaining the current contract volumes is not enough. Sanctioning GM&T hits Russia where it hurts most economically, while it insulates current European import agreements from attack.

Of course, it is true that other GM&T offices internationally could pick up some of the slack, especially via Singapore with Chinese assistance. But this would still make the process considerably more expensive.

The sanctions would still prevent Gazprom from having access to dollar-denominated banking internationally when it comes to financing for new projects.

Remember, the gas trade (like oil) is denominated in dollars globally. It’s possible to bypass that with other currencies, but it cost more. Just ask the Iranians.

So as the Ukrainian situation intensifies (once again), one factor is becoming more obvious.

Putting the screws to Gazprom is no longer off the table.

Source : http://oilandenergyinvestor.com/2014/08/time-play-gazprom-card/

Money Morning/The Money Map Report

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