Friends not Enemies Pose the More Difficult Challenge

What ultimately led US President Nixon to close the gold window was not its Cold War rival Russia. Rather it was US European allies who wanted to exchange their dollars for gold beyond levels that the US was prepared to accept. This has been a consistent theme through today.

As the German foreign minister put it, European officials got too excited about the opposition to the previous pro-Russia government that they forgot about the geopolitics. This created an opportunity for Russia to push its Medvedev Doctrine as it has done elsewhere. Essentially, the doctrine says that the post-WWII borders are not sacrosanct. They were a historical accident, and Russia has an interest where ever there are ethnic Russians living (Brighton Beach?. Georgia's miscalculations in 2008 provided Russia with a similar opportunity.

Among the first things that the unelected Ukrainian government sought to do was to reduce the status of the Russian language. There was speculation that it would seek to renegotiate the naval base lease in Crimea with Russia that had previously been agreed to under duress (pressure from Russia). Putin seized the opportunity to reassert is sphere of influence.

In Asia, it was the Governor of Tokyo that bought the disputed islands and in effect forced their nationalization. China was willing to let sleeping dogs lie. So for good reasons, time is on their side. Chinese officials expect to be stronger five years from now and ten years from now. There is not urgency to resolve longstanding disputes now. However, it refuses to be dealt a fait accompli.

The Philippines also seem to have used force to try to settle one of it disputed islands. It purposely sank a small ship on one of the Spratly Islands and turned it into a garrison to defend it. China sought in vain earlier this year to prevent it from resupplying. Vietnam appears to have been emboldened by Japan and the Philippines, but it lacks a critical thing they have: namely a security treaty with the US. Vietnam may offer China the best opportunity to set an example and hope others fall in line. An old Chinese saying puts it like this: Sometimes one has to kill a chicken to scare the monkeys.

Even after Russia's occupation of some areas in Georgia, France and German sold Russia more military resources. France is currently training Russian sailors on a ship that it is due to deliver later this year. Russian officials have boasted that it they had those resources earlier they could have achieved their aims in Georgia significantly quicker.

Now the US and Europe have agreed to sanctions and visa freezes formally. There are informal channels as well. US officials tried to dissuade companies from attending the St. Petersburg economic forum last week. While many US and European companies did not attend, several did. New energy deals were announced.

ExxonMobil strengthened its ties with Roseneft, even though the CEO is on the US blacklist. It extended the existing agreement to develop oil fields in Siberia and the Arctic. France's Total increased its ties with Lukoil, providing more investment.

BP, Royal Dutch and Eni also struck new deals. The majority of Russia's oil comes from the Siberia fields, which are being depleted. BP will help Rosneft develop fracking in Siberia and Volga-Urals. Royal Dutch is deepening its relations with Gazprom.

One of the interesting deals is with Italy's Eni. Eni is one of Europe's largest gas wholesaler and is owned in part by the Italy's government. It had renegotiated its contract with Gazprom last year. Reports suggested it won a concession of at least 7%. Last week, Eni won what appears to be an even larger concession from Gazprom. The Russian giant agreed to scrap its 50-year old practice of indexing gas supplies to oil prices, retroactively to the start of the year. This aligns prices more with the spot market and in effect lowers the price of natural gas. Some analysts estimate that the Gazprom concession can boost Eni's operating profits by half a billion euros this year alone. This is a transfer from Gazprom to Eni.

The new deals are clearly driven by commercial interests. Securing cheaper energy for Europe is one thing. It is quite another to help Russia develop its resources. At the same time, Russia's concessions to China and now Europe suggests it is more desperate than its bravado rhetoric suggests. Russia's concessions also appear to recognize that the price of LNG is likely to fall further as new supplies come on line, including the first US Gulf Coast exports next year. High cost LNG producers, like Australia (the prices of its LNG being sold to Japan is reported twice what China agreed to pay Russia), are vulnerable too. 

Building capacity for Russia and helping it develop its resources frustrates US and European policy makers who are trying to isolate it. Some of the agreements may adhere to the letter of the sanctions but violates its spirit. This is a well-known challenge for a sanctions regime.