The true cost of Russian sanctions to London and UK investors

With the west and the G7 nations unlikely to pursue military options in retaliation to Russian aggression to deploy troops in Crimea region of Ukraine, threats of economic sanctions is being talked up.

President Obama said that the US will take a series of steps, both economic and diplomatic, to isolate Russia. They have suspended trade and investment talks already.

The UK has equally talked up the potential for sanctions, with the potential for an agreement on the details of those sanctions could be reached at the end of the week in an emergency EU summit.

Yet still there remains a degree of ambiguity as to the form in which what those sanctions could take. The UK government wittingly leaked their initial thoughts on sanctions yesterday when a minister quite blatantly left documents on the cabinets view on sanctions in full view for the worlds media to photograph and analyse.

That document identified a preference for restricting travel and visa, as opposed to tougher economic sanctions. In essence, it showed a lack of appetite amidst the UK government for tough bargaining with Russia.

Yet the true cost of sanctions, if Russia is hit hard, could hurt the UK much more than people think.

First and foremost, let’s remind ourselves here that Russia holds ALL the cards:

• The Ukraine carries 50% of Russian gas through pipelines to Europe (this is down from 80% a few years ago thanks to the creation of the Nordstream pipeline)

• The Ukraine enjoys subsidised gas imports far below market prices from Russia, a deal that finishes at the end of this month

• The Ukraine owes Russia $1.5bn for its subsidised gas imports

• The Ukraine is in negotiations with the IMF for a $15bn bailout

• Russia made the first move by deploying troops in Crimea and strategically is positioning itself to protect its pipelines, making retaliatory military moves very difficult

• Ukraine has no financial appetite to engage with Russia on a military level

Russia has a natural hedge

Russia also has a natural hedge against a financial crisis of this nature. A weak Ruble actually helps Russian exports as non-Ruble holders can buy more Russian goods. In the same sense, commodity prices have also gone up significantly since the start of the crisis. Natural gas futures contracts for delivery in the next month has rallied by 10% for example, despite the fact Gazprom says there has been no disruption to production thus far and we also know stockpiles are relatively high following an uneventful winter.

And to draw you back to the bullet points noted above, the Ukraine needs Russia for money and fuel and Russia needs the Ukraine to help it to supply Europe’s fuel. They will always have a relationship as a consequence. This will not change and neither of them want it to. After all, where else can the Ukraine get such a good deal?

London could be hurt by Russian sanctions

There is a case that sanctions against Russia could in fact hurt the London and as such, the UK, with London being the heartbeat of the UK economy.

First and foremost, a huge amount of Russian assets lie in the UK. Russian wealth is placed in key western banks, whilst the popularity of strategic assets in the UK such as the London property market and even football clubs (Chelsea FC) has held true for oligarchs and wealthy Russian investors for some time.

It has been speculated that the majority of the residential property sales in London with a value of £2m or more has been undertaken by wealthy foreign investors, with the majority of these being Russian and Chinese. If these assets are frozen and Russians cannot buy into London properties, one of the sources of London’s price bubble will be taken away, putting property prices in London at risk.

Secondly, there could also be an unwanted impact on UK pensions. BP owns 20% of Russian energy giant Rosneft, a stake that was a consequence of BP’s decision to sell TNK-BP. The stake in Rosneft awards BP consistent healthy dividends of circa $800m per year. The majority of pension funds are invested in large UK companies such as Vodafone, Shell and BP. Sanctions, if they take the form of assets such as Russian companies, could harm this.

So perhaps there is much more to sanctions that meets the eyes, which is perhaps why the UK government is trying to use the media to talk down the severity of what form they could take.