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Slow reset of US-Russian relations

Trump and Tillerson should help improve US-Russia relations. But an end to sanctions doesn't look imminent

Western media may be agog at Donald Trump's apparent fondness for Vladimir Putin, but Russia's battle-scarred energy sector is watching the romance with a sceptical eye. Even the appointment to Secretary of State of Rex Tillerson, the former ExxonMobil chief with long experience of dealing with Putin, is being treated cautiously.

Although the Trump White House is expected to adopt a more pragmatic and open policy towards Russia, it would be naive to assume any major or early improvements. Less confrontational rhetoric is likely. A genuine thaw that boosts the oil and gas sector—not so much.

Trump has promised to take a softer approach to Russian relations than his predecessor but already the US president has faced significant pushback from the judiciary and his own party over controversial executive orders. That makes it much harder for him to bypass Congress and wave a magical wand to lift Russian sanctions.

"Sanctions are set to stay in 2017," says Chris Weafer, founder of Moscow-based consultancy Macro Advisory. "Our base-case assumption is that neither the EU nor the US will start any staged reduction of the August 2014 sectoral sanctions this year."

Companies like Rosneft, Gazprom, Lukoil and Novatek have been working under US and EU sanctions since 2014. These penalties were an effort to heap pressure on Russia over the annexation of Crimea and for backing separatists that helped prolong a conflict in Eastern Ukraine. Sanctions have blocked oil majors from foreign financing, technology and launching joint projects with Western firms, adding strain to companies already suffering the effects of low oil prices.

Sanctions related to the use of technology or oilfield services have had limited impact. Russia's oil production continues to set post-Soviet records and looks set to rise further. Large companies like Rosneft have managed to secure financing by selling equity in assets to Indian and Chinese strategic investors. Cooperation with some Western companies only stalled because some reserves are more expensive to produce than conventional crude, and were not commercially viable when oil prices dropped sharply in the second half of 2014.

But the finance sector sanctions have had a much more meaningful impact. Legally, the sanctions only block the state lenders from acquiring debt with a maturity of 30 days or more. But the contagion from that ruling has been much more extensive—most Western banks avoid any Russian risk for fear of incurring the wrath of US regulators.

Igor Yusufov, who served as President Vladimir Putin's energy minister from 2001 to 2004, is optimistic that Trump appointee Tillerson will be sensitive to US and Russian mutual oil and gas interests. But he doesn't think Moscow will offer concessions to achieve a lifting of sanctions.

"I would not see the possible sanction-easing or elimination as a part of a deal or bargaining," Yusufov, who heads the investment company Fund Energy, told Petroleum Economist. "This step should be taken to eliminate the political baggage, which hinders mutually beneficial projects in the energy area." Yusufov says he first met Tillerson in April 2002, when Yusufov was chairman of state-controlled oil producer Rosneft, which partnered with Exxon to develop oil and gas reserves on and offshore the far-eastern Siberian island of Sakhalin. That deal became the cornerstone of Exxon's relationship with Russia.

"Tillerson has always manifested firmness in defending the business of his company, in which he has been working more than 40 years," says Yusufov. "He is very pragmatic and, as we see, now an excellent diplomat. I have no doubts that he will find a common language with our foreign minister Sergei Lavrov."

Despite the headaches caused by sanctions, Yusufov says Exxon has continued working with Rosneft over the past three years. "They remained in the Sakhalin projects but had to stop a series of projects, such as in the Kara Sea."

Arctic revival

That Kara Sea project, in the Arctic, is among the first ventures tipped to be revived if sanctions are relaxed. In the summer of 2014, Exxon started drilling in the area, only for it to be halted as Western countries imposed sanctions.

At the helm of Exxon 2006-16, Tillerson needed to develop his business acumen in Russia. Putin bestowed the Order of Friendship on him in 2013. In March 2015, Tillerson complained that the US company's potential losses from the sanctions could hit $1bn.

Other areas of cooperation between Exxon and Rosneft remain unaffected by sanctions, including the Sakhalin 1 project at Sakhalin. Its partnership agreements with Rosneft include three blocks in the Kara Sea and a block in the Black Sea, as well as a potential liquefied natural gas plant on Sakhalin island.

Sergei Markov, a political consultant to Putin's staff, believes Trump will lift sanctions but not all at once and only in "a very artful way". Markov cited the two countries' coinciding geopolitical interests as one path towards a reset in relations.

"Sanctions could begin to be gradually phased in spring this year in parallel with the development of cooperation between Russia and the US in the fight against international terrorism," he says. "The US won't be able to fight international terrorism alongside Russia and maintain sanctions against the leadership of the Russian special services at the same time."

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