August 9, 2022
Military update
Ready to support, but not prepared to sacrifice
Energy hostages
Ten years for import substitution
Neither quantity nor quality
Mosaic
Military update
After the Russian army seized the Ukrainian cities of Lysychansk and Severodonetsk and occupied the entire Luhansk region of Ukraine, it had two weeks to regroup its forces and launch a new offensive. This time it is targeting the cities of Sloviansk and Kramatorsk in the Donetsk region, which are strongholds of the Ukrainian army, as well as the regional center of Mykolaiv, whose capture would allow Russia to cut off access to the Black Sea by the Southern Bug River, as well as to seize important industrial enterprises associated with arms production.
The Russian army is using its global advantage in artillery and is slowly advancing toward its goal. The Ukrainian army’s ability to stop the enemy’s advance is limited by a shortage of weapons, the supply of which by Western countries is highly restrained.
Ready to support, but not prepared to sacrifice
The six-month war, designed as a blitzkrieg, has made the cost of fighting it a significant macroeconomic issue. According to my estimates, the total current spending (not including the cost of weapons and ammunition) since the beginning of the war amounted to 800 billion rubles-900 billion rubles ($13.5 billion-$15 billion)—i.e., 3.5%-4% of the annual expenditures of the federal budget or 25%-30% of the yearly budget of the Defense Ministry approved by law.[1]
The transition of the war into a long form was unexpected for the majority of Russians, who, on the one hand, continue to pay lip service to the actions of the Russian army but, on the other hand, are not ready to provide material support to the military. This dualistic position can be traced in the answers to many questions asked by the sociological service Russian Field.
Thus, on the one hand, almost 60% of respondents think that the military operation has been delayed: 33% “definitely” delayed and 26% “rather” delayed. The opposite view is held by 28% of respondents. On the other hand, in answer to the “patriotic” question, “Do you feel tired of hearing about the military operation in Ukraine?”, opinions are split in the opposite ratio: 41% of respondents gave a positive answer, but the majority (56%) stated that they did not have such feelings.
On the one hand, 62% of Russians believe the special operation is “definitely” or “rather” successful, while only 19% hold the opposite opinion. On the other hand, 62% of the interviewed men said they were not personally ready to take part in the military actions in Ukraine. And those willing to help the Russian military financially were even less: 67% of respondents were not ready to donate their own money to support the special operation, and 12% agreed to spend no more than 1,000 rubles ($16) a month.
The lack of clarity in the Kremlin’s wording about the purpose of the war has been fully conveyed to the Russians: They are ready to support any decision of Vladimir Putin. Thus, according to the survey, 60% of respondents are prepared to support the hypothetical decision of the Russian President “to announce tomorrow the beginning of a new offensive against Kyiv” (26% are against it). On the other hand, 65% of respondents are ready to support the decision “to stop the special operation tomorrow and sign a peace agreement” (28% against).
If the question about continuing or stopping the war were put to a referendum, and if we assume that respondents did not try to give a “politically correct” answer to this question, then 52% would support continuing military operations, while 38% would be in favor of a transition to peace negotiations.
Energy hostages
The decree signed by President Putin on depriving residents of “unfriendly countries” of their rights of ownership of Russian assets, which I mentioned in the last issue (Here it was…), creates enormous problems for two major European energy companies: Italy’s Enel and Finland’s Fortum, which have found themselves in a hostage situation.
Both companies became major investors in the Russian power industry after purchasing controlling stakes in generating companies during the reorganization of the state monopoly RAO UES in 2006-2008. For 15 years, both companies actively modernized the capacity of power plants, making them the most efficient in the industry. After the invasion of Ukraine by the Russian army, both companies announced their intention to end investments in Russia and sell their existing assets.[2]
Enel had time to negotiate and announce a deal in the intervening period. As a result, the oil company LUKOIL and the Gazprombank-Fresia fund were to become the new owners of the company’s Russian assets. The deal was expected to close in the third quarter after receiving approval from the government commission on foreign investment and the antimonopoly service.
Fortum was at an advanced stage of looking for buyers: The collection of bids was completed at the end of July, with Gazprombank, AFK Sistema, and Invest AG of Evraz shareholders Alexander Abramov and Alexander Frolov among those who wanted to buy the company’s assets.
Suppose the European companies remain hostages of the Kremlin. In that case, they will have to solve a complex problem: How to continue the construction of new generating facilities and maintain the Western equipment installed at power plants under sanctions restrictions. Failure by the companies to fulfill their obligations will threaten European companies with substantial fines. It may result in the loss of assets through involuntary bankruptcy (as happened with the Yukos oil company in 2004-2006).
Ten years for import substitution
After the meeting with Vladimir Putin devoted to discussing the future of Russian metallurgy, the Industry Ministry became more skeptical about the possibilities of modernizing the sector. The experts of the Ministry estimate that the Russian metallurgical companies are critically dependent on foreign-made essential equipment and either will have to find detours to buy it or switch to low-quality analogs because of the Western sanctions. So far, metallurgical companies have been relatively successful in finding substitutes for raw materials and components. Still, access to large equipment is limited, threatening the abandonment of development projects. Moreover, Western companies whose equipment is used at Russian factories have refused to carry out service maintenance.
According to experts, the development of domestic equipment and technology and the organization of their production in Russia cannot be done fast enough: The “science-production” cycle is up to 10-12 years.
Neither quantity nor quality
Two months ago, Russian authorities predicted a record grain harvest this year, but the weather has failed them: The rains in many regions are making the harvest slower than expected. As of August 4, grain and leguminous plants were threshed from 13.3 million hectares, 35% less than a year earlier; a total of 56.5 million tons of grain were harvested, which is 12.5% less than at the same date last year.
Russian Agriculture Minister Dmitry Patrushev warned that the Russian government might set lower grain export quotas than previously expected.
... this [slow harvest] creates risks in achieving the grain harvest target of 130 million tons. Of course, we will fully supply our market; that will be no problem. However, if the planned volumes are not achieved, we will have to revise the export plans of 50 million tons.
Arkady Zlochevsky, President of the Russian Grain Union, complemented the Minister: According to his estimates, the quality of grain this year will be significantly below average, and grain losses (taking into account re-factoring, the share of waste) may amount to up to 15% of the possible harvest this year. In addition, Zlochevsky is worried about declining grain quality. According to his forecasts, the share of food wheat will drop to 60% from 82% last year, making it pointless to impose quotas on grain exports from Russia:
The drop in quality may not even have to revise some export items—we won’t have enough high-condition resources to export. After all, no one buys forage from us. We sell food grain of good condition and better quality on the world market.
Zlochevsky estimates that many agricultural enterprises will face grave financial problems this year. On the one hand, the prime cost of feed grain this year is about 10,000 rubles per ton on average in Russia, which equals the purchasing prices, which will have to go down after the harvest in the regions with unfavorable weather conditions. On the other hand, Zlochevsky pointed out the heavily increased prices for fertilizers: Some have jumped so much that their use becomes profitable only if the harvest is increased by 10%-12%, which is unrealistic. “It’s easier to refuse.”
Mosaic
Russia’s pipeline monopoly, Transneft, has failed to pay Ukraine’s UkrTransNafta, causing oil supplies through the southern branch of the Druzhba pipeline toward Hungary, Slovakia, and the Czech Republic to stop on August 4.
Hungary’s MOL said it wanted to help the Russian monopoly and pay for oil transit services instead.
Chinese exports to Russia rose sharply in July, surpassing last year’s July level by 22% and 2.5% on a seven-month basis. The detailed statistics of goods shipments from China to Russia over the six months indicate no change in the structure, except for a decrease in the share of chemical products, which fell from 9.1% to 5.6%.
In this situation, my central hypothesis is that the sharp drop in Chinese exports to Russia was due to logistical problems and the closure of Chinese ports because of coronavirus outbreaks. To some extent, the picture can be clarified by data on the operation of Russian seaports, which should be released in the coming days.
Russian Health Minister Mikhail Murashko has reported that male mortality at the age of 35-40 years is twice higher than female mortality. According to him, in the language of statistics, the causes of excess mortality are “external factors” (primarily alcoholism).
[1] My estimate is based on a Russian military group of 150,000 troops and considers an unbiased estimate of the number of dead (10,000-15,000) and wounded (30,000-45,000) Russian soldiers.
[2] Fortum owns 73.4% of German Uniper (going to plummet to 56% after the German government buys its shares), which owns almost 84% of another Russian generating company, Unipro. Uniper has also announced its intention to leave Russia, but this statement has not yet been transformed into an organized asset sale process.