Russian President Vladimir Putin was all smiles as he signed the annexation treaty between Crimea and the Russian Federation on March 18th that will allow the Crimea to be absorbed by Russia.  In a speech to the Russian Duma, Putin congratulated the 82% of Crimea citizens voting by a 96% majority to secede from the Ukraine. But Putin’s Cheshire-Cat smile isn’t just about welcoming two million more countrymen.  The day before, Crimea’s parliament nationalized Chornomornaftohaz and Ukrtransgaz, the two energy companies that control substantial offshore oil and gas reserves.  Putin intends for Russia to make a profit on acquiring and developing Crimea’s offshore oil and gas.

The Crimea is a lush region known for its palm-fringed seafront boulevards and rocky hills, but it receives subsidies for 85% of its electricity, 90% of its drinking water and most of its food. Putin has committed to continuing subsidies and lifting 560,000 Crimean pensioner payments from the Ukrainian average of $150 a month to Russia's minimum of $180. He also assured Crimean workers that average wages will rise from $270 as Ukrainians to the $660 average wages of workers in neighboring Krasnodar region.

Karen Vartapetov, an analyst at Standard & Poor's rating agency, calculated that Moscow will need to pay 38 billion rubles (just over $1 billion) a year to bring Crimea's per capita budget revenue to the same level as Russia's poorest regions, such as North Ossetia and Kabardino-Balkaria in the restive North Caucasus. According to economist Jouko Rautava, of the Institute for Economies in Transition at the Bank of Finland, economic growth in Russia in 2014 could dip below 1 percent after the “Crimea Weekend” -- short of the Russian central bank's forecast for 1.5-1.8 % expansion.

But these subsidies are only a fraction of the $29 billion in annual subsidies and debt relief President Obama and European Union (EU) leaders seemed to be willing to pay to support Ukraine’s “people’s revolution.” U.S. Secretary of State John Kerry recognized the rebel government on February 21st and pledged $1 billion of support; while the 28-nation EU offered to join with the International Monetary Fund aid package worth $27 billion over seven years. But when it came time for the U.S. to contribute the first billion dollars in cash last week, Congress objected and left for vacation. 

Russian officials have committed to initially send 30 to 40 billion rubles in financial aid to Crimea for transition to the Russian economy.  Russian Deputy Finance Minister Sergei Shatalov told reporters: “There will be changes in tax laws, the issue of forming a customs service, an internal revenue service, and the registration of legal entities and individuals, inventories and rules to adapt to the Russian tax system.”

But by acquiring the Crimea, I believe Russia will gain control of about 70% of Ukraine’s Black Sea offshore oil and gas drilling rights. After the 2012 discovery of the Domino Field in neighboring Romania that is so large the country expects to become a natural gas exporter, ExxonMobile Corporation quickly licensed from Ukraine the rights to drill in the Skifska tract off the Crimean Peninsula.  Exxon had partnered with Royal Dutch Shell Plc and planned to spend $735 million drilling two wells about 50 miles off Crimea’s southwestern coast. But according to Chris Weafer of Macro Advisory in Moscow, “Exxon and Shell are now in a legal limbo.” They pursued an “exploration deal with a government which may soon no longer have jurisdiction over the region.”  ExxonMobil said the company “isn’t choosing sides in the dispute.”

The United States and the EU retaliated with sanctions against Russia on March 17th, but there is little overlap between the 11 individuals targeted by President Obama’s Executive Order and the 21 people sanctioned by the EU Legislature. Only 4 individuals have been jointly sanctioned by the U.S. and EU, and only 2 are Russian.U.S. sanctions target the highest ranks of power in Russia, including parliament leaders; while the longer EU list targets lower level individuals with 2/3 Ukrainian or Crimean. 

Europe is much more vulnerable to Russian countermoves because of its strong economic ties to Moscow.  Russia supplies over 50% of Central Europe oil and gas and 30% of the EU.  There are also 6,000 German companies actively selling to Russia and German companies have invested heavily in Russian manufacturing according to a report today in the magazine Der Spiegel. European banks are also concerned with loss of the enormous amount of Russian capital flowing through London's financial district.

Vladimir Putin is the most popular Russian leader in the last 30 years with an approval rating of 71.6%. According to my sources, Russians see the same strengths of courage and strong moral purpose in Putin that they believe President Ronald Reagan used to lead the economic rebirth in America that overwhelmed the Soviet Union. They see Barack Obama as an updated Mikhail Gorbachev; a man who talked a good game but whose economic policies led to foreign weakness and internal collapse.They believe Putin’s addition of Crimea’s oil and gasreserves will economically strengthen Russia. 

The author welcomes feedback @ chriss@chrissstreetandcompany.com
Chriss Street is teaching microeconomic at University of California, Irvine this spring from March 31 – June 8, 2014.  Call Student Services at (949) 824-5414 or visit http://unex.uci.edu/courses to enroll!