In Translation: Russia Responds

Article by Yuriy Barsukov, Veronika Goryacheva, Anatoliy Dzhumailo, Mikhail Korostikov, Sergei Strokan, Oleg Trutnev, and Elena Chernenko. Originally published in Kommersant. Translation by Nick Trickett and Aaron Schwartzbaum.

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Photo: Reuters

On Wednesday night, the House of Representatives of the U.S. Congress passed a bill with an absolute majority imposing sanctions on Russia, Iran, and North Korea. The bill introduces additional restrictive measures against Russian individuals, legal entities, and sectors of the economy, depriving the U.S. president the possibility of calling off new or existing restrictions without congressional approval. The Senate will vote on the bill soon, after which it will be sent to the President’s desk. Moscow has warned that Congress’s actions bury hopes for the normalization of bilateral relations and has threatened “painful” countermeasures. We take a look at the trade relationship between the two countries to see whether Russia can punish the United States without hurting itself.

Hope Dies

The new bill significantly expands existing sanctions against Russia, Iran, and North Korea. It was supported by 419 members of the House of Representatives, with only three members opposing the toughest sanctions package since the Cold War.

Bob Corker, Chair of the Senate Foreign Relations Committee, has indicated that the upper chamber of Congress could consider the bill by week’s end. A bill passed by the Senate in June has a similar bent but differs from the bill passed in the House (in particular, it lacks a section on North Korea) and the Senate must meet again to deliberate over the proposed measures. The new bill is expected to pass with no problems: in June, 98 senators called for the imposition of sanctions against Russia and Iran with only two votes against.

After approval from both chambers of Congress, the bill will be sent to the President’s desk for his signature. The White House has not indicated whether President Trump will sign it or not. However, even if he uses his power to veto, there are enough votes in Congress (more than two-thirds) for the bill to pass. Previously, President Trump has stated his desire to establish a dialog with Moscow, but the bill prepared in Congress makes the President extraneous to the process: he is no longer critical to the future of Russian-American relations.

In Moscow, this is understood. Konstantin Kosachev – chair of the Federation Council’s Committee on International Affairs – had expressed “cautious hope” after the meeting of Russian President Vladimir Putin and President Trump that it could “foreshadow a breakthrough” in relations between the U.S. and Russia. But he is now under no illusion. “Hope dies last, but it dies. Judging by the monolithic vote on the sanctions package against Russia, Iran, and North Korea in the House of Representatives, there will not only be no breakthrough. There will be no normalization. Moreover, further degradation of bilateral cooperation is inescapable, as there seems to be nowhere else to go,” he wrote on his Facebook page.

Dmitry Peskov, Press Secretary for the President, called the news from Washington “very sad from the point of view of Russian-American relations and prospects for their development”. Sergei Ryabkov, Deputy Minister at the Russian Ministry of Foreign Affairs, told the news agency TASS that the adoption of the bill is a deliberate choice by Russia’s enemies in the U.S., who are “completely unhinged and don’t know how to handle their rage”. “Accordingly, we will perceive today’s America this way. Washington is a source of danger,” he asserted. “We need to understand and act measuredly, reasonably, and calmly with this in mind.”

Russian officials sidestepped the question of possible retaliatory measures. Dmitry Peskov would only say that Putin would make a decision “after thorough analysis”. Sergei Ryabkov said that Moscow has sent signals dozens of times to Washington about possible retaliatory actions against anti-Russian sanctions and Ryabkov believes they have reached their intended audience.

Konstantin Kosachev asserts that “the response should not be symmetrical, but painful for the Americans”. At the same time, the politicians refused to answer Kommersant’s questions about what kind of specific measures would be discussed. “Specialists are fated to making elaborate proposals in this domain, while decision-making is the president’s prerogative,” he said. “I only outlined the principle: asymmetrical and painful, with the exception of areas where they would harm our interests, they should be pointedly targeted.”

Double-Edged Sanctions

Meanwhile, according to Kommersant’s sources in the Russian Ministry of Foreign Affairs, should President Trump sign the bill, Moscow will start a series of symmetrical measures. Since the bill makes it virtually impossible to return to Russia the diplomatic properties in the U.S. seized by the previous administration, Russian authorities may take back the American Embassy’s summer residence in Serebryany Bor and its storage facilities. In addition, 35 American diplomats may be expelled from the country – the same number of Russian embassy representatives in Washington forced to the leave the U.S. last December. Additionally, Russia is considering limiting the amount of employees allowed in the American diplomatic mission in Moscow, a figure which currently exceeds the number of Russians working in the embassy in Washington.

Symmetrical sanctions, however, are likely to be ineffective. In terms of asymmetrical steps, then in the diplomatic sphere, Moscow could refuse to cooperate with Washington on issues that are critically important to it. For example, the U.S. is now pressing for Russia to strengthen means of pressure on North Korea, including in the U.N. Security Council.

In other areas, the levers at Moscow’s command are limited. “Our trade, economic, and investment relationships with the U.S. aren’t developed enough to prick our so-called American friends,” admits Alexander Shokhin, head of the Russian Union of Industrialists and Entrepreneurs. At the same time, he named the refusal to supply the U.S. with RD-180 engines and limiting cooperation on the International Space Station (ISS) as potentially sensitive “jabs” for the U.S.

However, according to Andrei Ionin, an associate of the Russian Academy of Cosmonautics, Russia will “shoot itself in the foot” should it adopt these measures. “Our engines are mounted on the Atlas 5 rocket from Lockheed Martin, and the Americans have two other rockets: Boeing’s Delta and Elon Musk’s Falcon, which claim 60% of the market. If we stop selling engines, the Americans will take time to shift the load to Delta and Falcon but there’s no question of paralysis,” he explained to Kommersant. “As for the ISS, the ban on transporting Americans will lead to a halt in the station’s work. The station is a big communal apartment where there are no excess people, and if something happens to one person, the apartment, everything starts falling apart. This, by the way, was initially planned to be done in 2015, then moved to 2020, and now to 2024.”

“If we begin to compete in terms of how painful measures are, at the end of the day it will be more painful for us. In this sense, we can freeze relations, but doing so stands to freeze off our own ears.”

Talking to Kommersant, Sergei Karaganov – Dean of the Department of World Economy and Politics at the Higher School of Economics also called cooperation on the ISS extremely mutually beneficial, but noted that there were areas where “Russia could inflict economic and psychological damage to the U.S.”.

Theoretically, Moscow could enact its own economic sanctions against Washington by cutting down trade turnover, restricting American companies’ work in the country, and random seizures of investments already made in Russia. Direct turnover between the countries is not significant – 2016 saw $20.2 billion distributed roughly fifty-fifty. The U.S. supplies Russia with engineering and other high-tech equipment (including that for energy and oil extraction and refining, with a third of imports labeled “secret code”). These could be replaced, for example, with European equivalents, but that may prove difficult. It would certainly be a bigger problem for Moscow than for Washington, since it would affect not only civilians – as the food sanctions against Europe and Turkey did – but entire strategically important sectors.

Moreover, and in contrast to the situation with Europe, energy carriers are not a big issue. Oil products make up the largest proportion of Russian exports to the U.S. (35% of the total in 2016), of primarily oil from Baltic ports and the Arctic, gas condensate, and naphtha. But American refineries can easily acquire these goods on the market just as Russian oil producers can find other buyers, industry sources note.

On the other hand, the U.S. has become dependent on imports of Russian enriched uranium products for its atomic power plants. Between 1994 and 2013, these imports – from Tekhsnabeksport (TENEX, Rosatom’s overseas trader) – were predominantly on a noncommercial basis through the Megatons to Megawatts agreement, and Russian uranium covered roughly half of the U.S.’s nuclear power generation demand. Since 2015, imports have been on a direct commercial basis with American energy companies: TENEX received a quota of 20% of the market (roughly 3 million separative work units, a measure of nuclear power generation, per year). From 2011 to 2016 that quota was reached, with 95% use expected between 2017 to 2020. TENEX has 25 contracts with 19 enriched uranium consumers in the U.S. through 2028 for a total of $6.5 billion. The possible cessation of exports would harm both sides: the U.S. would have to find a replacement for the Russian uranium in a market with few players, while it is doubtful TENEX would be able to quickly replace its American market share with other exports.

Another potentially double-edged measure concerns titanium exports. The U.S. remains the leading export market for Russia’s VSMPO-Avisma, accounting for 32% of the company’s shipments and 48% of export sales in 2016. Roughly half of the U.S.’s titanium imports are from VSMPO-Avisma, with Russia providing over a third of Boeing’s needs. The investments are mutual: VSMPO-Avisma has subsidiaries and joint ventures in the U.S., while Boeing has a joint venture in Russia. The Russian company is not ready to discuss the possibility of sanctions, though such questions haven’t yet been raised.

Aluminum accounts for a significant volume of Russian exports to the U.S., but limitation of the resource seems unlikely: these exports account for a fourth of Rusal’s sales (the company offered no comment on the topic). Another significant export category is ferrous metallurgy, primarily linked to the assets of Russian steelmakers in the states – but it makes up a tiny share of the American market. Moreover, in May the Deputy Director for Strategy and Development of TMK, Vladimir Shmatovich, told Kommersant that the company wants not only to double its pipe exports to the U.S., but sees the potential for the export of up to 300,000 tons of seamless pipes from Russia and Romania.

The last relatively significant element in Russian exports to the U.S. – mineral fertilizer – is of small consequence for both sides.

Limitations on American companies in Russia may prove more serious. These companies are most widely represented in the consumer market and I.T., which makes a ban relatively more likely. Sanctions impacting civilians have been tried successfully by Moscow in both Europe and Turkey.

Several branches of McDonald’s in Moscow were closed at the beginning of the Ukraine crisis. The shut-downs were never directly linked to the conflict with the U.S., but many in the market interpreted the incidents as related. If the situation were to be repeated in an official and more widespread manner with a greater number of companies, it could impact a number of sectors: from food production to pharma, from food services to the internet.

Coca-Cola and PepsiCo are by far the biggest producers of non-alcoholic drinks in Russia with their own soft drink and juice production facilities in the country. PepsiCo is also one of the largest local producers of dairy products (the Domik v Derevnye and Chudo brands) and of snacks (Lay’s, Cheetos). American companies also have a significant share of the confectionary market, with players such as Mondelez and Mars. The latter is also a leader in animal feed production (Pedigree, Whiskas), with 53% of the market.

Other American companies such as Google, Facebook, Apple, Adobe, and Microsoft are no less popular in Russia. The first four are theoretically possible to block (however unpopular the move would be with their users), but not even the government has been able to replace Microsoft products to date. Western software accounts for some three quarters of overall state software orders until today, not to mention its share in other sectors.

In the pharma market, where the most effective step may be an import ban – Russia imported some $560 million in pharmaceutical production from the U.S. in 2016 – operates Abbott Laboratories (which acquired major Russian producer Verofarm in 2014), Eli Lilly, and the global giant Pfizer, which along with Novamedika, a company in Rosnano’s portfolio, is constructing an injection drug factory in Kaluga Oblast.

Predictably, no market players are ready to discuss potential sanctions. Coca-Cola and Mondelez declined to comment on this most recent downturn in relations. Abbott and McDonald’s didn’t answer Kommersant’s query. Mars indicated it is “following the situation’s development”.

Deloitte – one of the “big four” auditing companies – may also suffer from countersanctions, note market participants. The company currently has no ties to the U.S. Deloitte and Touche CIS is owned by a Cypriot company and Russian citizens. Therefore, any direct sanctions against American companies will not touch it, but the Russian Deloitte may suffer. “The percentage of turnover from audits among Russian companies isn’t very large… a large proportion comes from consulting and associated services for state corporations,” notes a source at an auditing organization. “A potential result is that Deloitte simply won’t be invited to participate in such projects.”

“Even if that happens, I don’t think it will hit the mother company too hard,” comments Natalya Borzova, deputy head of Finekspertiza. “But with the subsidiaries of foreign companies working in Russia and with one partnership with their mother company – such as Deloitte – there may be an unpleasant surprise in store, as is the case for players with a state stake that are currently working with Deloitte. For example, the Russian subsidiary of Hungary’s OTP Bank, as well as other banks being audited by Deloitte.”

The expropriation of American companies in Russia’s assets directly, and not through a mandated withdrawal due to limitations, seems the least realistic scenario. It would inevitably be a serious blow to what’s left of the country’s investment climate and provoke a strong reaction not only in the U.S., but in other Western nations. Theoretically, note Kommersant sources, agreements with Exxon to explore the Arctic shelf – currently frozen due to prior sanctions – could be torn up. However, such a step would not speed the exploration of the shelf, and would undercut Russian leverage in a situation where U.S. sanctions are hitting American oil companies.

The Iran Scenario

The sanctions discussed by Congress evoked a negative reaction not only in Moscow, but in European capitals. The EU conveyed its concern over an article banning significant investment in Russian oil and gas export pipelines. The language directly threatens the Nord Stream 2 project and the interests of the European companies participating in the project. Coupled with President Trump’s recent rhetoric – two weeks ago, he spoke of the U.S.’s  global “energy dominance” – this aspect of the sanctions drew a number of European politicians and business representatives to conclude that the new measures were aimed at moving American LNG into Europe and squeezing out a competitor: Russian gas.

Jean-Claude Juncker, President of the European Commission, announced that that the U.S.’s stated “America First” principle, as it concerns sanctions at least, cannot mean “Europe Last”.  “The American bill may impact the EU’s interests in the sphere of energy security. Therefore, the Commission has made a decision: if the concerns of the Union aren’t heeded, we are ready to take the necessary measures,” he noted, not clarifying what measures he meant. The leadership of Germany, France, Austria, and a number of other EU states has criticized Congress’s initiative, as have a number of other business representatives.

“What congress is doing is a nightmare for traditional American geopolitics…they’ve already facilitated closer relations between Russia and China, and now are pushing Europe in that direction,” notes Sergei Karaganov.

This isn’t the first time US measures have targeted European piplines: in 1962 the U.S., then the lead exporter of oil to Europe, convinced NATO member states to block the export of large diameter pipes – to be used in the Friendship Pipeline – to the Soviet Union. The limitation was ultimately removed under the pressure of European companies.

In 1982 the Reagan administration enacted far-reaching sanctions against the export of oil and gas equipment, which was aimed at disrupting the construction of the Urengou-Pomary-Uzhgorod pipeline, though French, German, and British companies fell under the ban as well. This caused a conflict between the allies, the result of which was a cancellation of the embargo in 1982.

“Right now we see a direct parallel with American sanctions during the Cold War,” notes Andrei Baklanov, Deputy Director of the Association of Russian Diplomats. “Then, they also put a lot of pressure on the Europeans to end their cooperation with Moscow.” According to Baklanov, the current situation is different in that back then, political considerations influenced U.S. pressure on Moscow, while today there is an economic interest as well. He adds that Russian authorities must mobilize the forces in Europe – politicians, business representatives, social figures – to stand against American pressure.

Alexander Shokhin, head of the Russian Union of Industrialists and Entrepreneurs, does not exclude the potential for Europeans to cease cooperation with Russia anyway. “For us the most unpleasant thing in this sanctions regime is the behavior of other countries – Europeans most of all – who, fearing compliance consequences for their work in Russia, may roll back their partnership,” he says. “It is like the Iran sanctions scenario, when they were essentially country-specific and any bank or company working with Iran could fall under the regime. The Americans imposed fines indiscriminately, regardless of the country of origin.”

“In a situation where sanctions hit Russia’s weak spot – the export of oil and gas – her answer should be to develop and reform her economy,” says Aleksei Arbatov, Director of the Center for International Security at IMEMO-RAN. “This will allow us to make the country less dependent on importing advanced technologies and foreign investment. We need to do what we can, so that the same Americans fear their own sanctions, risking greater losses.”

Arbatov notes that getting caught in a trade war won’t allow this economic development – Russia’s economy remains dependent on oil and gas and makes up some 2.2% of global GDP. “If we begin to compete in terms of how painful measures are, at the end of the day it will be more painful for us. In this sense, we can freeze relations, but doing so stands to freeze off our own ears.”

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