Report

Beware the Bear

Beware the Bear

Despite a tenuous and partial cease-fire announced by Ukraine and Russia on Friday that could bring a respite to the fighting in eastern Ukraine, both the United States and the European Union have a fresh slate of sanctions locked-and-loaded and ready to unleash on Moscow.

EU officials huddled Friday, Sept. 5, in Brussels to finalize the fourth round of sanctions on key Russian economic sectors, including finance, energy, and defense, while U.S. President Barack Obama said that the United States is working to "deepen and broaden" existing sanctions meant to ratchet up financial pressure on Russia.

The European Union was poised to expand its earlier sanctions that banned major Russian banks and energy firms from global capital markets, according to drafts that leaked out this week. The latest sanctions, for example, would target Rosneft, Russia’s big oil company. Europe would also aim at the export of sensitive technologies, such as those used for oil exploration offshore and in the Arctic, two priority areas for a Russian state anxious to boost its oil and gas production to compensate for declining output at aging fields.

A last-minute cease-fire agreement may have forestalled Europe’s latest steps to bring pressure to bear on Russia, which it says is responsible for the armed violence in eastern Ukraine. German and British officials said late Friday that they could suspend new sanctions if the cease-fire holds; German Chancellor Angela Merkel said "everything is in flux," during a press conference at the NATO summit in Wales.

Many observers view the cease-fire skeptically because it does not address the underlying political drivers of the conflict between Kiev and Moscow. But European officials said they are willing to give the plan, drafted by Russian President Vladimir Putin, a chance to end five months of sporadic fighting that has left more than 2,500 dead, according to the United Nations.

More broadly, the question now is whether the drumbeat of Western sanctions, which threaten to choke off much-needed financing for big Russian banks and energy companies, will trigger tough reprisals from Putin. Russia and the West, that is, could be locked in a different kind of arms race than that which prevailed through the Cold War: an escalation of economic measures and countermeasures.

While the West has so far carefully calibrated its sanctions, Russia has a history of responding unpredictably. After the United States and the European Union issued sanctions targeting banks and defense companies at the end of July, Moscow halted Western food imports, for instance. When the United States blacklisted Russian officials for human rights abuses in 2012, Putin banned Americans from adopting Russian children.

Putin has long threatened to wield the energy weapon to cow European countries, which are heavily reliant on imports of Russian oil and natural gas, and he threatened to shut off gas exports to Ukraine in May. The energy weapon will become more powerful for Russia as temperatures drop.

And energy isn’t the only arrow in Moscow’s quiver. Russia’s dominant role in a handful of other key sectors, such as critical metals, could also give it leverage to inflict targeted pain on major U.S. and European manufacturers.

Gary Litman, vice president for international strategic initiatives at the U.S. Chamber of Commerce, says American companies are much more afraid of Russia’s response than the West’s latest move.

"It’s the next wave of Russia’s responses that throws us into unknown terrain," Litman said.

He says Russian metal exports are a particular vulnerability. Russia is the biggest global supplier of key titanium components used by aircraft manufacturers such as Boeing and Airbus, for example. Reprisals from Moscow could complicate production of a major and lucrative Western exports.

Boeing has been stockpiling Russian titanium parts since March out of concern that the Ukraine crisis might disrupt supplies, the Wall Street Journal reported Aug 7.

The Federal Reserve said airplane-makers in the Pacific Northwest were concerned about metal supplies, in its survey of local economic conditions published eight times a year.

"Aerospace manufacturing contacts noted that increasing tensions and broadening sanctions against Russia may reduce titanium supplies," the San Francisco Fed said in the report, known as the Beige Book.

Although titanium is perhaps the most vulnerable supply, nickel and palladium could also be targeted. The U.S. Geological Survey publishes a report that includes U.S. dependency on foreign metal and mineral supplies. Of the metals for which the United States is more than 50 percent dependent on other countries, Russia is listed as a major source for eight, including tantalum and thallium, which are used in electronics.

"I’m concerned that we are not appreciating the dependence on Russian metals and minerals," said Daniel McGroarty, founder of the American Resources Policy Network and a consultant with Carmot Strategic Group. "The idea that I see all too much in Western statements is [that] we’re going to turn the screws on Russia. But Russia also has some screws they can turn on us."

Because supply chains often weave through several different companies from raw material to component part to finished product, McGroarty said there may be unrealized dependencies that aren’t revealed until the supply is halted.

"To a certain extent, we would sometimes only find out how much metal we were getting from a certain source when that source was cut off and the component stopped showing up," McGroarty said.

Europe’s deepest fear, and Putin’s ultimate ace in the hole, would be to run a reliable play and halt natural gas exports to Europe, as it did in the winters of 2006 and 2009. Europe gets about 40 percent of its gas supplies from Russia. Demand is highest in the fall and winter, leaving Europe much more vulnerable to supply disruptions than it has been so far this year.

Of course, cutting off energy flows is a double-edged sword. About half of Russia’s revenues come from energy exports, and Europe is gas giant Gazprom’s biggest export destination. What’s more, Europe has braced itself for the worst. Gas storage levels in the European Union today are around 90 percent of capacity. And European countries learned from 2006 and 2009 and bolstered their ability to shift gas supplies from one country to another to absorb sudden shocks. That makes the continent less vulnerable to Russian energy blackmail, though countries in Central and Eastern Europe could feel the pinch.

"Europe could probably sit out a supply disruption for about two months, but then countries like Romania, Bulgaria, Hungary, and Greece would be in trouble again," said Tim Boersma, a European-gas expert at the Brookings Institution.

Throughout the Ukrainian crisis, Russian officials have promised to keep energy exports flowing to Europe: They want to ensure the $100 million a day in revenue and maintain Russia’s reputation as a dependable energy supplier. But Europe could suffer even if Gazprom and Putin play ball. That’s because Ukraine is in the middle.

About half of Europe-bound Russian gas passes through the country; Russia shut off gas exports to Kiev this spring. As colder temperatures arrive, Ukrainian officials may have no choice but to tap into gas supplies meant for other European countries downstream in order to keep their citizens from freezing, as appears to have happened in 2006 and 2009.

"The biggest concern for Europe may not necessarily be Gazprom shutting off supplies, but rather the Ukrainians deciding, ‘We don’t want to sit in the cold, and we’re going to take some of that transit gas,’" Boersma said.

Richard Sawaya, the head of trade group USA Engage, said one thing is certain: Putin will keep the West guessing. He points to the shuttering of 12 McDonald’s restaurants in Russia last month on alleged health and safety violations as an example of Moscow’s unpredictability.

"It won’t be reciprocal," Sawaya said. "There are all sorts of ways you could screw up business operations without, quote, ‘sanctioning.’"