Retaliatory sanctions hovering over  the US

How can Russia react to the new restrictions from the US?

July 27, 2017

US Sanctions against the Soviet Union

Tuesday night, the US House of Representatives voted overwhelmingly in favor of a sanctions bill against Russia, Iran and North Korea. The bill imposes additional restrictions targeting Russian individuals, legal entities and entire economic sectors, basically disabling the US president to lift any new or existing sanctions without approval from the Congress. The Senate will be considered by the Senate shortly and then will go to President Trump’s desk. Moscow has warned that the Congress is killing any hope for normalizing relations between the two countries and threatened to respond with “painful” measures. We at Kommersant have attempted to gain an understanding of whether Russia is able to punish the US without damaging its own interests.

The hope is dying

The document significantly broadening the sanctions against Russia, Iran and North Korea was passed by the House of Representatives by a vote of 419 to 3. The bill contains the strictest sanction package since the Cold War.

Bob Corker, the Chairman of the US Senate Committee on Foreign Relations, made it clear that the Senate may consider the bill before the end of this week. A similar document passed by the Senate in June somewhat differs from that approved by the House (it does not discuss North Korea). Now the Senate has to once again voice its opinion on the proposed measures. However, there will hardly be any hurdles with passing the new bill through the Senate: last time fresh sanctions against Russia and Iran were welcomed by 98 senators, with only 2 voting against.

Upon approval by both chambers, the bill will go to the President's desk. The White House is not ready to comment on whether Donald Trump will sign the bill. However, even if he does exercise its right to block it, the majority of the votes given in favor (more than two thirds) will be enough to overcome the veto. Donal Trump has repeatedly said he would like to restore the dialog with Moscow, but the bill prepared by the Congress virtually makes the US President a bit-part actor who will no longer influence the Russian-American relations.

Moscow is aware of this. Konstantin Kosachev, head of the Russian Federation Council's Foreign Affairs Committee, who earlier expressed a “cautious hope” that the first meeting between presidents Vladimir Putin and Donald Trump may “indicate a breakthrough” in bilateral relations, harbored no illusions in this regard. “Hope is the last thing to die. – But it dies. Given the House’s unanimous support of the new sanctions package against Russia, Iran and North Korea, we will not see any normalization in relations, let alone a breakthrough. Moreover, further worsening of our bilateral cooperation is becoming unavoidable, although you cannot imagine how they can get any worse,” Kosachev wrote in his Facebook post.

Dmitry Peskov, the Press Secretary for the President of Russia, said the news from Washington was "sad news in terms of Russia-US relations and the prospects of their development." Russian Deputy Foreign Minister Sergey Ryabkov said to TASS that the new bill is a calculated hostile move of Russian’s enemies in the US who “have got on the loose and run completely wild”. “So, that’s what we’ll be thinking of the today’s America. Washington is a hazard, – he said. —  We must understand this and act accordingly: carefully, reasonably and composedly”.

Russian officials have avoided comments on the possible retaliatory measures. Dmitry Peskov only said that this decision will be made by Vladimir Putin “upon careful consideration”. Sergey Ryabkov stated that Moscow had signaled to Washington “on numerous occasions”, warning of retaliation in response to anti-Russian sanctions, adding he hoped those signals had hit home.

Konstantin Kosachev was a bit more specific, saying that “our response must not be symmetrical but must be painful for Americans.” However, the politician refused to elaborate on the specific measures. “Any suggestions in this area must be made by relevant experts and decisions must be taken by the President, he said. – I have only described our approach which reads, “Do not respond symmetrically but make it painful”. This means, avoid acting where our interests might be harmed plus act in a targeted, more precise way.”

Double-edged sanctions

Meanwhile, our sources in the Russian Ministry of Foreign Affairs claim that Moscow will still go for some “symmetrical” measures if Donald Trump signs the bill. Since this document basically denies Russia of the opportunity to return its diplomatic properties in the US seized by the Obama administration, Russian authorities may order the seizure of the American Embassy’s summer residence in Serebryany Bor and the related storage facilities. In addition, Russia may send home 35 American diplomats — which is equal to the number of representatives of the Russian embassy in Washington, D.C., who had to leave the US in December last year. Russia may also limit the number of representatives of the US diplomatic mission in Moscow. Today, they outnumber Russian diplomats at the Embassy in Washington.

Symmetrical anti-US sanctions in all other areas would be, in fact, non-effective. Speaking about targeted non-symmetrical response, Moscow may refuse from diplomatic cooperation with Washington in the areas that are important to the US. For instance, America is currently trying to force Russia increase pressure on North Korea, including through UN Security Council.

In all other directions, Kremlin has few levers to pull. Aleksandr Shokhin, Head of the Russian Union of Industrialists and Entrepreneurs, acknowledged, “Our commercial, economic and investment relations with the US are too limited for us to prick our American “friends". According to Shokhin, the “pricks” that could potentially be perceptible for the US include canceling supplies of Russian RD-180 space engines and cutting back Russian-American cooperation with respect to the International Space Station (ISS).

However, Andrey Ionin, corresponding member of the Russian Academy of Astronautic Science, said such measures would harm Russia itself. “Our space engines are used by Lockheed-Martin’s Atlas 5. But Americans have two more rockets, Delta by Boeing and Elon Musk’s Falcon that target 60 percent of the market. If we stop selling space engines to Americans, they will need some time to rearrange and move to Delta and Falcon, but this cannot cause any paralysis,” Ionin commented in an interview with Kommersant. As for the ISS, banning Americans from using it would result in a cease of the station’s operations. This station is a large shared apartment with no people to spare. If anything happens with one of the astronauts, we will have to sink the whole thing down. This, by the way, is how it was planned originally: the ISS was scheduled to last until 2015, but then its lifetime was extended to 2020 and later to 2024.”

In his interview with Kommersant, Dean of the HSE Faculty of the World Economy and International Affairs Sergey Karaganov also referred to Russian-American space cooperation as highly beneficial to both parties. At the same time he emphasized there are areas where Russia can cause harm to the US both economically and psychologically.”

Hypothetically, Moscow’s economic sanctions against Washington can be achieved through directly cutting the trade turnover between Russia and the US, restricting operations of American companies in Russia and somehow withdrawing their investments already made in the Russian market.

The trade volumes between the countries are already insignificant – only USD 20.2 bln in 2016 – and spread almost evenly. Russia’s imports from the US primarily comprise automotive and other high-tech products, including E&R equipment, with third of the imports classified as confidential information. We probably could replace this equipment with, say, similar European products, but this might be difficult from a number of perspectives, including technology, and would certainly create a lot more trouble for Moscow than for Washington, because such measures would affect not only common citizens – like food sanctions against Europe and Turkey – but some strategically important sectors of the Russian economy.

Restrictions on Russian exports to the US could cause a more perceptible impact but would hit Russia equally bad.

Unlike the case with Europe, the focus would not be on energy carriers. Oil is Russia’s largest exports to the US, accounting for 35 percent of all exports in 2016. This is generally oil from Russian Baltic and Arctic ports, gas condensate and naphtha. However, industry representatives told us that American refineries could easily buy – and Russian producers could easily sell – these products elsewhere.

On the other hand, over the last decades the US have been heavily dependent on Russian supplies of enriched uranium product (EUP) for American nuclear power plants. Over the period from 1994 to 2013, TENEX (Rosatom’s international business unit) supplied EUP to the US on a non-commercial basis (“Megatons to Megawatts Program”). Back then, Russian uranium satisfied the US needs by 50 percent. Effective from 2015, all supplies have been made under direct commercial contracts with American energy companies: TENEX obtained 20 percent of the market (around 3 mln SWU per year). In 2011–2016, the quote was used in full, and in 2017–2020 — by 95 percent. TENEX has signed 25 contracts with 19 EUP consumers from the US worth USD 6.5 bln and effective until 2028. Termination of uranium supplies would cause damage to both parties. If this is the case, the US will have to look for replacement of the Russian EUP in the sparsely populated market, while TENEX will hardly be able to quickly find alternative markets for its products.

Titanium supplies is another sensitive area for both countries . The US remain the key target market for VSMPO-AVISMA Corporation. In 2016, 32 percent of the corporation's shipments and 48 percent of its export sales were attributable to the US. At the same time, VSMPO-AVISMA accounts for about half of the US imports. Russia satisfies more than 30 percent of Boeing titanium needs. Investments in this area flow both ways — VSMPO-AVISMA has subsidiaries and joint ventures in the US and Boeing has joint ventures in Russia. VSMPO-AVISMA representatives told us the company is not prepared to discuss the possible sanctions, but such matters have never been raised before.

Aluminum also makes a significant portion of Russian exports to the US, but these supplies are not likely to be cut as they account for 25 percent of Rusal’s revenues (Rusal has not provided any comments). One more export item important to Russia but absolutely irrelevant to the US is iron-and-steel products (mainly because Russian producers supply products to their US entities). In May, however, Vladimir Shmatovich, Deputy CEO for Strategy and Development at ТМК, told us the company strives to double its supplies to the US and believes there is potential to increase their Russian and Romanian exports to the American market up to 300 thousands of tons of weldless pipes per year.

Finally, mineral fertilizers – the last relatively important export item — is not so important to both parties.

Sanctions against American companies operating in Russia could have a more significant impact. US-related companies are primarily represented in the Russian CBT and IT sectors, which means their banning is relatively probable. Moscow has already tried similar sanctions with Europe and Turkey.

McDonald`s problems in Russia at the beginning of the Ukrainian crisis were never directly associated with the US conflict, however many in the market interpreted it that way. If the issue recurs, officially and at a larger scale, it could cause damage to a range of industries: from food production to pharmaceuticals, catering and Internet services.

For instance, Coca-Cola and PepsiCo are the uncontested leaders in the production of soft drinks: the companies have their own facilities for the production of soda and juices in Russia. PepsiCo is also one of the country's largest producers of dairy products (Domik v Derevne, Chudo) and snacks (Lay`s, Cheetos). The US companies have significant shares in the confectionery market with Mondelez and Mars operating on it. The latter is also the leader in the Russian pet food market (Pedigree, Whiskas) with a share of 53%.

Google, Facebook, Apple, Adobe and Microsoft are also very popular in Russia. While the former four could be excluded from the market (though it may incur the user’s displeasure), the products of the latter four have not yet been completely replaced by analogs even in the government entities (the Western software still accounts for about three quarters of the respective category of public procurement), not to mention other areas.

The pharmaceuticals market (which could potentially profit from direct import ban as Russia imported pharmaceuticals worth 560 million US dollars from the US in 2016) accommodates such players as Abbott Laboratories (in 2014 acquired Veropharm, a major Russian pharma producer), Eli Lilly and Pfizer, the world’s pharma giant ( engaged in construction of a production facility in Kaluga Region in collaboration with Novamedika, Rosnano’s portfolio company).

Today, the market players are not willing to discuss potential sanctions. Coca-Cola and Mondelez refused to comment on their attitude to the latest flare-up between Russia and the US. Abbott and McDonald`s did not respond to Kommersant’s request. Mars said it “keeps its fingers on the pulse of the situation”.

The market players note that counter sanctions could also affect on Deloitte, a Big Four firm originated from the US. De jure, the company is not associated with the US. ZAO Deloitte & Touche CIS is owned by a Cypriot entity and Russian citizens. Therefore, it will not be affected by direct sanctions against the US companies. However, de facto Deloitte in Russia is at risk. According to Kommersant’s source from a major audit firm said "The share of the company’s revenue from audit services in Russia is not very large, the major portion of its revenues is generated by various consulting and related services to state-owned companies. In the end, it may happen that Deloitte would not be invited to participate in such projects."

“Even if it were to happen, I don’t believe that it could materially affect Deloitte’s parent,” said Natalya Borzova, Deputy Head of Finexpertiza, - “however the subsidiaries of foreign companies operating in Russia and having Deloitte as a a foreign parent this could come as something of a shock. This also relates to those state-owned market players who work actively with Deloitte. For instance, Deloitte serves as the auditor for the Hungarian OTP Bank’s Russian subsidiary, as well as for other banks of the group".

It is rather unlikely that the US companies will divest their assets from Russia. This regards divestments performed directly without constraints on the business. This will inevitably deal a heavy blow to the remnants of the investment climate in Russia and spark off a strong response not only in the US, but in other Western countries too. Kommersant’s sources believe that in theory, it could be possible to terminate agreements with Exxon on the development of the Arctic shelf, which remain frozen due to sanctions. This will not accelerate the development of deposits; however, it will eliminate the advantages for Russia when the US sanctions particularly hit the largest US oil and gas company.

The Iran sanctions model

The bill on the US Congress calendar elicited  overwhelmingly negative responses not only in Moscow, but also in Europe. The EU is concerned about the paragraph prohibiting considerable investment in the Russian export oil and gas pipelines. Europeans fear this measure poses immediate threat on the Nord Stream 2 project and its stakeholders. Alongside Donald Trump’s rhetoric two weeks earlier towards the US “dominance in global energy” this aspect of the sanctions gave some European politicians and business representatives grounds for alleging that the new restrictive measures are actually aimed at promoting the US liquefied natural gas in the EU market and the eliminating the Russian gas from the competition.

“America First cannot mean that Europe’s interests come last,” Jean-Claude Juncker, the commission president, said in his statement. "The US bill could have unintended unilateral effects that impact the EU's energy security interests. The European Commission decided: if the EU's concerns are not taken into account sufficiently, we stand ready to act appropriately (to preserve our interests - Kommersant),” he said. However, Jean-Claude Juncker did not mention the exact actions to be taken. The authorities of the Federal Republic of Germany, France, Austria and a number of other EU countries, as well as representatives of the European businesses were also highly critical of the US Congress initiative.

"What the Congress is doing is a disaster for the US traditional geopolitics," said Sergey Karaganov. "They have already contributed to the rapprochement between Russia and China, and they are pushing Europe towards the same actions.”

Yet this is nothing new. In 1962, the US, which at the time was a major supplier of oil to Europe, convinced NATO to impose sanctions on supplies to the Soviet Union of large-diameter tubes for the Druzhba oil pipeline. Subsequently, the ban was lifted under the pressure from the European tube suppliers.

In 1982, the Ronald Reagan administration imposed a broader embargo on the supply of oil and gas equipment, which was to prevent the construction of the Urengoi-Pomary-Uzhgorod gas pipeline. This time the sanctions directly affected the French, German and British companies. This lead to a conflict between the allies and the US lifted the embargo in autumn 1982.

"What we see today is a direct analogy with the US Cold War sanctions.  The Europeans were also put under enormous pressures to shut down cooperation with Moscow at that time,“ Andrey Baklanov, Deputy Chairman of the Council of the Association of Russian Diplomats, told Kommersant.  According to Andrey Baklanov, the current situation with pressure on Moscow is different to the extent that today the US is not only guided by political considerations, as it was during the Cold War, but it also has a certain economic interest.  Andrey Baklanov beleives that the Russian authorities need to "mobilize those forces in Europe - policymakers, business representatives and the public, who counter the pressure from the US.”

Alexander Shokhin, Head of the Russian Union of Industrialists and Entrepreneurs (RSPP) believes that the European companies may as well refuse to cooperate with Russia. "The most unpleasant thing for us about this sanctions regime is the behavior of other countries,  primarily European countries, who may shut down their cooperation programs with Russia in an attempt to avoid the sanctions  consequences of such cooperation. This is quite similar to the previous Iran sanctions which were essentially country-specific, and any banks and companies that worked with Iran could be subject to the US sanctions regime.

 The US used to penalize such companies regardless of the country of origin, “ said Alexander Shokhin.

According to Alexei Arbatov, Director of the International Security Center of the Institute for International Security of the Russian Academy of Sciences, "when sanctions hit us where it hurts, the oil and gas exports, we should respond by developing and reforming our economy.” "This will allow the country to gain independence from advanced technology and foreign investment. We must make sure that the US becomes intimidated by its own sanctions and the risk of losing more,” he told Kommersant.

According to the expert, Russia is not in the position to enter into a full-scale war of sanctions with the US. This is due to the state of the Russian economy which continues to depend on oil and gas prices and which accounts for 2.2% of the world's GDP. "This competition for whose measures are the most painful will bring us no good," said Alexey Arbatov. "In this sense, our potential responsive actions are fraught with hurting ourselves.”

Yuri Barsukov, Veronika Goryacheva, Anatoly Djumailo, Mikhail Korostikov, Sergey Strokan, Oleg Trutnev, Elena Chernenko