Putin Threat to Retaliate for Sanctions Carries Risks

President Vladimir Putin’s threats to retaliate for further sanctions on Russia set the stage for escalating economic warfare that may have painful effects for U.S. and European companies.

While the Russian leader is casting himself as reluctant to take countermeasures against additional penalties from the U.S. and European Union, he hasn’t ruled out doing so eventually. Such a move could dash billions of dollars in foreign investment in some of the world’s biggest untapped oil reserves.

“I would expect Putin to make life somewhat difficult for foreign companies in Russia whose governments are doing the sanctioning,” said Gary Hufbauer, a sanctions specialist at the Peterson Institute for International Economics in Washington.

Putin’s warning yesterday of consequences for U.S. and European companies came hours after the EU announced new measures over the crisis in Ukraine. His comments took aim at the interests of companies such as Exxon Mobil Corp., which has drilling rights to 11.4 million net acres (46,134 square kilometers) in Russia, the company’s biggest single cache of drilling rights outside the U.S. Exxon also is planning Arctic drilling in an alliance with state-owned OAO Rosneft.

“The Russian government has already proposed some retaliatory steps,” Putin said at a Supreme Eurasian Economic Council summit in Minsk. “I consider these not necessary. But if something like this continues, then of course we will have to consider who’s working and how in the Russian Federation, in the key sectors of the Russian economy, including energy.”

Companies Contacted

Other major companies may suffer from the backlash, including Royal Dutch Shell Plc, which plans to expand its Sakhalin-2 oil and gas project in Russia’s Far East, and PepsiCo Inc., which earned 7.4 percent of its 2012 revenue from Russian business, according to data compiled by Bloomberg.

The State Department and White House National Security Council have provided some companies with information about U.S. sanctions on Russia, State Department spokeswoman Marie Harf said, without identifying the businesses.

“The U.S. government has routinely provided such outreach, for example previously for Iran and Libya sanctions, to help U.S. companies understand the legal obligations that have been put in place,” Harf said today in an e-mail.

Hufbauer said in an interview that Putin’s response is likely to be limited, because any pain he inflicts on Russia’s trade partners and investors can boomerang on him. “I don’t think he’ll over-escalate, but he’ll show he can play the sanctions game, as well.”

Russia GDP

Economic retaliation by Putin -- whether punishing foreign investors or cutting off gas exports to Europe -- would rebound back to Russia, harming its $2 trillion economy more than the $16.8 trillion U.S. economy or the EU’s $17.4 trillion gross domestic product, according to Michael Corgan, a professor of international relations at Boston University.

The International Monetary Fund this month lowered its estimate of Russia’s GDP growth this year to 1.3 percent from 2 percent in January. Russian Finance Minister Anton Siluanov went even further on April 15, saying economic growth may halt this year as capital flight accelerates.

Even so, Russia has long prided itself on its ability to withstand hardship, and six U.S. and European officials said they’re analyzing the potential economic risks to their economies and companies if Putin retaliates. All six spoke on condition of anonymity to discuss internal deliberations.

EU Concerns

The European Union in Brussels has circulated a document outlining possible sanctions on sectors of the Russian economy, including energy and finance, and soliciting feedback from member states with interests at stake.

While economic considerations aren’t stopping them from considering additional penalties, the U.K. is concerned about financial services, France about military sales, Italy about luxury goods and Germany about overall trade with Russia, according to several European diplomats.

The White House is leading a separate U.S. interagency review, according to U.S. officials, who said that a few American companies already have felt a pinch from existing sanctions on Russian individuals and institutions with which they do business.

Sanctions already are “forcing Russia to pay a steep price” for supporting separatists in Ukraine, U.S. Secretary of State John Kerry said yesterday in Washington.

Capital Outflow

U.S. officials say sanctions now in place have fueled a record $60 billion capital outflow in the first quarter of this year, as well as losses in Russia’s stock market and currency. The benchmark Micex Index has lost more than 13 percent this year.

Corgan said that if Putin were to penalize U.S. and European energy companies, doing so would accelerate those trends, damaging a government that relies on oil and gas exports for 50 percent of its revenue.

Decades of communist rule isolated the Russian oil sector from technological advances that have enabled U.S. and European explorers to find and tap fields deep below the North Sea and Gulf of Mexico, Corgan said. If Russia snubs the biggest foreign producers, the country won’t have access to the drilling techniques and equipment its needs to explore and open fields in the Arctic, Siberia and elsewhere, he said in a phone interview.

Meanwhile, international oil producers from Exxon to The Hague-based Royal Dutch Shell have courted favor with Putin and his inner circle, including Rosneft Chief Executive Officer Igor Sechin, to gain access to fields that hold crude valued at almost $9 trillion at current prices.

Closest Allies

The U.S. Treasury blacklisted Sechin, one of Putin’s closest allies, on April 28, cutting him off from direct contact with U.S. oil executives. Rosneft was not sanctioned.

The stakes are huge for Exxon and Shell, the world’s largest energy companies by market value. Russia is Exxon’s largest exploration province outside the Irving, Texas-based company’s home country, while Shell now pumps more than 100,000 barrels of oil a day from Russian wells.

Alan Jeffers, an Exxon spokesman, declined to comment on Putin’s remarks.

Shell owns 27.5 percent of the Sakhalin-2 oil and gas-export complex off Russia’s Pacific Coast. The Hague-based company also owns 50 percent of a group of Siberian oilfields known as Salym that pumped the equivalent of 145,000 barrels of crude daily last year.

Shell’s Stance

“We will stay the right side of the law,” Shell Chief Financial Officer Simon Henry told reporters on a conference call today. “I don’t think we’ll be jumping into new investments in the short-term.”

“Our top priority would be to help develop further LNG, gas production and exports from the Sakhalin joint venture, the only existing LNG plant” in Russia, Henry said. “Shell always complies with all sanctions that are applicable in the environment we are operating.”

Russian wells accounted for almost one in every 10 barrels that French oil giant Total SA produced last year, according to a U.S. regulatory filing. Total, which has been operating in Russia since the Soviet Union collapsed in 1991, boosted its oil and gas output in Russia by 16 percent in 2013.

The bulk of Total’s Russian production comes from its 40 percent stake in the Kharyaga field and its 17 percent ownership of Novatek OAO, a publicly traded energy explorer based in western Siberia. Only Nigeria, the United Arab Emirates and Norway were bigger contributors to Total’s worldwide production.

Total executives couldn’t be reached for comment on Putin’s remarks.

Alcoa’s Revenue

Putin’s comments suggested that foreign companies working in other sectors in Russia may be vulnerable, too. New York-based Alcoa Inc. earned almost 3 percent of its revenue in 2012 from Russia, according to data compiled by Bloomberg.

The EU has more trade with Russia than the U.S. does, making it more vulnerable to disruption, said William Pomeranz, deputy director of the Kennan Institute for Advanced Russian Studies at the Woodrow Wilson Center in Washington.

Germany, with $50.6 billion in exports, was the leading exporter to Russia, followed by China at $44 billion, and the Netherlands at $37 billion, according to data compiled by Bloomberg for 2012, the most recent year available.

One concern that European diplomats have discussed is that Russia may cut off natural gas supplies to EU members, which import a third of their gas from Russia.

Russia-EU Ties

Several economists downplayed such concerns, saying Putin is more dependent on selling Russian natural gas than other European countries are on buying it.

Timothy Ash, head of emerging markets research for Standard Chartered Group Ltd. in London, called cutting off gas exports “killing the goose that lays the golden egg. In the end, the loser in a sanctions war is Russia,” he said.

There’s a co-dependency between Russia and the EU that makes both sides, in theory at least, hesitate about tit-for-tat sanctions, Pomeranz said. “The U.S. has a much smaller trade relationship with Russia, so I think it’s willing to move faster and more harshly than the EU.”

The continuing effort to forge a unified European energy policy “isn’t directed against Russia,” German Chancellor Angela Merkel said today at a rally in Aachen, Germany. “We still want to buy gas from Russia -- no problem.”

Last year, the U.S. imported $27 billion in goods from Russia -- 1 percent of all U.S. imports -- according to Commerce Department data. About 65 percent of U.S. imports from Russia were petroleum products, including oil products.

U.S. Exposure

Even so, some American companies have significant exposure in Russia, which has prompted U.S. Commerce Department and trade officials to urge the White House to consider the downside of imposing additional sanctions.

The U.S. is holding off on sanctions against some Russian companies because it doesn’t want to hurt American holders of their debt, according to Fitch Ratings.

“We’ve heard quite a lot of anecdotal evidence that there’s actually a lot of consultation with big investors and bondholders in terms of what sanctions might be imposed by the U.S.,” James Watson, a managing director at Fitch, told reporters today in London. “It seems there has been a significant push back on potentially sanctioning companies that have significant foreign debt.”

Putin yesterday hinted at the risks of retaliating, even as he threatened to do so. “We really don’t want to take these reciprocal steps,” he said. “I hope we won’t have to.”

(Updates with Harf comments starting in seventh paragraph. For more on the Ukraine conflict, see EXT2.)
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