U.S. Sanctions Squeeze Putin, Stop Short of Economic War

The most aggressive U.S. sanctions yet on Russia are intended to inflict pain on President Vladimir Putin’s inner circle for supporting Ukrainian separatists, while giving the Russian leader room to reverse course before the standoff escalates into economic warfare.

The pressure on Putin could increase dramatically if it becomes clear that, as some U.S. officials now think, Russia-backed separatists were responsible for shooting down a Malaysia Airlines jet yesterday, killing all 298 people on board.

New penalties, enacted before the airliner was downed, target Russian banks, energy and military firms run by Putin loyalists, but they spare gas giant OAO Gazprom, reflecting a strategy to shield Europe from a wintertime natural gas cutoff and to escalate gradually, rather than risking blowback on the U.S. and European economies.

“We are focused on making clear to President Putin and the people around him that they have a clear choice to make between increased costs and sanctions pressure, or de-escalating” Russia’s interference in Ukraine, U.S. Undersecretary of Treasury David Cohen said in a Bloomberg Television interview yesterday.

The Obama administration’s latest action makes “very clear that we are prepared in a calibrated and thoughtful way to increase the pressure,” he said.

Sanctions Targets

The U.S. Treasury on July 16 imposed penalties on two major Russian banks, two energy companies and eight defense firms, including the maker of the ubiquitous Kalashnikov assault rifle. The targets included OAO Rosneft, Russia’s largest oil company; OAO Novatek, the second-largest gas company; Gazprombank OJSC, the country’s third-largest lender; and state development bank Vnesheconombank, or VEB.

The measures bar the companies from accessing U.S. debt markets for new financing involving maturities of more than 90-days. They also bar VEB and Gazprombank from U.S. equity markets.

Shares of Rosneft declined as much as 6.2 percent in Moscow yesterday, while Novatek fell as much as 11.5 percent.

While the bank affiliated with Gazprom was hit, the energy giant itself, which supplies 30 percent of Europe’s natural gas, wasn’t among the targets. And though oil giant Rosneft’s chief executive Igor Sechin, one of Putin’s closest allies, was sanctioned by the U.S. in a previous round of penalties, Gazprom chief Alexey Miller, also part of Putin’s inner circle, was passed over again.

‘Minimize the Backdraft’

That’s in part to limit potential retaliation against the European Union, whose leaders have said publicly that they have few options to replace Russian gas supplies if they’re cut off this winter, according to U.S. officials who spoke on condition of anonymity to discuss policy deliberations.

U.S. officials “want to minimize the backdraft to Western business interests,” said Timothy Ash, chief of emerging markets research at Standard Bank Plc in London. “This is about creating as many sanctions gears as possible so that pressure can be cranked up as need be. They still want to give Putin a way out.”

The U.S. and EU want Gazprom to return to talks with Ukraine to resolve a price dispute that spurred the Russian supplier to cut off gas to Ukraine on June 16.

Gazprom raised the price it was charging Ukraine for gas 81 percent in April, after a pro-Moscow government was ousted in a popular uprising. Gazprom’s Miller said last month that Ukraine must pay its debt before any price talks restart.

Gas War

Ukraine rejects the new price and has said it could survive this winter without Russian gas by cutting consumption. Yet half of Ukraine’s gas comes from Russia, and half of Europe’s imported gas from Russia passes through Ukrainian pipelines.

Transit flows to the rest of Europe have not been affected since Russia cut Ukraine’s supply a month ago. During previous disagreements, Gazprom halted supplies to Ukraine, and Ukraine consumed gas meant for other European buyers, disrupting European deliveries for weeks during freezing weather in 2006 and 2009.

Russia provides 30 percent of the Europe’s natural gas. Twelve EU member states get more than 50 percent of their gas from Russia, including four -- Lithuania, Estonia, Finland, and Latvia -- that depend entirely on Gazprom, according to Eurogas, a Brussels-based lobby group. Europe also imported 32 percent of its crude oil last year from Russia, according to the Paris-based International Energy Agency.

‘Bigger Shock Wave’

“In part, it’s a political concession” to the EU to focus on financial penalties such as access to debt markets, rather than targeting energy companies directly, but it’s also an economic calculation, said Erich Ferrari, a sanctions lawyer in Washington. “If you hit Gazprom and Rosneft at the same time, it sends a bigger shock wave, which could have a severe impact on the energy market.”

“The financial services industry is at the center of any economy, and therefore targeting banks more aggressively” has more impact that hitting any other sector, Ferrari said. U.S. officials don’t want to play “too many cards at once. With sanctions, you always want to leave some leverage open to ratchet up pressure in the future,” he said.

U.S. officials say that’s one reason for leaving Gazprom off yesterday’s list and limiting penalties against the companies that were hit: It gives the U.S. room to impose tougher sanctions if Putin doesn’t respond constructively before the situation escalates further.

U.S. Aims

The U.S. and EU have not said publicly what Russian actions would trigger harsher sanctions. Instead, they’ve demanded that Putin cease military support for rebels, stop the recruitment of volunteers in Russia and secure the release of Ukrainian hostages who the U.S. State Department has said were seized by separatists and transferred to Russian territory.

The Obama administration also has calculated that if Putin ignores pressure to withdraw support for the Ukrainian rebels, the 28-member EU -- which until now has been divided over how much to penalize Russia over the crisis -- will stiffen its resolve. Evidence that separatists shot down the Malaysian passenger jet is likely to bolster EU support for a tougher stand against Russia’s support for the separatists, said two U.S. officials who asked not to be named because they weren’t authorized to speak publicly.

The U.S. says it’s prepared to continue ramping up what Assistant Secretary of State Victoria Nuland has called “scalpel sanctions,” penalties aimed at specific companies and individuals.

Broader Sanctions

Broader sanctions affecting entire sectors of Russia’s economy -- including finance, defense and energy -- remain unlikely unless Putin sends Russian forces into Ukraine, one U.S. official said. According to the State Department, Russia repeatedly has provided tanks and other heavy weapons to separatists from a deployment area in southwest Russia near Ukraine’s border.

Unlike the former Soviet Union, Russia is reliant on foreign capital, markets and technology, and the reaction from markets and investors to sanctions is at least as significant as the specific penalties themselves, analysts and U.S. officials said.

“Investors will be asking which Russian companies will be next and what assets and financing will be subject to further sanctions,” said Ash. “Risk management teams and investors are likely to dump Russian assets first, rather than be caught further down the line with sanctioned Russian assets on their balance sheets.”

Markets React

Negative spillovers in Russian markets overnight have been widespread. While the yield on the 5-year bond of Gazprombank increased approximately 90 basis points yesterday, the yield on the 5-year bond of Sberbank, which isn’t sanctioned, also increased 60 basis points, reflecting market concern that other financial institutions could be targeted if Russia’s actions continue.

Russia’s sovereign debt yields also increased about 30 basis points yesterday, one of the largest one-day moves of the year.

The measures haven’t stopped commerce with Russia by major U.S. companies. Exxon Mobil Corp., the world’s largest oil company by market value, is forging ahead, despite sanctions, with a $3.2 billion partnership with Rosneft. The Irving, Texas-based oil explorer rebuffed U.S. government appeals to skip an energy forum in St. Petersburg in May, and Chairman and Chief Executive Officer Rex Tillerson appeared alongside Rosneft boss and Putin confidante Sechin last month at a Moscow petroleum conference. Tillerson has publicly questioned whether sanctions are a useful diplomatic tool.

Russia is Exxon’s largest international exploration prospect. BP Plc, the London-based oil producer, is Rosneft’s second-largest shareholder with a 19.75 percent stake.

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