Sanctions can hurt Russia, if EU can take pain

BERLIN — The European Union could impose harsh sanctions on Russia that would hurt, analysts say, but the growing economic ties between the two may make that nearly impossible.

Russian President Vladimir Putin has thus far been unfazed by the sanctions placed on his inner circle for his military takeover of Crimea, a province of Ukraine on the Black Sea.

Dutch Prime Minister Mark Rutte framed the conundrum for the world when he took the stage with President Obama at The Hague, where world leaders are meeting on nuclear issues but also discussing Ukraine.

"The Russia economy is very much gas and oil dependent," he said Tuesday. "If economic sanctions will be necessary … these things will hit Russia very badly."

Then came the rub.

"Obviously, you can never guarantee that the people in Europe, in Canada, in the U.S. would not be hurt," by sanctions aimed at Russia, he said.

"But obviously, we will make sure that we will design these sanctions in such a way that they will have maximum impact on the Russian economy and not on the European, the Canadian, the Japanese or the American economy."

The upshot? "We are not there yet," he said of strengthening sanctions.

Lilit Gevorgyan, senior sovereign risk analyst at IHS Global Insight in London, suggests Europe may never get there.

"The EU has been hesitant to pursue full-scale embargo and serious sanctions against Russia precisely because not just Russia but also the European bloc will bleed from them, although arguably Russia will suffer more," Gevorgyan said.

The World Bank warned Wednesday that Russia's economy could contract this year if the country is hit with more serious sanctions following its annexation of Crimea.

The organization said in its annual report that it expects the Russian economy to grow 1.1% this year if the fallout from the Crimean crisis is short-lived, but warned of a 1.8% fall if Russia is hit with more serious sanctions than those already specified.

So far, the sanctions have been fairly limited and haven't touched on Russia's vital economic interests. The United States and the European Union have imposed travel bans and asset freezes on two dozen Russians who are believed to be close to Putin.

Over the past weeks, the European Union and the U.S. have imposed sanctions, including asset freezes and visa bans on at least 33 officials said to have been involved in the annexing of the Crimean peninsula from the Ukraine. The latest sanctions targeted individuals, including Russian deputy prime minister Dmitry Rogozin.

But many claim the sanctions are too "tepid" and will do little to persuade Moscow to change course.

"It is not just energy dependence on Russia but also intertwined bilateral commercial relations, counting at an annual turnover of billions of U.S. dollars that makes EU decision-makers cautious," said Gevorgyan.

Imports from Russia to the EU have grown consistently, from $88 billion in 2002 to almost $294 billion in 2012, when the Russian Federation joined the World Trade Organization. During the same decade, EU exports to Russia have increased from $47 billion to $170 billion, according to figures from the directorate general for trade of the European Commission.

Europe is Russia's biggest trading partner. And Europe gets a significant segment of its mineral energy, such as natural gas, as well as lubricants and related materials, from Russia. The last thing European leaders want is the hopes of a fragile recovery amid years of economic woes dashed by a sudden drop in trade with Russia, and disruptions to its supply of energy, analysts say.

"It is very difficult to replace gas and oil from the global market in the short term. … This discussion is even maybe dangerous for Europe and will not bring the desired effect in Russia," said Stefan Meister, senior policy fellow at the European Council of Foreign Relations in Berlin.

The talk of sanctions has overshadowed a meeting of the industrialized economies at G-7 meetings in The Hague. Rutte held out hope that sanctions could be made more muscular, but all 28 EU member states would have to agree if the EU is to act effectively, says Gevorgyan. Some countries would find that hard.

In 2010, Europe's biggest economy, Germany, imported 39% of its gas from Russia, according to the International Energy Agency, while some central and eastern European countries rely almost exclusively on Russia for their gas supply.

Although the EU produces its own energy, mostly nuclear, it is still dependent on Russia for the import of hard coal, crude oil and natural gas, 23% of which came from Russia in 2012, according to the statistical report of Eurogas, an organization representing the gas industry in Europe.

Ukraine remains the main corridor to bring gas and crude oil to Europe, with 82.3 billion of a total of 167.2 cubic meters imported though the former Soviet satellite state in 2013, according to the International Energy Agency in Paris.

And despite the ongoing crisis in Ukraine and the potential for escalation if Russia were to try to invade the east of the country, as some fear it might, the 28 EU member states will not agree on targeting the energy sector with sanctions, say some analysts.

The EU members "can only replace the supply from Russia in the long term by finding alternative resources," such as investing much more in Caspian resources," Meister said.

Some suggest Europe can make up for any disruption on gas supplies from Russia by buying from U.S. liquefied natural gas suppliers. The Senate Energy and Natural Resources Committee plans to hold hearings on expanding U.S. natural gas exports.

"Diminishing Russia's economic leverage in the region should be a key component of America's response," said Nile Gardiner, an author of a recent white paper on U.S.-Russia relations as director of The Heritage Foundation's Margaret Thatcher Center for Freedom.

"This could be accomplished to a large extent simply by liberalizing global energy markets. The U.S. has antiquated and unnecessary restrictions on exporting liquefied natural gas and crude oil, and Congress should make lifting these restrictions a priority."

Ukraine, which has seen its gas supplies shut off by Moscow in the dead of winter as a weapon, has been making plans to wean itself from dependency on Russia. In 2013, Ukraine reached deals with Royal Dutch Shell and Chevron to explore and develop the country's two large shale gas fields in Yuzivska and Olesska.

Though the United States has seen an increase in natural gas production due in part to exploitation of shale gas through hydraulic fracturing techniques, it does not have the facilities to rapidly increase exports.

An import terminal in the United States is being retrofitted to handle exports and may be ready in 2015, but it can take at least five years to get through the approval and construction to complete a new liquefied natural gas terminal in the United States.

"Lifting gas-export restrictions might not have a direct impact on the Ukraine crisis in the near term, but it would send an important signal to Russia and the rest of the world," Gardiner says. "It would show any leader from any country that derives power from controlling energy interests that such strategies will no longer be effective."

In the short-term, however, Europe and the USA can do things that will make Russia take notice. Issuing travel bans against Putin's inner circle of oligarchs who control Russia natural resources is not enough, say analysts.

"To inflict an immediate economic pain on Russia, the EU and U.S. have to impose far more serious economic and energy embargoes," said Gevorgyan.

"They need to cancel large contracts, freeze assets of a whole range of state-run Russian commercial entities, and target far more government-linked business people over a sustained period of time to send the Russian economy into dramatic decline, wiping away the wealth of the country's business brass."