July 21, 2014

TSG IntelBrief: MH17 and EU-Russian Relations

• With the downing of MH17, European Union nations must reassess their policies towards an increasingly aggressive Russia, a reassessment they have been hesitant to undertake given the level of trade between the EU and Russia

• Instead of fearing dependency on Russia energy imports, the EU should leverage it, turning a seeming vulnerability into a source of real strength, given that the EU is by far Russia’s largest trading partner

• The country with the largest loss of life in the incident, the Netherlands, also has the EU’s largest trade deficit with Russia, presenting the Dutch with complications as it reacts to the tragedy

• Russian President Putin will continue arming and training his proxy in eastern Ukraine until sufficient economic pressure from his largest trading partner is applied; the lack of diversity in the Russian economy is Putin’s Achilles’ heel.

The downing of flight MH17, allegedly by separatist rebels armed and advised by Russia, could end the 27-member European Union (EU)’s months-long hesitancy to apply pressure on Russia over its actions in eastern Ukraine.

Ever since Russia annexed Crimea and began encouraging and supporting rebels in eastern Ukraine to break away from the Kiev government, a great deal has been written about the EU’s dependency on Russian energy imports. But the dependency more than cuts both ways. The EU has the ability to leverage its seeming vulnerability into serious leverage against Russia. The fact is that the EU is by far and away Russia’s largest trading partner, accounting for 41% of Russia’s trade. Economic sanctions from the EU will have much larger and quicker impact on Russian actions than the current US sanctions.

Even with the EU’s dependency on Russian oil and natural gas, it still has a trade surplus with Russia (€13.1 billion in 2012, according to the EU), with most exports to Russia consisting of manufactured goods, chemicals, transportation, and computer goods and services. The EU has sufficient stockpiles of natural gas to withstand short-term shortages in delivery, should the situation deteriorate more. Simply put, Russia needs to sell its gas more than the EU needs to buy it right now.

Putin has been betting that the EU’s desire to avoid potential economic disruption will be stronger than its objections to his actions in Ukraine. Up until now, he has been correct. The downing of MH17 might change the calculations of various EU nations; the outrage could translate into policy even if Putin maintains the fiction of an innocent bystander. The €267.5 billion of trade between Russia and the EU is all the proxy the EU needs to pressure Putin to restrain his own proxies in Donetsk and Luhansk.

Of all the nationalities on board MH17, the Netherlands has suffered the largest loss, with 193 Dutch citizens killed. It is also the EU country that has the largest trade deficit with Russia, at -€21 billion in 2012. Most of that is from energy imports. But the Netherlands also has a large, though underutilized, liquid natural gas (LNG) terminal, meaning it is possible to offset reduced Russian deliveries with increased maritime LNG deliveries from the US or the Gulf Region. Whether the Netherlands’ push for meaningful sanctions will depend on public outrage driving public policy, as well as support from countries such as Germany and France, that have also heretofore been reluctant to pressure Russia for what they viewed as a far-away regional squabble. The deaths of 298 civilians, none of whom were Russian or Ukrainian, put to rest that notion.

Up until now, EU sanctions have only targeted Russian individuals, not companies or economic sectors. The potential for tough sanctions against Russia is sufficient enough that just the serious discussion and consideration of them by the EU might be enough to move Putin from his current course of confrontation. Putin will be reluctant to appear to back down, given how much of his public support is now tied with jingoistic propaganda against Ukraine and its Western backers. When Russian industrial and economic leaders begin to complain to Putin about the impact of EU sanctions on what is essentially a petro-oligarchy of a country, he might look for a face-saving way out. But he will likely not look for one until those sanctions seem possible, leaving the next move in the hands of the EU.


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