Caught in the Crossfire

Russian threats of economic reprisals could hurt U.S. firms -- and Russia itself.

If Russia and the United States really launch the economic war both countries are threatening, American companies operating in Russia could find themselves caught in the crossfire. But Russia itself might end up being the biggest victim, scaring away would-be investors in its crucial energy sector and making it a far less appealing destination for the Western business leaders who have long seen it as a lucrative but largely untapped market.

U.S. companies have invested billions of dollars in Russia in recent years in industries ranging from food production to oil exploration. General Motors rolls out nearly 100,000 SUVs a year from factories in St. Petersburg and Togliatti. Coca-Cola Co. is part owner of a bottling company that employs 13,000 people and produces Coke products as well as local brands like Fruktime from Moscow to Vladivostok. PepsiCo gets about 7 percent of its overall revenue from Russia and spent more than $5 billion in 2010 to buy Russian dairy company Wimm-Bill-Dann Foods. Boeing plans to spend more than $20 billion in Russia over the next seven years securing much-needed supplies of titanium, among other investments.

Those American firms, some of the world's biggest, now have to worry about being squeezed at both ends. Washington is threatening to impose sanctions that could limit U.S. firms' business in Russia. The companies could also be hit by the Russian government in retaliation. Goldman Sachs chief executive officer Lloyd Blankfein warned Wednesday that the rising tensions between the United States and Russia threatened to ignite a "vicious circle" that could damage the global economy.

"Actions invite counter-reactions," Blankfein said in an interview on CNN Wednesday. "We want to make sure that people understand the context and how severe those ramifications could be."

The U.S. companies that would feel the pain of Russian retaliation most directly, and most strongly, would be the energy companies that have poured billions of dollars into oil and gas production projects across Russia. The firms, including U.S. giant Exxon Mobil Corp., hope to spend billions more tapping virgin fields in the Black Sea, Arctic, and off the Pacific Coast.

U.S. officials have been threatening sanctions after Russian troops moved into Ukraine's Crimea region over the weekend, but it's still unclear what shape they would take. Many analysts see the U.S. starting with a small symbolic step such as revoking visas, like it did with Ukrainian officials allegedly responsible for a violent crackdown on protesters. If Russia is unresponsive, the U.S. could ramp up the pressure by freezing the assets of Russian individuals, companies, and banks that are close to the government of Russian strongman Vladimir Putin.

Russian lawmakers seem poised to strike back. According to Russian news reports, members of Russia's parliament are considering legislation that would allow them to seize the assets of American and European companies in Russia if the U.S. moves ahead with sanctions. The threats ring hollow to many experts, who point out that punishing American firms has the potential of devastating the fragile Russian economy. Trade lawyer Doug Jacobson, with Jacobson Burton law firm, said that moderate American sanctions on Russian firms would be merely a shot over the bow, but seizing the assets of American companies would be the economic equivalent of using a nuclear weapon.

"When you do something like that you lose the confidence of the entire global economy," Jacobson said. "No one wants to invest in a country where you have the potential to be nationalized."

To be sure, numerous countries have seized the assets of foreign firms, usually as part of a domestic economic program rooted in socialism or communism. Russia itself nationalized swathes of foreign industry in the wake of the 1917 revolution. Cuba famously nationalized big chunks of the island's economy, including iconic brands such as Bacardi, after its own revolution. More recently, countries including Venezuela, Bolivia, and Argentina have incurred the wrath of foreign investors by expropriating businesses, especially in the energy sector.

For Russia, though, striking back at the U.S. by hitting American energy firms could be a double-edged sword. Exxon has a 30 percent stake in Sakhalin-1, a major Russian oil and gas project. Sakhalin is at the heart of Russia's plans to become a bigger gas supplier to Japan, which has been desperately in need of new sources of energy since shutting down its nuclear plants after the 2011 Fukushima accident.

More recently, Exxon teamed up with Rosneft, Russia's largest oil company, to invest billions of dollars into efforts to find oil in the Arctic and in the Black Sea. Exxon calls the scheduled startup of a big offshore oil and gas platform in Russia one of its most significant projects of 2014.

The reason Moscow may have to tread carefully when dealing with energy firms? It needs the technology and expertise Western, and especially U.S., firms have in coaxing oil and gas out of challenging environments, such as offshore or from shale formations. Oil production in Russia plummeted for a decade after the fall of the Soviet Union. While it has steadily crept upward in recent years, aging oil fields put a premium on using the latest technology to tap the country's potential hydrocarbon riches.

As Rosneft boss Igor Sechin made clear when he signed the Siberian deal with Exxon, "Developing tight oil reserves in Western Siberia is becoming increasingly important for the company and the country in general, as it will boost oil production volumes in Russia." He especially highlighted the use of "Exxon Mobil's experience and technologies" in tight-oil production.

An Exxon spokesman declined to comment about Russia or the possibility of sanctions complicating its business there.

To be sure, energy companies are used to a little political drama wherever they operate. Argentina, for example, just lured Chevron back even before the country resolved the expropriation fight with Spain's Repsol. Shell was undeterred by Russian hardball tactics and last year signed a new deal for Arctic exploration with Gazprom.

For now, even as the rhetoric escalates, executives can do little but wait and see.

"We're watching the situation very closely on all fronts to be prepared to act," GM President Dan Amman told Bloomberg. "It's a big market for us."

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Market Correction

The Obama administration hoped global markets would punish Russia. It's not happening.

When President Barack Obama stepped before the White House press corps on Friday to announce that Russia would face "costs" for moving military forces into Ukraine, it remained maddeningly unclear just how Washington planned to punish Moscow for its surprise invasion.

By Monday, it appeared those costs had become better defined, as markets around the world plummeted on the news Russian forces had seized de facto control of the Crimean peninsula. The ruble traded at record lows, and the Russian Central Bank had to spend in excess of $10 billion to prop up its ailing currency. By day's end the bank jacked up a key interest rate by 150 basis points to halt the ruble's slide. Meanwhile, Russian stocks plummeted, with key state-led companies such as Rosneft and Gazprom seeing double-digit losses. The Russian benchmark Micex index fell 10 percent, erasing a year's worth of gains.

The market, it seemed, had accomplished what the White House had not: Quickly crafting and executing a punitive response to actions that have brought U.S.-Russian relations to their lowest point since the Cold War.

But then global markets did something unexpected: By Tuesday's end, they had more than recovered from the previous day's losses. "We haven't seen military action being the focus," Joyce Chang, JPMorgan Chase & Co.'s global head of fixed-income research, told Foreign Policy. "Obama just seems more unlikely to go there. That's why I think the market is rallying."

With a full-scale shooting war in Ukraine appearing less likely than during Monday's frenetic trading, U.S. analysts struck a cautiously optimistic tone. In his first public comments on the presence of Russian troops in Crimea, Russian President Vladimir Putin wholeheartedly defended his decision to deploy forces there but said that he saw no immediate need to send his troops elsewhere in Ukraine. "For the moment there is no need for that, but the possibility still exists," he said. "On the whole, it seems to me that it's stabilizing." Moreover, the Russian defense minister ordered Russian troops taking part in an exercise near Ukraine's borders to return to their bases.

Those comments helped markets recover some of Monday's losses. By day's end, the Dow had gained 227.85 points, or 1.4 percent, and the Micex, the benchmark Russian exchange, saw gains of 5.3 percent, its largest single-day gain since May 2010. The ruble, meanwhile, regained 1.4 percent of its value against the dollar -- this after trading at record lows only 24 hours earlier. Both Rosneft and Gazprom recovered some of their losses on the previous day. Correspondingly, investors abandoned the safe-haven assets to which they had fled. Gold futures fell just under 1 percent, and the yield on 10-year Treasury bonds increased to 2.691 percent from their one-month low in late trading Monday.

Win Thin, global head of emerging-market currency strategy at Brown Brothers Harriman, said he was surprised markets had rebounded so quickly. He said there was an "uneasy calm" as investors waited to see what Putin would do next and how the West would react.

Meanwhile, the Obama administration is slowly assembling a package of punitive economic measures targeting Russia, including some specifically aimed at senior Russian officials involved in the invasion of Crimea. "We're not just considering sanctions, given the actions Russia is taking," State Department spokeswoman Jen Psaki said Monday. Administration officials have spoken of visa bans and asset freezes, but it's not clear what other measures are under consideration.

In a blow to the Obama administration, European allies, including Britain and Germany, oppose imposing sanctions on Russia and have instead called for intensified diplomacy. Both countries have deep trade ties to Russia -- much more so than the United States -- and are heavily reliant on Russian natural gas, so they are reluctant to impose punitive measures that could harm their own economies as well.

The Obama administration has also promised an aid package to prop up the struggling Ukrainian economy, but that measure requires congressional approval. Negotiations in the relevant committees of the House and Senate are only just underway. According to congressional aides in both chambers, the bill will likely include $1 billion in loan guarantees, aid for civil society and election monitoring, and authorization for sanctions against Russian officials.

Beyond diplomatic reprisals such as the cancellation of military ties and suspending preliminary talks ahead of this summer's G-8 meeting, little substantive pressure is being brought to bear on Russia. With markets rebounding, Moscow has even less incentive to heed Western calls for a withdrawal from Crimea.

Thin, the Brown Brothers Harriman strategist, said it's far from clear that the administration will be able to impose punitive measures on Russia given the European opposition to sanctions. "The U.S. can't really do anything in the U.S. if London's still open for business," Thin said in an interview. But he said that there was also considerable risk that another morning of bad headlines could send the markets diving again.

At the moment, the prevailing wisdom on Wall Street holds that the worst of the crisis may have passed. "My base case scenario is that the European countries will express along with the United States outrage at Russia's actions in Crimea but most European countries will also take a sanctions-lite approach as long as Russia does not begin military operations in the rest of Ukraine," said Chang of JPMorgan Chase, who added that the threat of war and instability has led her to shave a full percentage point off of her GDP growth forecast for Russia, from 1.8 percent to 0.8 percent.

Global markets, then, are feeling cautiously optimistic -- but that's something Putin could easily change. "We finally see a faint glimmer of light at the end of the tunnel," said Tim Ash, head of emerging markets research at Standard Bank Group. "Let's hope this is the exit and not a Russian truck coming the other way."

Staff writer John Hudson contributed to this report.

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