Leibowitz: Reworking the Trading System in a Crisis

A bit over a week into the new world order (i.e., the Russian invasion of Ukraine) and things are proceeding, but slowly.

We have all been following the conflict—but the decision of the West to combat V.V. Putin with sanctions instead of planes, tanks and soldiers is moving into uncharted territory.

The sanctions have inflicted some pain on Putin and several oligarchs. The pain is affecting commerce. For example (one of several), Alexey Mordashov, the largest shareholder in Severstal, was sanctioned on March 1 by the European Union (no sanctions have been imposed by the U.S. so far). The sanctions will prevent Mr. Mordashov from being paid through the information exchange known as SWIFT. Almost immediately, Severstal announced suspension of all steel shipments to the EU from Russia. These banking sanctions apparently have teeth.

As the war in Ukraine intensifies, other sanctions will affect other companies. There are conflicting reports about how these sanctions will affect the Russian economy, but the recent news stories suggest that steel, aluminum and other exports will be redirected to prevent Russian companies from shipping goods to traditional markets (like Europe) and not get paid for them. The announcement on March 2 by Severstal appears to be based on this desire. If the war continues for long, Western countries will seek to have other countries impose similar sanctions.

Powerful people (e.g., members of Congress) have recommended that the U.S. and Europe make Russia pay for its aggression by restricting imports of important commodities. Energy (oil and gas) and steel are among the most important products that Russia supplies to the U.S. In 2021, Russia supplied $17 billion of oil products (crude oil and refined products) to the United States. This is on top of about 40% of energy products to the European Union.

Third on the list of Russian exports to the U.S. is steel products. In 2021, Russia supplied about $2.6 billion of steel products to the U.S., the fourth most important source of foreign steel to the United States. If the U.S. and other countries could replace Russia as a source of energy and steel, the ability of Russia to continue to invade Ukraine would be significantly reduced. That would require rearranging production of energy and steel, but that could be done.

Increasing U.S. energy production would create controversy because our production of fossil fuels would need to increase substantially. If the crisis is temporary, energy production could be increased rapidly, by resuming federal leasing of energy-producing lands (this was halted last year by the Biden administration) and by overruling state prohibitions on fracking (e.g., New York).

But steel is even more easily done; Russian steel imports to the U.S. in 2021 totaled 2.6 million metric tons. The overwhelming majority of Russian steel imports are of semifinished steel. Replacing those imports would require a 2% increase in production by domestic producers or a 5% increase in imports from other countries to accomplish. This would not be a heavy lift, between domestic and foreign suppliers of semifinished steel.

In energy, a similar situation prevails with respect to the United States. U.S. energy imports from Russia are overwhelmingly refined petroleum products (80% of Russian imports, $17 billion in 2021). This is only 8% of total imports of energy for the U.S. Increased domestic production combined with increased imports of refined products from other sources could easily displace Russia in the U.S.

Europe presents a more difficult problem. The countries of the European Union, including Germany, Italy, Poland and others, have come to rely substantially on imports of oil and especially gas from Russia (Russian gas is nearly half of European imports). To make sure that this reliance does not affect Europe’s willingness to defend the post-Cold War order, the countries of the West will need to step up.

Can they? The evidence seems to suggest that they can. On Thursday, the EU’s Energy Commissioner, Kadri Simson (from Estonia), declared that the EU has “contingency plans” if Russia should cut off natural gas supplies to Europe. But clearly this will involve hardship for Europe. Given the situation, which shows no sign of improvement any time soon, Europe needs to get ready for a cutoff, whether it is initiated by the Russians or by the West.

Natural gas from countries that do not have pipelines requires a lot of infrastructure. Germany, among other countries, is already taking steps to build that infrastructure, including LNG terminals that permit “regassification” for sending throughout Europe in existing pipelines.

Where will that gas come from? Qatar and the United States come to mind. Both can ramp up production of oil and natural gas rapidly.

The steel situation in Europe is considerably easier to manage, compared to energy. Steel is available from many countries, including the United States. And Russian imports into the EU are only about 4% of total imports (4 billion euros, or $4.3 billion). If the West decides to end imports of iron and steel from Russia, that amount can be quickly redirected to other countries.

If we can do that, the impact on Russia would be profound. Russia is banking heavily on EU reliance on Russian imports of oil and especially natural gas. If there is a credible threat to Russia from a cutoff of those exports to Europe, the strategic situation will become untenable for Russia.  

Last week, many in the U.S. have started to make exactly these points. Europe is not there yet, but as the brutality of the Russian invasion becomes more difficult to ignore or explain away, those voices will arise. UK Prime Minister Boris Johnson put forward a six-point plan yesterday to put more pressure on Russia to halt the invasion. While the invasion is not likely to stop, the West is clearly interested in increasing the pressure on Putin.

The economic pressure on Russia would increase enormously if the West finds a way to stop Russian exports. The U.S. can help achieve this by rearranging its own trade patterns in response to the crisis. Based on developments in the last few days, this appears to be happening.

Lewis Leibowitz

The Law Office of Lewis E. Leibowitz
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