Oral evidence: Cost and Effectiveness of Economic and Financial Sanctions, HC 1242[Tuesday 6 May 2014]

Oral evidence, 6 May 2014.

Witnesses

John Lough, Associate Fellow, Russia and Eurasia Programme, Chatham House, Roger Munnings, Chairman, Russo-British Chamber of Commerce, and Dr Chi Kong Chyong, Director, Energy Policy Forum, University of Cambridge, gave evidence.

Chair

Thank you very much for coming to give evidence to us this morning. I am grateful to you for coming in time to have heard a good deal of the evidence that we have taken in the first session, too, which will be helpful to us. We will perhaps be able to avoid some repetition. Could I begin by asking all three of you in a sentence or two to characterise the EU’s response to this crisis so far? Perhaps to assist, would you consider the response vigorous and effective at one extreme, or pusillanimous and ineffective at the other extreme, to give us a feel? I will go left to right. Mr Munnings.

Roger Munnings

I think slow and uninformed.

Chair

We have heard “slow” this morning. Can you just develop “uninformed”?

Roger Munnings

Yes. One of the issues, looking on from the outside, for me has been the fact that both sides have been very slow to talk to each other and very slow to appreciate the other side’s position. I spend quite a lot of time in Russia, and Russia has some solid logic to its approach, as you will appreciate. One of the problems that we have seen of late certainly is—

Chair

The solid logic being that they feel Ukraine should remain within their sphere of influence?

Roger Munnings

That it is part of their sphere of influence; that the Russian-speaking large minority in the east—and this is from Russian friends—has been disadvantaged by the actions of the Kiev Government, certainly in terms of language. The way it was put to me was if you are a Russian speaker in the east and you are faced with Ukrainian-speaking policemen, Ukrainian-speaking judges, then you are at a disadvantage. That was the basis of the use of the word.

Chair

I am just trying to clarify. I know I have interrupted you twice in response to explain the question on “uninformed”.

Roger Munnings

That is fine, yes.

Chair

Just to be clear, when you say the logic of the Russian position is clear, is it a logic that involves retention of Ukraine in the Russian sphere of influence or a part of the Ukraine? Which is it?

Roger Munnings

I think they would see Ukraine as their sphere of influence.

Chair

Okay. Therefore, their purpose is to retain territorial integrity and independence, but an independence that was within their sphere of influence?

Roger Munnings

All of the Russian rhetoric has been that they will not cross Ukraine’s border unless there is incitement to do so.

Chair

Isn’t that the other way round? Doesn’t that argument point in exactly the opposite direction, that they will if there is incitement, of which there appears to have been a good amount?

Roger Munnings

Well, other than in Crimea, they haven’t so far.

Chair

Okay. Well, that is a fairly big “other than”.

Roger Munnings

Of course.

Chair

I apologise, particularly since it is the first round of questioning, but you have said some very interesting things in your opening few remarks. Let us just go back to “uninformed” because I broke your train of thought on that.

Roger Munnings

Yes. For me, there just does not seem to have been enough dialogue between Russia and the EU and the US on how to solve the core problem. The core problem is how you assist Ukraine to be governable and to govern itself.

Chair

Okay. Mr Lough?

John Lough

I would characterise the EU’s policy so far as weak, ineffective, betraying a significant degree of division. Russia knows how to handle the EU, and it does that through bilateral relationships. It does it pretty effectively. I think what we have seen from the EU so far is just a series of pinpricks. The Russians are much more worried about what is coming down the line from the US.

Chair

Dr Chyong?

Dr Chyong

I would characterise the EU response—and particularly the response in terms of energy response because that is my sphere of expertise—as uninformed. The energy policy of EU towards Russia in the Ukrainian crisis as uninformed in the sense that portraying Russia as using energy and particularly natural gas as a weapon to achieve its goal in Ukraine particularly, I do agree that there is some pressure—

Chair

I have not understood that point. Could you just explain that point again?

Dr Chyong

There is widespread opinion that Russia is using its energy resources as a weapon against Ukraine and Europe particularly in this.

Chair

That is uninformed?

Dr Chyong

Yes, and that is uninformed in the sense that what is happening between Russia and Ukraine at the moment is that Russia has a legal basis to act in the sphere of natural gas exports to Ukraine because it based its behaviour on the contract that has been signed in 2009 and is asking for the price, which is high but has been agreed between Russia and Ukraine back in 2009. I think that most of the public opinion at the moment that Russia is using gas prices against Ukraine to pressure Ukraine is somewhat uninformed in that sense.

Chair

I am perplexed by that piece of evidence, but no doubt colleagues will come back to it in a moment. I want to ask one further question before passing the questioning over to Brooks Newmark, which I will ask initially to Mr Lough and then if others want to chip in please do. It is widely reported that President Putin has extensive holdings of foreign assets personally abroad and has accumulated these over many years. What is your understanding of that, and what is your best estimate of the scale of that? Is this a card that can or should be deployed, and if it has not been deployed, why not?

John Lough

Mr Chairman, this is all in the realm of speculation. I do not believe anybody has any information about what Mr Putin is worth outside a very, very small number of people in Russia.

Chair

We have these WikiLeaks via the US. I do not know what store you place on those.

John Lough

Where is the evidence? I am certainly prepared to believe that he is not a poor man and there is a certain amount of evidence to suggest that he started earning a good deal of money when he was the deputy mayor in St Petersburg in the 1990s, but to attempt to put a figure on it—

Chair

And placing it abroad?

John Lough

Very possibly. Given that Russia was a rather unstable place at the time, I think that is quite likely.

Chair

And that it has not been repatriated?

John Lough

Who knows? He has been calling on his associates to repatriate their assets. There is widespread belief that the US authorities have targeted a certain Mr Timchenko and his company Gunvor, in the belief that Mr Putin has a stake in that company, but I cannot comment on that. That is speculation.

Chair

Before I hand the questioning over, on the basis of what you know about Russia and President Putin, would targeting it be likely to have any effect should this speculation be correct?

John Lough

It is very hard to say. I think Mr Putin has an intention to remain in office for some time. I am not sure that his living expenses are particularly considerable, so we can assume that he may need to have access to a level of cash. I would hazard a guess that he has a good deal of money accessible in Russia and believes that he is going to hold on to it.

Chair

Okay. Before I pass the questioning to one of my colleagues, is there anything else that any of you would like to add on that point?

Roger Munnings

Perhaps I could comment on the question of Putin’s wealth. It is a comment you hear often. It is possible, may even be likely, but every time somebody makes it to me and I say, “Have you seen any proof of this?” because it would be interesting to know if proof existed, then the answer is always, “No, but don’t you think it is likely?” That would be the only comment I could put forward.

Mr Newmark

Gosh, I do not know where to start, Mr Chairman.

Chair

That is not like you, Brooks.

Mr Newmark

No, I am trying to not delve into the sphere of the political, Mr Chairman. I will stay focused for a little bit, how about that? Dr Chyong, besides your very obtuse response to the fact that Russia is not using gas or energy as a weapon, which I am not sure what parallel universe you came to that conclusion in, which they are—

Chair

Steady on, give Dr Chyong a further opportunity.

Mr Newmark

I am just going to focus on the UK.

Chair

We are not going to abuse the witnesses here.

Mr Newmark

Okay. The UK does not import any gas from Russia. Does that mean that sanctions then are less concerning from the UK perspective, as opposed to if you were German or Eastern Europe?

Dr Chyong

I think, yes, you are right, the United Kingdom does not import any gas from Russia, but it does import gas from continental Europe. It is about 10% to 15% of our annual gas consumption. If there were some energy sanctions against Russia that could lead to some sort of disruption to the European gas customers, then that might have some indirect effect on the UK for which those effects are going to be very limited in scale.

Mr Newmark

Okay. Focusing on the eurozone itself, given that Europe relies more on energy than the UK, is there a risk that the eurozone itself could be tripped into some form of recession as a result? Even though you say energy is not going to be used as a weapon at all, on the hypothetical circumstance that energy is and that they do turn off the gas supplies for whatever reason, could that trip the eurozone into a recession again and then that in turn could be a risk to the UK?

Dr Chyong

The macro-economic effects of energy disruptions and effects of those disruptions on European economies I cannot comment, but I do think that there will be some effects on the national economies of European countries.

Mr Newmark

Just because we are ultimately concerned about our constituents with high energy bills, which they have suffered a lot lately before this crisis happened, is there a risk that if we go and look at it from our constituents’ perspective, even though we are not reliant, their energy bills nonetheless could be tripped higher?

Dr Chyong

Certainly, I do not possess any information with regard to the possible effect of those sanctions on the retail bills.

Mr Newmark

Okay. I saw John nodding there. Do you see an impact on energy bills if sanctions have an impact on Europe? Forget the UK, because we do not rely that much on them.

John Lough

I think if there were to be a restriction of Russian gas supplies to Europe through perhaps a chaotic situation in Ukraine, the 50% supply of Russian exports coming through Ukraine—it is 20% of Europe’s consumption—that would have a significant effect. Obviously, spot prices would be affected, and in turn I think my colleague would agree that the British consumer would feel the knock-on effect from that.

Mr Newmark

Do you think then that the Ukraine crisis will be a wake-up call to the EU that having an energy partnership with Russia perhaps was a mistake because they are not necessarily a stable partner it looks like? Despite what Dr Chyong says, they could use it as a weapon. They have done it before. I am just curious if Dr Chyong would agree with this. They have used gas as a weapon before in terms of turning the gas off. No, yes, in Ukraine? You cannot say that they have not done because they have done.

Dr Chyong

I do disagree on this. The 2009 crisis was due to the fact that Ukraine has not paid its bill and Russia has legitimate cause to cut off gas supplies to Ukraine. In turn, Ukraine took the gas that was destined for European customers.

Mr Newmark

Okay. Then again, sorry, going back to Mr Lough, do you see that the impact of what is going on now, maybe the Europeans will look for alternatives and an alternative supply relationship for energy rather than Russia? Is that something in the calculus of the Russians today, or do they feel at the end of the day, when push comes to shove, that relationship will remain?

John Lough

I think experience shows that in 2008 when Russia went to war with Georgia, the Five-Day War, there was horror in European capitals at what the Russians were doing, a sense that we cannot just stand by and watch this, we have to act, we should not let them get away with it longer term, but within a matter of months the Russians felt the business relationship was back to normal. What I am saying is from where the Russian stance started out, they think, “The Europeans need us. They need our gas. They cannot readily find substitutes, at least not at favourable prices, so the relationship will remain in place.” Now, we said in 2006, 2009, during the previous Ukrainian gas crisis, that the EU finally needed to do something, and I think 2009 was a really big wake-up call. Some things have happened since then. Interconnections have been built. Countries have looked more seriously at the issue of energy security. The EU is implementing its third energy package, forcing Russian companies like Gazprom to unbundle. In the European market, that is having an effect and the Russians do not like it, but you could argue that we have not gone nearly far enough yet to create the diversity of supply we need in order to manage the relationship with Russia. I would say at the same time it is a relationship that by and large has worked extremely well for Europe over a long period, because—

Mr Newmark

It has worked for Russia as well.

John Lough

It has worked for Russia, so—

Mr Newmark

A huge amount of their GDP depends on—

John Lough

So it may have been a stabilising factor in the relationship, but my view is it became unstable at a certain point when Russia began to use gas—I disagree with my colleague here, in fact—as a political tool and Europe found in some cases it was very exposed to the Russian market. I think German dependence particularly on Russian energy sources, the fact that Germany is now closing its nuclear power plants, in fact increases the need for alternatives. Russian gas is one of them.

Mr Newmark

Right, but given they are trying to reverse their nuclear policy—I am not going to ask if they are going to reverse it once again—

John Lough

Unlikely.

Mr Newmark

But the lesson in the past couple of months clearly is that Europe is exposed to some form of risk of supply. On the flipside of that coin obviously Russia sees itself as vulnerable, I am assuming, because a huge amount of its GDP relies on exporting that energy. Do you see them switching where they are supplying energy to sources other than Europe? Is there a risk that the Russians themselves will look elsewhere to find outlets for their energy?

John Lough

I think the best way to answer that question is to draw attention to the importance of oil exports for Russia. Russia earns vastly more money from exporting oil than gas. Putin used some figures, which I believe are correct, just a couple of weeks ago to say that oil sales brought—if I remember correctly—$191 billion per annum to the Russian state budget, whereas gas he said the figure was $28 billion. He said, “Do you sense the difference?” I think what he was saying was the Europeans might be able to try to reduce their gas dependency on Russia over time, but it is not going to hurt us an awful lot. Russia can try to redirect some of its gas exports to China. It has been in negotiation with the Chinese for at least 10 years, as far as I am aware, and still no price has been agreed. It is something that will happen over time. Logically, Russia should be exporting more, in my view, to the Asia Pacific markets, so they will seek, I think, to create that optionality.

Mr Newmark

So in the game of three-dimensional chess, my final question, of which Putin seems to be three steps ahead of everybody else and we are playing a game of draughts, it would seem. Do you feel, Mr Munnings, that in his calculus, it is exactly this: he has seen that talk is cheap in the West and their memories are short, and at the end of the day somehow this will be history, and in five years’ time business will be back as usual with the west, particularly Europe, in terms of energy supply, and that if we fast-forward to 2019, this will be a dim and distant memory and gas and oil will have been going back and forth?

Roger Munnings

Yes, I think that is an element in his thinking, certainly. I think they will diversify, too; I think they will build. I was in Ufa, where there is quite a large oil production, a couple of weeks ago and the talk already there was of contracts with China and pipelines to China, although nothing had started beyond that. I think they will diversify; I think they will look to the far eastern market as has been said. Russia supplied gas to Europe for 50 years without interruption throughout the cold war. I rather agree with Dr Chyong about using it as a weapon. Certainly, they had the excuse that Ukraine owed them a huge amount of money for gas, and although turning it off in mid-winter was absolutely brutal and rather in line with Russian negotiation, then I think, rather than using it as a weapon, it was just being done to get the cash.

Mr Newmark

To get their money back.

Roger Munnings

Yes. Russia does produce, I think, 9 million barrels of oil a day, which is about 10% of the world’s production. If for some reason that flow was to be switched off, then it would have a really marked effect on economies around the world, because I do not think Saudi has the capability of anywhere near filling in that gap. The cost of oil would rocket really significantly, would be my view. So I think there is a concern there, but of course, as you have already said, that is a very painful thing for Russia to do with whatever the number was—$196 billion a year coming in. But it is always worth remembering that if they have 9 million barrels—

Mr Newmark

Yes, it goes back to Putin’s calculus, I am assuming, short-term pain for long-term gain, “If I can keep Crimea and maybe get a bit of Moldova, who cares, because in five years’ time, it will be back to business as usual.”

Roger Munnings

Yes, I think that may well be the way he thinks.

Mr Newmark

Okay, thank you.

Chair

I just want to clarify one point, possibly with Mr Munnings, but initially Dr Chyong. Your argument is they turned the supplies off in 2009, but that is because they were not getting their bill paid. Correct?

Dr Chyong

Yes.

Chair

Therefore, if they do get their money, they are not going to, also perhaps for the reason that Mr Munnings just gave. Correct? Yes. Is it therefore your view that the Russians are motivated partly by a desire to demonstrate compliance with legal norms and with treaties and agreements, once signed, as well as wanting the cash?

Dr Chyong

I think with respect to the commercial relations between Russia and Ukraine and particularly in the gas trade, it is the case that they have signed a very good deal in 2009, which has a base price substantially higher than the price was at the time in Germany, for example. Ukraine, perhaps because of its inability to diversify away from Russia, and particularly from Russian gas, had to sign that agreement. Of course, this is the commercial interest of Gazprom.

Chair

I have understood that, but I was asking a different question. I’ll have one more go. I will give it to Mr Munnings. Is it part of what Brooks Newmark calls Russia’s calculus that they need to continue to demonstrate compliance with contracts, once signed, or is this about the money?

Roger Munnings

It is part of the way Russians do business. Once there is a legal contract, they will abide by it almost without exception. Having run a business there for 12 years, I never had one instance where a contract was broken or not honoured in any form at all. For example, if you have a series of—

Chair

The BP contract there some years ago?

Roger Munnings

Unless it is something that is absolutely of huge—

Chair

It looked a pretty big breach from the outside, but you were a little bit closer to it than me.

Roger Munnings

Yes, and of course in 1998 there were contracts broken relating to financial instruments and those sorts of areas, but unless it is absolutely critical, I think in routine day-to-day business, they will not break a contract.

Chair

But this is not routine day-to-day business we are talking about here.

Roger Munnings

No, it is not. No, it is not.

Chair

So I go back to the question: do they have the same view as some say the Chinese have that they want to build credibility by demonstrating adherence?

Roger Munnings

I would say that has been part of their tactic in internationalising themselves, yes.

Mr Love

The effect of sanctions imposed so far has been variously described as symbolic and cosmetic. Is that a fair description, Mr Munnings?

Roger Munnings

Yes, I think so.

Mr Love

Any others would disagree? So you think that we have just been playing at this so far. How about indirect effects? We heard earlier on from witnesses that there has been a substantial impact, although disaggregating what is happening to the economy generally and what has happened as a result of sanctions. What is your view, Mr Lough?

John Lough

We have certainly seen some chilling of the Russian market and the threat of sanctions is still there. Russian business appears to think that this is still a problem and could go further, and looking at the situation in Ukraine now, which is steadily deteriorating, and seeing that President Obama and Chancellor Merkel have both said that, if the presidential election on 25 May is disrupted, that would be—and I do not like using this term, but just as shorthand—a red line and then we would see a next stage of sanctions, although they have not been specific. So there could be more coming down the line, and as previous witnesses have pointed out, the underlying condition of the Russian economy is not as strong as it was, let us say, in 2006, 2007. One of the biggest problems is investment, and if FDI is now adversely affected, we are going to see knock-on effects in the Russian economy that are going to be negative, so we are already seeing the Russian authorities lowering their growth forecasts. The World Bank put out a very, very pessimistic growth forecast last week, I believe. The economy, they said, could be contracting by 1.8%. This is going to make itself felt.

Mr Love

Mr Munnings, you were nodding your head there. Do you agree with that analysis that the indirect impact has been much more substantial?

Roger Munnings

I think there is a significant impact and there is significant fear, but I am not sure that that will enable the EU and the US to achieve the goals of sanctions, because they have some very strongly held views about what they would like to see in Ukraine. Once again, Putin has become pretty popular in Russia. His popularity, I think, was on the wane because economic performance—you asked the question earlier about how much was due to sanctions and how much was happening anyway. Economic performance was really poor. Growth was probably under 1%, whereas the population’s expectations had been ramped to 5% to 8% up until 2008, so the issue was the so-called middle class were no longer comfortable with the advance in their standard of living. That lack of growth has now been overshadowed by something that wins him support from Russian people.

Mr Love

But the inference is that as the economy declines, assuming it does continue to decline, that will then become a factor in his popularity. Does he have limited room for manoeuvre popularity at the moment, as a result of the strong way in which he has defended so-called Russian interests in Ukraine?

Roger Munnings

Yes. This is not my sphere of even competence necessarily, but I would say there was real danger of Russia becoming fortressed and very supportive of its leader for the reasons they believe to be good ones.

Mr Love

There has been quite a lot of talk, Mr Lough, carrying on that comment about a fortressed Russia, of a return to doing it all themselves, but what impact would that be likely to have? It would have a very negative impact on Russia in economic terms, but what impact would that be likely to have on the west?

John Lough

We could first of all see Russia becoming a more unstable place. Secondly, it would have effects on Russia’s periphery. Russia is engaged in a quite ambitious project called the Eurasian Economic Union, so that is a union of three countries at present, Russia, Belarus and Kazakhstan, the biggest Central Asian economy, with Armenia set to join. I believe this would impact quite heavily that project. It would, I think, have an adverse effect on some of the Central Asian economies, so we could see quite a complicated cycle there of, let’s say, negative trends. The question would then arise to what extent are these manageable? We are not even talking about the situation in Ukraine, and nobody has given any indication so far about who is going to prop up the industrial heartland of Ukraine, where there are a lot of loss-making coal mines around, where Russia is engaged at the moment in south-east Ukraine. So I think Mr Putin is going to face, sooner or later, a problem of resources. Yes, he has very healthy international currency reserves, but a lot of economists agree on the fact that those could be actually used up very quickly. If, for example, financial sanctions were imposed against Russia and the country was effectively cut off from international financial markets, then there is a great deal of Russian corporate debt that would have to be refinanced, and I believe the Russian state would have to do that.

Mr Love

Let me come to that, and I will start with Mr Munnings. There has been a lot of talk about third-tier sanctions, whatever that means. President Obama is, if you like, taking a lead on this in terms of suggesting that further sanctions need to be imposed. You mentioned about financial sanctions, what type of sanctions would have the effect that the west is looking for in terms of a change in Russian attitude towards Ukraine, Mr Munnings?

Roger Munnings

I think it is an incredibly difficult question. I just do not know the answer to it. There is very strong Russian feeling in support of what they seem to be doing at the moment, at least what the Russian media are showing them as doing at the moment. That would be represented not as anything to do with NATO, which there must be some pieces missing, but as supporting a Russian minority that they see as being dangerously oppressed by, for want of a better word, an illegal Government. The elections are critical, and the response to the elections are critical.

Mr Love

That was probably an unreasonable question I just asked, so I will not repeat it, Mr Lough, but let me ask you what is politically possible in terms of further sanctions that will not expose the weaknesses and differences either in the EU or between the EU and the United States. What is politically possible in these circumstances if the decision is taken that more action needs to occur to try to influence Russia in terms of Ukraine? What would be the options that would be available?

John Lough

I see two options, neither of them particularly attractive. The first one is restrictions on Russian companies expanding abroad. There is a case at the moment of the Russian state nuclear company is looking at opportunities in the UK, I believe, together with Rolls-Royce. I imagine that there might be measures put in place that would make that sort of deal, if it were ever to come to fruition, impossible. Coming from the United States, which is less exposed to the Russian economy and is in perhaps a much stronger position to act, in principle, the issue of financial sanctions, I imagine, will be discussed quite seriously because this would be a way of having immediate impact on the Russian economy. I am informed that it is the sort of thing that would tip it into recession immediately and it would have a long-lasting effect, but that is something of a nuclear option, and you then have to model how the Russians would respond to that. But I imagine if the US went ahead with those sorts of measures effectively Europe would be obliged to follow. If there is a big division across the Atlantic in terms of how we manage Russia or how we even read this crisis in Ukraine, then that could be very, very risky for the transatlantic relationship just at a time when we feel the need to reinvigorate NATO. So it is a complicated issue.

Mark Garnier

Mr Munnings, can I direct most of my questions—in fact, all my questions—to you? Looking at UK businesses, what difficulties do you think they are going to face in complying with these sanctions?

Roger Munnings

The practical ones have already been mentioned. We tried to circulate with the members of the RBCC after hearing that this hearing was taking place and we had about a 10% response. About 5% or 6% of those mentioned that just carrying out the due diligence to understand who they were dealing with might be an issue for them, so I think there is a practical problem. Sorry, could you repeat the whole question again?

Mark Garnier

It was to do with the complexities of the problems that UK businesses face, and while we are thinking about that, do you think the Government understands what they are asking of businesses who are going to have to comply with these sanctions?

Roger Munnings

It is difficult to say whether the Government understands it or not, but it is a complex issue for businesses whenever they go into a contractual relationship, understanding all of the strands of ownership, including beneficial ownership, which is the difficult step. You can carry out due diligence on registered ownership, but beneficial ownership is difficult. But we have had to deal with that issue for a long time. If I can, I have three areas of concern.

Mark Garnier

Yes, please.

Roger Munnings

The first is the City, and we have talked a lot about the City. Now, I think “minimal” was used or some expression was used. I would say there is a manageable effect on the City now, but the danger is if Russian companies stop coming for the longer term or London is seen as no longer a friendly place for companies to list, so there is that area. It is not a huge financial impact as is, but it is prospectively not good. Oil of course is the other area, and specifically I think BP and Shell and oil majors. The worst possible thing to happen would be that BP’s shareholding in Rosneft was somehow affected, so BP’s value is fatally undermined for whatever reason. I think that is the danger. The probability is low-ish, I would think, but nevertheless it is there. The next thing is just the long term. We are only 20 years into a kind of thawing of relationships from cold war times and the UK has been behind other European countries in terms of building relationships with Russia, for understandable political reasons, but nevertheless behind. We were making a bit of—

Chair

You are talking about alleged murder in the streets of London?

Roger Munnings

Yes, exactly, exactly. We are in the process of catching up, but I think this is going to set all of those developments back, but it will do it for the rest of the Europe as well.

Mark Garnier

This is part of an EU-wide thing, isn’t it? This is not just London—

Roger Munnings

Yes. It will be the same for the rest of Europe too, but somehow the Germans seem to have a good way of speaking to the Russians.

Mark Garnier

Better diplomatic relations?

Roger Munnings

They have a better high-level political relationship, for sure. A point I have continuously made is to win big infrastructure projects in Russia, you need those high-level political relationships. That is where the Germans I think are very good. The Italians have been quite good. The French have been fairly good.

Mark Garnier

Our Foreign Office has been slightly lacking in comparison?

Roger Munnings

Not entirely lacking, but we have had reasons not to and we have not been able, probably for political reasons, to park those issues.

Mark Garnier

To a certain extent, part of my question is when we are talking about BP and we are talking about some of the big banks and all the rest of it, they have pretty substantial resources at their disposal in order to be able to invest more money into this compliance function in order to make sure they do not stray across the line with these sanctions, but what about the smaller businesses? Presumably, for some smaller businesses, trying to comply with this is going to be quite technically difficult for them to try to understand it. Do you think the Government understands the problems that they face? Maybe I will ask that question in a slightly different way: are you getting many representations about this?

Roger Munnings

Talking about third-level sanctions, and who knows what they are, I would say that it probably means that the Russian market closes for British companies. It certainly gives British boards the opportunity to say, “Much too risky. We are not going to go there.”

Mark Garnier

This is the over-complexity response, if you like. It is far safer to turn around and say, “Forget it. Let’s go and do something else in another part of the world.”

Roger Munnings

Absolutely, so we are going to lose a potentially good market for a number of our services. I would not say a fantastic market. It is not China.

Mark Garnier

It is a good opportunity and it is growing, isn’t it?

Roger Munnings

It is a good opportunity, 140 million people compared with China’s, what, 1.4 billion—I am not sure—so it is not China, it is not India, but there are areas where British companies can do very well, not least in the City. In financial services, Russia is looking to establish decent pension funds, those sorts of areas; oil, obviously, and oil services. So it is much more looking into the future and saying, “Is that going to retard us still more?” that I would be worried about.

Stewart Hosie

Mr Munnings, can I just carry on from the questions that you have had there? Is it your view that in terms of compliance now with sanctions businesses are being over-zealous in the sense they are over-complying because they are not quite sure where the lines are?

Roger Munnings

I think there is a danger, isn’t there? What is really interesting is that you see a complete disconnect between companies that are invested in Russia, UK companies, and UK companies who are not, but are looking at it. Those who are invested in Russia find it relatively straightforward to do business in accordance with their international values largely and do well. Those who are not, I think there is still a kind of residual cold war issue, corruption gets very, very high profile and so they are very resistant to doing it. The companies that are there will, I think, fight their boards to stay there and find ways to do it. Those who are not there will just say, “We always understood that that was going to be a problem so we will not take what we now see as enhanced risk,” and it will be enhanced risk, “of infringing sanctions.”

Stewart Hosie

In terms of an enhanced risk of infringing sanctions then, is the fear of reputational damage as strong as the actual practical impact of accidentally breaching a sanction? How big is reputational damage risk playing on the minds of boards?

Roger Munnings

I think if your Government makes a law, you want to comply with it. That is a business requirement, so you have to do it. Reputational damage, for those companies already there, a lot of them have lived with talk of operating in a corrupt environment yet have not been operating corruptly for a number of years, so they would be likely to find ways to live with it, I would say, because it is a good market for most companies that are already invested there. Not a huge number of British companies, by the way, but nevertheless a good market for those that are.

Stewart Hosie

Okay. Mark Garnier asked you some questions about the Government’s view on things, but let me ask from the business point of view. Do you feel that the Government have given enough reassurances or clarity to businesses on how to comply with the sanctions regime that is in place?

Roger Munnings

Again, I am not sure I am equipped to answer that, but my guess is you can never give enough, so the more you give, the better—the more you set out your stall, the better—and if you are already slow reacting with your European partners and there is some disagreement with your European partners, then the information that is going to feed to business is going to be slow.

Stewart Hosie

In that case, to all of the panel, if the businesses you are interacting with tell you, “We need more information in this area, that area,” that would be useful for us to have to get a clear understanding of where businesses think there is a lack of specific detail in terms of compliance.

Roger Munnings

Yes. The RBCC has run sessions in Russia and in the UK on the current state of affairs and we have asked the embassy and UKTI to come and talk to those. My view would still be you can never give too much information in these circumstances, so if you are going down the route of stage 3 sanctions, please publicise and share what compliance requires.

Stewart Hosie

That is helpful.

Jesse Norman

Just a couple of quick questions. Mr Munnings, both Mr Putin and the Russian Deputy Foreign Minister have pointed to potentially painful consequences for people working in key sections of the Russian economy from any current or escalated round of sanctions. Obviously, you spend a lot of time advising foreign investors on investments in Russia in your own career. Can you tell us a bit about what that might involve, how you grade that, what you think the consequences might be of that and what advice you give businesses that are looking at investing in Russia?

Roger Munnings

Clearly, the first piece of advice is try to understand what the sanctions involve now, what they are likely to involve in the future, and that is a bit of a guess, but if you put that aside—

Jesse Norman

You were hinting that you shared Open Europe’s view that EU tier 3 sanctions were highly unlikely.

Roger Munnings

No, I didn’t say that.

Jesse Norman

I was getting that from your earlier—

Roger Munnings

Yes, it has been said, but I did not say it.

Jesse Norman

But is that a position you would support?

Roger Munnings

Again, it is not my area of competence. I do not know where the EU is in discussing it—I do not know how close it is to agreement on it—but my advice to companies has always been the same, which is find a Russian partner you can trust, and that takes time to get to know the person or the company, see if you can have meetings with the local governor so that you can access the local governor or his administration whenever you have concerns. It is possible to do business there without corruption.

Jesse Norman

You were suggesting, I think it is true to say, earlier that ideally—or, in fact, perhaps as a necessity—one needed high-level support for investment in Russia to give a kind of political backdrop or backstop to ensure—

Roger Munnings

If you are looking at major infrastructural projects, then you would do well to have full Government support and vociferous Government support.

Jesse Norman

But do you think companies with existing investments should think about disinvesting, given the way that the climate is going?

Roger Munnings

I think if sanctions require you to disinvest, you are going to have to disinvest. That is a very unattractive move to make, but if that is what sanctions require, you have no choice.

Jesse Norman

Right, so they should perhaps be at least making contingency plans against that possibility?

Roger Munnings

I dare say they are, yes.

Jesse Norman

Yes, okay. That is interesting. Mr Lough, can you just pick up the point we were discussing about where you read or where Chatham House reads the possibility of tier 3 sanctions from the EU? Do you think that is a possibility, or do you think that the EU is in too much disagreement over motives and vulnerable to pressure?

John Lough

Let me put it this way: I think we are in disarray at the moment, for the simple reason that our leaders are having great difficulty understanding Russia’s logic in Ukraine, how far it wishes to go and what the end result is going to be. If the end result is effectively the destruction of a country’s independence and sovereignty in Europe, a major country that impacts on our security, then I believe we will take further measures and some form of stage 3 sanctions. The Germans have effectively said this, not in quite those words, but they said, “We will go, if there is further destabilisation, to the next stage,” and I think, coming from Berlin, that is quite a significant statement. Sooner or later, we in Europe and we in western countries need to make up our minds about what we want to do about Ukraine and the extent to which this country matters to us. That will then determine our response.

Jesse Norman

So the EU is in disarray at the moment—

John Lough

On this issue.

Jesse Norman

Germany is giving some leadership, but it is unclear at the moment, okay. Perhaps I can go back again to you, Mr Munnings. We see at BP Bob Dudley said that his company was unaffected by sanctions, and similar things have been said by senior Russians at the moment, even those who have been specifically targeted as named individuals. Do you think that, in fact, it is true that BP can be unaffected even by the current levels of sanctions?

Roger Munnings

That BP are unaffected by sanctions?

Jesse Norman

Even by the current level of sanctions.

Roger Munnings

I think the ultimate worry is the one I have already referred to, which is that some kind of reciprocal action be taken and BP’s shareholding in Rosneft be somehow frozen or removed. Bob himself may have an issue, given that he is an American citizen, so quite how that relates to him sitting on a board, the chairman of which is one of the people who say sanctions do affect them, I am not sure, but clearly that is for BP and his personal lawyers to advise on.

Jesse Norman

Mr Lough, it appears to many outside observers that there has been a staggering lack of US leadership on this issue. Would that be your view?

John Lough

I think there has been an absence of leadership. There have been sporadic signs of life from Washington, but I think the problem arose because the US had largely outsourced the issue of Ukraine to the EU.

Jesse Norman

Although its own sanctions are stricter, in fact.

John Lough

Indeed, but I am talking about the origins of this crisis. The United States has not been heavily engaged, and the problem has been that this whole issue around the association agreement, whether Ukraine would sign or not, then triggered political destabilisation in Ukraine. The EU is not by any stretch of the imagination a geopolitical actor, so finds, by definition, this sort of thing very difficult to deal with. When you have to get, as we have mentioned before, the consensus of 28 countries, some of which have vastly differing degrees of relations with Moscow, this is well-nigh impossible. I think in Europe we are looking for leadership from the United States, and we have to see whether it is going to arrive or not.

Jesse Norman

Okay, so let us just be clear about that. The US has outsourced leadership on this major foreign policy issue to the EU. The EU is in no way a geopolitical actor and its policy is in disarray. That is just summarising your view.

John Lough

If I may clarify—

Jesse Norman

It is quite an interesting combination of claims; that was all.

John Lough

The US had outsourced the Ukraine problem and it woke up late to a problem with Ukraine that was of course then impacting hugely on its own deteriorating relationship with Moscow. We are in a situation now where the EU finds it, for understandable reasons, difficult to act. We are all trying to, I think, digest the consequences of this crisis. In particular, one of the questions is what is this going to do to Russia? Russia seems to have just shifted gear over the last three or four months, and it feels as though we are dealing with a country that does not care two hoots about its relationship with the west. It is prepared to take enormous risks to pursue its goals, and as Roger said, Mr Putin appears to have the people behind him at this stage. So we are dealing with a different actor and it is fair to say that the United States is also struggling with this. From what we know, there is a view among the analysts, the desk officers in the State Department, the Pentagon and elsewhere, they read this in pretty clear terms, and their advice has gone to the political level, but so far not much has come out of it. John Kerry was part of that Geneva process on 17 April, which delivered an agreement that, in my view, just was not worth the paper it was written on, because it could not be implemented.

Mr Newmark

It sounds like Syria.

Chair

Did you want to come in? Sorry, Mr Munnings.

Roger Munnings

Yes, just talking to businesses, and I have talked to the CBI a little bit about it, the thing that businesses are having difficulty understanding is why Geneva is not in permanent session. The core issue here is the governability of the Ukraine and how to govern it for the future, and nobody seems to be working on that at the moment. Therein lies the solution, and business is asking, “Well, why aren’t people working on this? Why are we making escalating statements on one side, or aggressive, belligerent statements on the other? Why don’t we attack the core issue, which is how do you govern Ukraine?” or “How does Ukraine govern Ukraine?”—sorry.

Chair

Thank you for that. Mr Lough wants to come in and then I am going to ask Dr Chyong, who has been very quiet and patient, whether he has anything he wants to add to any of the areas that he has heard since he last had the opportunity to speak. Mr Lough on this point and then Dr Chyong, and then it will be Pat McFadden.

John Lough

Thank you, Chairman. I just wish to state perhaps the obvious here, that the reason why there is not a permanent process at the moment in Geneva is that we have no common ground to discuss with Russia, because western countries wish to give Ukrainians, broadly speaking, the choice of how they wish to govern themselves and it seems that Russia wishes to restrict that choice. So this has become a chasm between Europe and the US on the one hand and Russia on the other, and I just do not believe we are able to deal with this right now, regrettable as that is.

Chair

Dr Chyong.

Dr Chyong

I do not have anything to add and I mostly agree with what has been said by my colleagues in those questions.

Mr McFadden

Mr Lough, I would like to take you back to a comment you made at the beginning of this session, where when all three of you were saying that the sanctions so far have been pretty symbolic, pretty cosmetic, have not had much effect and so on, that what Russia was worried about was what America might do next. Could you expand on this a little bit and what kind of further sanctions from the United States might make Russia think differently about what has been done so far?

John Lough

I am not inside Mr Putin’s head and I cannot tell you exactly the calculations he is making, but he and those around him and senior figures in Russian business must be aware of what western sanctions did to Iran and they finally brought Iran to the table after a long period. They know that sanctions take a long time to work, that they take a high degree of political will, and it seems, as far as we can tell to be their calculation, that the game they are playing at the moment in Ukraine comes almost certainly with costs, but to them the costs of doing nothing in Ukraine are far greater.

Mr McFadden

To them, the United States, or the—

John Lough

To Russia, of doing nothing at all, because they believe that somebody else will fill the vacuum.

Mr McFadden

Right, okay, to Russia. Going back to the Iranian parallel you mentioned, what was it about the sanctions against Iran that brought them to the table, what type of sanction really bit hardest?

John Lough

I am not an expert on sanctions against Iran, but it seems to me that the combination of the oil embargo and then locking them out of the international financial system were very powerful forces that finally had a political impact. So if you look at an economy such as Russia’s, which is well-integrated with the west and Russia being a major energy supplier, I completely agree with the view that if you were to put Rosneft, Russia’s largest oil company, on a sanctions list, you would be taking 2.5 million barrels of oil out of the picture immediately. Some of that of course could be redirected, but it would have a catastrophic effect on the oil price, so the Russians know that, they know that the Saudis cannot pump that much oil, they know the Saudis have to live at a certain level of oil price, so they do not believe that we can deflate the oil price in any way, which would be a way, of course, of hitting them. The global economy is recovering. This crisis might not have happened three or four years ago. The aftermath of the global financial crisis, Russia took a big hit and I think there was a bit of a wobble in Moscow as the oil price plummeted. They seem to think that, from what we can tell, they are sitting pretty, that sanctions are not going to have a huge impact, and we are talking about the way the decision makers are communicating at the moment, but from what I hear elsewhere in Russian business, there are concerns about this is going to be a sort of drip, drip effect and if investment dries up in Russia, this is just going exacerbate the country’s problems. So this is probably going to be a long march.

Mr McFadden

Again, sorry to keep going back to the parallel with Iran, but one of the things that was done there was the removal of access of a number of Iranian banks to the SWIFT—I do not know if you were in the earlier session when I asked the witnesses the same thing—international payments system. Given that the oil sales, which you earlier said were worth far more than gas sales, are denominated in dollars, is that kind of action in the thinking of people in the United States, and if it was, might it have an effect?

John Lough

The answer is that I do not know what people in the US are thinking. I imagine a whole range of scenarios are being looked at. Certainly, there has been discussion in Russian circles about potential de-dollarisation of the economy, although I do not take that very seriously, given the source it is coming from, at least the main source. It is certainly a factor, but I think you need to talk to a technical specialist to understand how the Russians would be able to cope with that, because I suspect they would find a way of coping.

Mr McFadden

Dr Chyong, you are an energy expert. This is Russia’s key export. What is your view of the potential for the United States to step up sanctions, especially on the payments side of this energy contracts business?

Dr Chyong

As far as I know, when we embargoed Iranian oil, for example, some of the Chinese importers transferred the imports of oil and payment into the Iranian business in Chinese currency, as well as some of the Indian customers who also imported oil from Iran transferred that from dollars to rupees. So I think there will be some complicated schemes where Russia would find a way to still trade oil, but probably that would raise the transactional costs as well as the oil prices. On the potential sanctions, I would like to mention particularly in the gas sector in Russia, as you may know, the gas is mainly transported through pipelines to Europe. In December 2013, Russia liberalised the export of gas through the means of seaborne ships, the liquefied natural gas ships, to take it to markets other than the European markets, the traditional markets for Russian gas. So the technology that is used to liquefy this gas is all coming from the western companies, and if we were to put sanctions on those specific technologies, that could somehow, I imagine, shift the internal dynamics between Putin’s inner circle, because the LNG export is mostly supported by Rosneft and Novatek. They are the companies that are competitors to Gazprom and that could potentially put some cost to Russia in the sense of not allowing Russia to diversify away from Europe, but on the other hand, we would then still keep the Russian gas exit to Europe secure, in the sense of not touching the Gazprom export contracts to Europe, so that is my point.

Mr McFadden

Do you think there is an appetite in the United States to go significantly further than we have seen so far?

Dr Chyong

I don’t know.

Mr McFadden

Do you think there is an appetite, Mr Munnings?

Roger Munnings

I have no idea. There is some belligerent comments coming from the United States, but I have no idea of the underlying reality.

Chair

Thank you very much for coming to give evidence to us this morning. I am pleased to say we have been able to end this session in the morning rather than the afternoon, which I thought might not be the case half an hour or so ago. Can I end by saying we all found the evidence that you provided of considerable interest and if you have further points that you feel should be made, on reflection, please do put them down in written form? We will be glad to receive them. Thank you very much indeed. Oral evidence: [Inquiry name], HC [XXX] 2