Apr 24, 2014 | 09:30 GMT

7 mins read

German Business Ties With Russia Curb the Threat of EU Sanctions

German Business Ties With Russia Curb the Threat of EU Sanctions

The Europeans will continue to threaten Russia with sanctions to pressure Moscow to help implement the Geneva agreement on eastern Ukraine, but the likelihood of European financial and economic sanctions is small. An important reason is that Germany has prioritized strategic commercial deals with Russia and is reluctant to see relations deteriorate further. Yet with the German public and other European countries calling for greater energy freedom from Russia, it will become more difficult for Berlin to defend stronger ties with Russia.

It is difficult for the European Union to reach a consensus on financial and economic sanctions against Russia because member states have their own bilateral ties with Russia to preserve. Even before the April 17 agreement, it was not possible to clearly define which countries were for or against financial and economic sanctions — the so-called third phase of sanctions — because a country's position depended on the type of sanction in question. Ensuring that all countries are affected equally is an impossible task for Brussels, since countries weigh the importance of certain sectors and possible Russian retaliation differently and since cross-country compensation is difficult to implement.

Yet throughout the sanction debate, Germany's reluctance to move forward with the third phase of sanctions has been an important reason for the European Union's hesitance to take a tougher stance against Russia.

Germany's Dilemma

Like other European leaders, German Chancellor Angela Merkel has warned that the European Union would go to the third phase of sanctions if Russia escalated matters in Ukraine. In response to German businessmen warning against sanctions, Foreign Minister Frank-Walter Steinmeier said April 9 that business as usual could not continue between Germany and Russia because of the Ukraine crisis. In an interview last weekend, however, he said that he sometimes wished "the same engagement being used for the debate about sanctions would also exist when it comes to avoiding a further escalation." Germany's dilemma when confronting Russia is apparent in these somewhat conflicting statements.

On one hand, Germany has to take a tough stance against Russia by signaling its willingness to implement more sanctions to strengthen its leadership role in Europe. Berlin needs to reassure countries worried about a weak European response to Russian actions. Countries such as Poland and the Baltic states are watching how Berlin positions itself to assess the support they can count on should Russia try to expand its influence along Europe's eastern border.

On the other hand, Berlin wants to avoid a larger economic confrontation with Russia because it would undermine efforts to stabilize Europe's economy and sour important business ties between Germany and Russia.

Economic Ties

Russia is not a top-10 trade partner for Germany (11th in exports and 12th in imports), but strong economic ties are still important to Berlin — a point reflected by the fact that, apart from halting defense company Rheinmetall from exporting to Russia, important business negotiations have continued over the past few months. Moreover, Russia is an important supplier of energy, particularly natural gas, to Germany, and when it comes to natural gas, pipeline connections matter more than in the oil trade. Russia provides about 38 percent of Germany's natural gas imports and about 35 percent of its oil imports.

Russia's status as an energy supplier is one reason Europe and especially Germany is not interested in further escalating the standoff over Ukraine. Germany could handle being cut off from Russian natural gas for a few months because of higher than usual natural gas storage levels due to a mild winter and lower consumption during the summer months. Beyond the summer, however, Germany's fundamental dependence on Russian natural gas will remain.  

Germany is Russia's largest European natural gas customer, so Russia would feel the effects of cutting sales to Germany. But stopping the natural gas trade would hurt Germany's economy overall more than Russia's because Moscow has ample financial reserves, and revenue from natural gas sales is less important than revenue from oil.

But the importance of strong Russo-German economic ties goes beyond energy. The German economy is heavily export-oriented, and while Russia is not a leading export market for Germany, Berlin does not want its companies locked out, especially in light of weak economic growth in Europe. The German Committee on Eastern European Economic Relations, an initiative bringing together businesses with interests everywhere from Southeast, Central and Eastern Europe to Russia and Central Asia, notes that more than 6,000 German companies have invested 20 billion euros (nearly $28 billion) in Russia and that approximately 300,000 jobs in Germany depend on exports to Russia. A fear among the German industry is that if German companies are forced to distance themselves from Russia because of sanctions, they will lose market share to countries such as China, which has already been gaining ground over the past decade in machinery, electronics and plastics while Germany's share has dropped.

Russian Imports from Germany and China

Russian Imports from Germany and China

Slower Russian growth and the weakening Russian currency over the past year have made it more difficult for German exporters to sell products to Russia, especially at a time when Russia is making more effort to source goods domestically to strengthen the domestic industry. According to the German statistical office, German exports to Russia decreased by 5.2 percent, to 36 billion euros, in 2013. The current crisis adds uncertainty for German companies that are considering setting up offices and manufacturing plants in Russia to gain greater access to the Russian market. The continuing negotiations on strategic business agreements between Germany and Russia, however, signal that Berlin and Moscow want to mitigate the effects that the current standoff over Ukraine has on their business ties.

The head of Germany's Siemens met with Russian President Vladimir Putin on March 26 in Moscow and noted that the German government was aware of his trip. Through a joint venture in Russia, Siemens builds locomotives for Russian Railways, and it hopes to get more contracts in Russia's rail sector together with other German companies such as Deutsche Bahn. Russia has wanted to modernize and expand its rail lines for decades. It has plans for a series of high-speed rail lines both within Russia and to many of the former Soviet states. These lines are expensive, however, and Russian Railways relies on technical expertise from abroad. Russia has been in negotiations with foreign firms to possibly help out, though these talks have stalled multiple times due to the financial crisis, internal Kremlin disputes and negative international sentiment toward Russia.

On April 4 it was announced that Siemens will provide electronic systems for the offshore part of the South Stream natural gas pipeline, indicating that while the European Commission is questioning the legal status of the pipeline, politicians have not taken steps to stop European firms from collaborating with Russia on the project. Wintershall, a German oil and natural gas producer and daughter company of the German chemicals company BASF, is co-owner of the South Stream project as well as the existing Nord Stream natural gas pipeline. Late last year, the EU Commission approved a deal between Wintershall and Gazprom that will give Gazprom a greater share of the German natural gas storage and trading market while Wintershall gets more shares in Russian hydrocarbon fields. The deal is supposed to be completed later this year, and Berlin indicated in early April that it has no reason to stop it. It said the same about a second, similar deal in the making.

German energy company RWE on March 28 signed a preliminary agreement to sell its natural gas trading branch to Russian oligarch Mikhail Fridman; the deal is supposed to be finalized by year's end. Fridman is believed to be on good terms with the Kremlin. So while the German trading branch is being sold to a private Russian citizen, it is one the Kremlin can likely influence.

For its part, Russia has little interest in putting Germany in a position where it would be forced to support meaningful sanctions on Russia (for example, by invading eastern Ukraine). Germany is Russia's second-largest import and third-largest export market, according to Trade Map. Moscow nonetheless has an interest in undermining the work of Ukraine's new government because the rising and falling of tensions undermines the cohesiveness of the European Union as member states squabble over whether Russia is sincere about working with the West to find a solution for Ukraine.

With tensions between Russia and the West unlikely to dissipate anytime soon, Berlin will have a difficult time finding its place between leading the European Union and preserving economic ties — particularly in the energy sector — with Russia. Germany cannot reduce its dependence on Russian energy supplies in the short term, especially since its transition toward more renewables hinges also on a stronger reliance on natural gas. Supporting stronger integration of the European energy infrastructure will be a way for Berlin to address the fear among its European partners that Germany will put its bilateral relationship with Russia above the goal of European cohesion.

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