Research Project:

Impact of Ukraine Crisis on the U.S. and the

European Union Economy





GBBT 695-01
By: Iya Tsyrkot
May 12, 2014
In the past few months the whole world has been watching over the tensed situation in
Ukraine. After annexation of Crimea by Russia, Ukraines inner crisis turned into geopolitical
crisis involving Russia, the European Union (EU) and the U.S. Even though Ukraines economy
plays a relatively small part in the global economy, the crisis in Ukraine started affecting global
economy, particularly Europe and the U.S. As of today, the crisis resulted in numerous sanctions
against Russia impacting global trade and triggering gas and global oil redistribution. In addition,
there is a deep concern that further escalation of the situation will contribute to global economic
and geopolitical instability. In order to analyze and anticipate the repercussions of Ukraines
crisis, it is important to understand how this crisis started and what evoked its development.
The civil unrest in Ukraine erupted in late November 2013 when thousands of protesters
gathered at the main square in Kiev, also known as Maidan, to express disapproval of suspended
trade agreements with the European Union by the Ukrainian government. The European Union
association and free trade agreement would allow Ukraine to build closer ties with the West as
well as weaken the dependence on Russia. Russia, who didnt want to lose its former state
Ukraine, made an effort to prevent Ukraine from signing the EU association and trade agreement
by imposing trade restrictions and threatening further such restrictions if Ukraine will proceed
with the EU pacts ("The Geopolitical Realities 12). In addition, Russia was aware about
Ukraines account deficit of $17 billion and made a tempting offer to buy $15 billion worth of
Ukrainian debt in lieu of Ukraines rejection of the EU pacts ("The Geopolitical Realities 12).
After peaceful protests and demonstrations were brutally banned by the governments corrupted
parties, the pro-European protests, called Euromaidan, turned into more aggressive protests
against human rights violations and government corruption. After nearly three months of protests
and clashes with the police, the former President Victor Yanukovych authorized the planned
massacre of the protestors. February 18-20 marked the peak of bloodshed and was also a turning
point in Ukraine crisis as Ukrainian parliament ousted President Yanukovych from power. In
early March, Russia, who didnt recognize the newly elected interim government of Ukraine,
invaded Crimea on the grounds of a supposed humanitarian crisis for Russians living in Ukraine
(Kapur). The tension between Ukraine and Russia escalated, as thousands of Russian troops have
been positioned near eastern borders of Ukraine causing pre-war conditions and raising security
concerns not only in Ukraine but also in Europe and other former states of Soviet Union. In
addition, heavy Russian propaganda has been used in the eastern regions of Ukraine as means to
trigger separatist provocations.
Since the annexation of Crimea, the U.S. and the EU have been playing an important role
in the evolving geopolitical crisis in Ukraine. The pressure put on the U.S. and the EU is partially
due to the involvement of these two sides in the Budapest Memorandum on Security Assurances
dated 1994. According to this diplomatic memorandum Ukraine gave up its entire nuclear
arsenal, which was the worlds third largest as of 1994, and in exchange was guaranteed
sovereignty and the security of its existing borders by the officials of the U.S., UK and Russia
(Mathews 1). The annexation of Crimea and inability of West and the U.S. to prevent Russia
from the invasion raises questions over trustworthy, credibility and power of these countries.
Some diplomats also view the current situation as an assault on the world's nuclear
nonproliferation agreements, and fear that failure of the U.S. to guarantee Ukraines security
will negatively affect the negotiations with nuclear countries like Iran and China (Mathews 2).
Moreover, Russian military actions in Crimea are raising concerns and fear of possible invasion
of other former Soviet Union states like Moldova, and eastern Baltic countries such as Estonia,
Lithuania and Latvia, which have large percentage of ethnic Russian population. There is a
widespread opinion that the Russian incursion into Ukraine is a direct challenge to the US-led
world order and a vital test of the foreign-policy rules of a new era - the era of globalization
(Rachman 9).
The escalating tension between Russia and Ukraine shifted the main nations concern of
the U.S. from recession to outdated foreign policies. Unrest in Ukraine and Russian aggression
are not the only issues with the potential threatening consequences. Among other escalating
trends is Syrian two-year long ongoing civil war that is being supported by Russian and Iran,
tensions in the Middle East between China, whos military power is emerging, and Japan, and
lack of progress in international negotiations regarding Irans nuclear program (Seib A4).
According to the article Political Conversation Takes on a Foreign Accent, all these ongoing
tensions raise questions about the purpose of NATO, how to confront and deal with Russian
aggression, if the U.S. can cut on the military spending as much as planned, and if President
Obamas position to decrease U.S. military involvement in the overseas unrests is justified (Seib
A4). As more crises unfold, the U.S. President is being severely criticized by its opponents.
Senator John McCain claims that the Ukrainian crisis is "the ultimate result of a feckless foreign
policy where nobody believes in America's strength any more," and that countries such as
Russia, China and Iran may decide defying America is getting less risky (Rachman 9). There is
also an opinion that the lack of preparedness at the White House was not merely a weakness of
policy but also a weakness of worldview (Wieseltier 59). Escalating global tensions and the
perception of weakened U.S. power are forcing the U.S. government to rethink its foreign
policies strategy.
Currently, the crisis in Ukraine resulted in numerous sanctions against Russia, which had
an impact on the global trade and cash flow. Even though many sanctions imposed by the U.S
and the EU are targeting Russian officials and individuals who support Russian government,
some sanctions are targeting businesses and financial entities as well. As stated in the article
from Forbes magazine, the U.S. Department of the Treasurys Office of Foreign Assets Control
imposed sanctions on twenty individuals, which include asset freezes, blacklisting, travel bans
and suspension of business with certain Russian companies (Robehmed 24). In addition, U.S.
authorities decided to cut off new export licenses for Russia on products that have potentially
sensitive military uses, also known as dual use, as they have potential to be applied as both
civilian and military (Mauldin, Crittenden A8). U.S. decision to cut off export licenses to Russia,
who is the second biggest market for U.S. defense-related goods, means that the U.S. is in need
to find an alternative trade partner for the export of dual-use goods; otherwise, there will be
about $1.5 billion decrease in export revenues. Adding to the list of sanctions, the U.S. has also
imposed restrictions on Visa and MasterCard payment transections in Russia. As of the end of
March, Visa and MasterCard stopped supporting transaction services for customers of Bank
Rossiya and Sobinbank, which might speed up a process of creating a domestic payment system
in Russia ("Russia Feeling The Heat 15). The restrictions imposed on Visa and MasterCard
payment transactions in Russia will not affect Visa and MasterCard companies much, as Russia
accounts for a very small segment of these payment networks.
Imposing economic sanctions in the global economy is tough, as there is risk of
boomerang effect, and countries that impose sanctions might end up hurting their economies as
well. The managing partner of Federal Financial Analytics, Karen Shaw Petrou says that
"Ukraine situation is a sobering reminder of how geopolitical events fought over issues like
national borders, ethnic solidarity, and resource allocation can quickly explode into currency,
commodity, and cross-border financial crises" (Borak 9). Moreover, the cross-border financial
crisis can turn into more serious threat to the global economy, as most tools used in fixing
financial crisis are oriented on the financial causes and not geopolitical ones. Karen Petrou also
argues that global financial markets are more vulnerable than ever due to the highly
accommodative monetary policy from the U.S. and other central banks, which have helped to
distort investment patterns and encourage unusually large holdings in obligations subject to
geopolitical risks and to counterparties with concentrated exposures (Borak 9).
The sanctions from the EU are milder comparing to the more aggressive sanctions
imposed by the U.S. This can be explained primarily by the trade volume with Russia, where
Russia U.S. trade is about $40 billion, and Russia EU trade is $460 billion. The EU has
stronger ties with Russia, depends on Russian gas and trade, and has more to lose, which makes
it harder to impose restrictions. According to the article in Stratfor Analysis, many EU members
use caution in moving against Russia due to the fear of economic repercussions, as any trade
sanctions would potentially harm European countries ("The U.S. Levies Sanctions 54).
Moreover, the sanctions have to be approved by all 28 countries-members of the EU, which
makes the whole process more complicated than it is in the U.S.
The Merrill Lynch European investor survey conducted by the Bank of America shows
that the risk of a geopolitical crisis is the second biggest concern after a severe slowdown in
China (Barley C12). No wonder that the flow of capital out of Russia increased drastically in the
past few months due to the tension with Ukraine. The Wall Street Journal reporter, Alexander
Kolyandr, states that investors are concerned about sanctions against Russia and are reluctant to
make investment decisions because of acute international environment of the past two months
(A11). The data released by Bank of Russia indicates that as of the middle of April, net capital
outflow from Russia reached $60 billion, which accounts for outflows of the entire 2013 fiscal
year. This suggests possible damage to investment climate or redistribution of global cash flows.
Escalating tension between Ukraine and Russia, annexation of Crimea, military actions in
Eastern Ukraine and economic sanctions start affecting not only Ukrainian and Russian
businesses, but also business beyond these borders. Executive directors around the globe start
anticipating the consequences of the current geopolitical tension on their businesses, and coming
up with the scenarios to safeguard employees, supply chains and assets (Knox and Monga A7).
As it is difficult to forecast outcomes of the tension and magnitude of the economic spillover,
many companies and investors that are directly or remotely involved in Ukrainian and Russian
business worry about possible business disruption, show decreased confidence and look for
partnership elsewhere.
High uncertainty and limited ability to calculate the economic spillover of the current
tension has raised concerns of more than 100 public companies globally. According to the Wall
Street Journal reporter Richard Barley, Ukraine has only few direct economic linkages with
Europe and accounts for a small part of the emerging-markets aggregate, but if tougher sanctions
against Russia will be imposed, there would be greater danger of contagion (Barley C12).
Geopolitical unrest and economic sanctions are hitting Russian market the most, but the stock
prices have shown a declining tendency in the global market as well. The negative affect of the
crisis is seen in the European stock such as Stoxx Europe, DAX, FTSE, Asian markets and U.S.
stock markets, but many investors and portfolio managers hesitate to make any changes yet and
continue monitoring the situation in Ukraine (Strumpf and Connaghan C1).
Another major area of global concern is centered around dependence on Russian gas and
oil. The EU receives about 30 - 35% of its total gas demand from Russia, which deepens its
dependence. Crimean annexation served as a wake up call to West and Eastern European
countries to consider alternative sources of gas. Some European analysts are concerned that the
tension between Russia and Ukraine may result in disruption of gas supply to Europe, as it has
already happened in January 2009 (Page 36). The main problem is rooted in the location of
Ukraine, which is situated between Russia and Europe. Due to the location of Ukraine, 50% of
the gas imported to Europe from Russia is routed through Ukrainian territory.

Any further escalation of the current conflict between Ukraine and Russia is increasing
the risk of gas supply disruptions, which would impact gas prices on the global level. John Page,
who assessed the impact of Ukraine on chemical markets, states that even though European
countries took some steps to reduce the dependence on Russian gas and gas routes through
Ukraine, Europe's reliance on Russian gas is expected to rise in the near future because of
declining gas production in Europe and relatively low-cost of Russian gas (37).
Even though Europe has its own shale-gas reserves, some countries have banned the
technology for extracting gas, also known as fracking, due to environmental worries. The report
prepared by U.S. Energy Information Administration reveals that Europe has up to 470 trillion
cubic feet of potentially recoverable shale-gas reserves, but some countries such as France,
Bulgaria and Germany have banned fracking in 2011 because of environmental opposition
(Williams A9).



The fear of potential water contamination and new regulations resulted in the slowdown of
explorations in European countries that havent banned fracking. As stated in the Wall Street
Journal article, countries like Poland and Ukraine experience higher dependency on Russian gas
imports, and are more receptive to easing regulations to allow faster development of shale gas
(Williams A9). However, recent aggression from Russian side and pressure from energy-
intensive sectors on European governments might speed up the development of the shale gas
industry in Europe. In addition, new technological advances during the past few years stimulated
the global energy revolution. The report on Russians energy problems prepared by Jason Kirby
reveals that new discoveries and technologies such as hydraulic fracturing have boosted the
supply of both oil and gas, and are already shifting the balance of power in energy markets
towards Norway's state-controlled Statoil (48). Many people believe that if Europe would
construct more terminals capable of handling liquefied natural gas, countries such as Qatar and
Australia can increase shipments to the continent (Kirby 48). Currently, the prices for gas in
Europe are twice higher than it is in U.S., so the support of shale gas development has incentives
such as lower gas price, improved competitiveness and decreased dependence on Russian gas.
For the first time since Russia joint the group of leading nations in 1998 also known as
G-8, the country was suspended from the organization due to its aggressive actions in Ukraine.
The G7 leaders, which include officials from the United States, Germany, France, Britain, Italy,
Japan and Canada, agreed to work together to reduce their dependence on Russian oil and gas
(G7 warns 4).
Russian military aggression also served as a push in U.S. gas exports. As of right now,
U.S. congress is working on the bill that will allow liquefied natural gas (LNG) exports overseas.
LNG exports suppose to weaken the importance of Russian gas and create economic
opportunities in U.S. Bruno Macaes, Portugals secretary of state for European affairs,
emphasizes the importance of the Transatlantic Trade and Investment Partnership (TTIP) and its
newest project, trans-Atlantic energy market, which focuses on U.S. energy exports. In order to
create a trans-Atlantic energy charter, the following four conditions should be met: American
exports restrictions for gas and oil should be lifted, the U.S. has to build terminals and transport
facilities to be able to exploit the new energy market, Europeans have to commit to infrastructure
development by creating electricity interconnections and cross-border gas pipelines, and Europe
should bring its environmental and state-aid standards closer to American (Macaes A15).
According to Mr. Macaes, by reducing the difference in energy prices between U.S and E.U.,
Europeans will be able to benefit by paying less for energy, and American energy producers will
profit by selling at competitive market prices (Macaes A15). A trans-Atlantic energy pact might
appear as an ambitious project, but both sides have strong incentives to compromise and proceed
with this project. Taking into consideration growing tension between Ukraine, Russia, West and
the U.S., the risk of gas supply disruptions is increasing, and need for alternative gas sources is
increasing as well.
As it has been already mentioned earlier, in January 2009 Europe suffered the longest in
the history (two weeks) disruption of gas supply caused by the disputes between Russia and
Ukraine. In order to increase the margin of safety in terms of gas supplies, the European Union
has been seeking alternative sources of gas and working on the additional gas routes that would
bypass Ukrainian territory and diversify gas supplies. One of such projects called South Stream
includes building a $22 billion pipeline that would send natural gas from Russia to Italy across
the Black sea bypassing Ukraine territory (Williams and Mock A7). However, current
geopolitical tension and Russian aggression raises questions of whether the South stream
pipeline should be build. Even though this project would minimize the possibility of gas supply
disruptions, it would also deepen Europes dependence on Russian gas. As stated in the Wall
Street Journal, the E.U. is working on another alternative project, which would allow supplying
gas from Azerbaijan via Turkey and Greece, but this pipeline would become operational only in
2019 (Williams and Mock A7). Taking into consideration the latest aggression by Russia, South
Stream project does not seem as a reliable option anymore. In addition, the completion of
Azerbaijan project and U.S. imports infrastructure might take several years. Current geopolitical
situation and limited availability of the alternative gas sources might force the E.U to reconsider
its own natural gas supplies and reserves. Some countries might consider investing into gas
development in Europe, which in the future would drive gas prices down and decrease
dependence on unreliable and unpredictable suppliers.
Even though Ukraine accounts for relatively small percentage of chemical production, it
is an important global producer and exporter of nitrogen fertilizer products derived from natural
gas (Page 36). According to the research done by John Page, Ukraine is important not only
because of export volumes but also because it has historically been a high-cost producer, and
exports from Ukraine have been a key determinant in setting global prices (36). The chemical
industry and global chemical markets have not been affected by the tension between Ukraine and
Russia yet. However, production of ammonia and fertilizers is very sensitive to the gas price, and
any further unfolding of the current conflict is increasing the risk of possible disruption of the
production and exports of petrochemical products. Since Ukraine is the fourth-largest exporter of
ammonia, and Ukraine urea exports in 2012 were 8.4% of global trade, the loss of both Russian
and Ukrainian exports would create significant fears of supply deficits and lead to global prices
increasing in both fertilizers and ammonia (Page 36-37). John Page suggests that some chemical
products like methanol, styrene, and polypropylene would not be affected by the disruption of
the ammonia exports due to the availability of the alternative export routes; however, it would
have a negative effect on global production of fertilizer products, such as monoammonium
phoshate, diammonium phoshate, NPK, and AN, as well as chemical products, like caprolactam
and ethanolamines (37). For Western European countries, the U.S. and Turkey, who import
ammonia related products from Ukraine and Russia, the disruption of the ammonia exports might
cause a significant problem.
There is a deep concern that further escalation of the situation and increased amount of
economic sanctions will contribute to global economic instability. Prices for oil, gold and wheat
have the highest potential to increase as the crisis unfolds. The gold prices already start climbing
as many people consider it one of the safest investments. However, economists and investors are
more worried about rising prices of wheat and oil. Ukraine is a third major wheat supplier in the
world, so concerns over escalating tension in Ukraine and possible supplies slowdown drives the
U.S wheat prices up. As Ukraine is also considered a valuable exporter of other grains, prices for
corn and soybean are increasing as well. At the same time crude oil climbed 2.3%, to settle at a
five-month high $104.92 a barrel, amid worries over supply disruptions (Strumpf and Connaghan
C1). Higher oil prices are also driving gasoline prices up, and in a long run this can have a
negative impact on the recovery of the U.S.
The reporter Ian Tallev reveals that deepening sanctions over Ukraine are already tipping
Russia into recession, disturbing nearby economies and threatening Europes wobbly recovery,
which has a potential to impact global growth (A2). Even though the West and the U.S. are
concerned about wider spillover as the tension escalates, both sides are pressured to prepare the
next round of sanctions. The most effective sanctions would be to target Russian oil and gas
exports, but both the U.S. and EU understand that it is unrealistic due to Europes dependency on
Russian gas. Currently, the U.S. and the E.U. agreed that the next round of sanctions would most
likely target the entire sector of Russian economy if Moscow will attempt to disrupt presidential
elections in Ukraine (Tallev A2). Targeting the Russian financial industry has the potential to put
at risk European investments and loans, and possibly slow down Europes recovery, but it would
be less harmful than any other options so far. Regardless the choice of future sanctions, the risk
of wider spillover is increasing and threatening not only businesses but also the global economic
growth. Twenty-first century policies and global economy formed an interdependent world,
where any crisis has the potential to hurt the global market.




































Works Cited

Barley, Richard. Investors Show Nerve on Ukraine Concerns. Wall Street Journal 16 Apr.
2014: C12.

Borak, Donna. "How Geopolitical Crises Could Pose A Financial Systemic Threat." American
Banker 179.39 (2014): 9. Business Source Complete. Web. 12 Apr. 2014.

"Europe's Risky Russian Energy Habit." Bloomberg Businessweek 4372 (2014): 16. Business
Source Complete. Web. 30 Apr. 2014.

"G7 Warns Russia Of More Sanctions If Ukraine Crisis Escalates." Regional Today (2014): 4.
Business Source Complete. Web. 12 Apr. 2014.

Kapur, Arjun. Ukraines Geopolitical Crisis. Harvard Political Review, 3 March 2014. Web.
30 Apr. 2014. <http://harvardpolitics.com/world/ukraines-geopolitical-crisis/>

Kirby, Jason. "How Russia's Energy Problem Fuels Unrest." Maclean's 127.10 (2014): 48.
Business Source Complete. Web. 12 Apr. 2014.

Knox Noelle and Vipal Monga. Companies Gird for Ukraine Turmoil. Wall Street Journal 18
Apr. 2014: A7.

Kolyandr, Alexander. Russia Shuns Stimulus Spending. Wall Street Journal 17 Apr. 2014:
A11.

Macaes, Bruno. Send a message to Putin with a Trans-Atlantic Energy Pact. Wall Street
Journal 23 Apr. 2014: A15.

Matthews, Owen. "Ukraine's Broken Nuclear Promises." Newsweek Global 162.12 (2014): 1-6.
Business Source Complete. Web. 23 Apr. 2014.

Mauldin, William, and Michael R. Crittenden. "U.S. Expands Sanctions Against Moscow." Wall
Street Journal - Eastern Edition 28 Mar. 2014: A8. Business Source Complete. Web. 30 Apr.
2014.

Page, John, et al. "The Crisis In Ukraine." Chemical Week 176.9 (2014): 36-37. Business Source
Complete. Web. 12 Apr. 2014.

Rachman, Gideon. Ukraine is a test case for American power. Financial Times 11Mar. 2014:
9. Business Source Complete. Web. 23 Apr. 2014.

Robehmed, Natalie. "U.S. Treasury Sanctions Four Russian Billionaires For Ukraine
Involvement." Forbes.Com (2014): 24. Business Source Complete. Web. 12 Apr. 2014.

"Russia Feeling The Heat To Start Payment System." ISO & Agent 10.16 (2014): 15. Business
Source Complete. Web. 12 May 2014.

Seib, Gerald. Political Conversation Takes on a Foreign Accent. Wall Street Journal 08 Apr.
2014: A4.

Strumpf, Dan and Clare Connaghan.Stocks Take Hit From Ukraine Unrest. Wall Street
Journal 04 Mar., 2014:C1.

Tallev, Ian. Fear in West Tempers Sanctions. Wall Street Journal 05 May, 2014:A2.

"The Geopolitical Realities Behind The Ukraine-Russia Natural Gas Deal." Stratfor Geopolitical
Diary (2013): 12. Business Source Complete. Web. 29 Apr. 2014.

"The U.S. Levies Sanctions On Russian And Ukrainian Officials." Stratfor Analysis (2014): 54.
Business Source Complete. Web. 30 Apr. 2014.

Wieseltier, Leon. "Washington Diarist." New Republic 244.24 (2014): 59. Business Source
Complete. Web. 23 Apr. 2014.

Williams, Selina. Ukraine Crisis spurs Calls For Europe to Rethink Shale. Wall Street Journal
27 Mar. 2014: A9.