Economic Warfare in the Russian-Ukrainian Conflict: Crimea

Russia’s “hybrid warfare” concept embraces economic warfare as one of its key elements. Yet, less attention has been paid to the details of the economic war between Russia and Ukraine in the conflict over Crimea and parts of Donbas (eastern Ukrainian region encompassing Luhansk and Donetsk provinces). Indeed, the effects of pure economic war are difficult to separate from the overall destructive impact the military conflict in Donbas has had on the regional economy. Moreover, the significance of Western sanctions or issues of natural gas supply regularly overshadow Russian-Ukrainian economic issues in Western media. Yet, examining those effects is useful for developing an accurate outlook of the present conflict.

Perhaps Ukraine’s largest loss in the current war originates from the Russian annexation of Crimea, costing Ukraine over $1 trillion, foremost due to the forfeiture of its offshore oil and gas reserves (see EDM, April 14). It is difficult to judge whether Moscow had only military or also economic considerations when designing the Crimean operation. Yet, President Vladimir Putin’s habit personally directing Gazprom’s business strategy (kremlin.ru, October 24) suggests that the annexation might have had at least some economic rationale. Furthermore, Crimea’s inherent value offers the Kremlin a plausible justification to the Russian public for the costs incurred during the annexation, as well as from the ensuing Western sanctions.

Notably, Kyiv has not resisted Russia’s Crimean operation militarily, but it has applied subsequent economic counter-measures by exploiting Crimea’s dependency on the supply of water, natural gas, electricity and telecommunications from mainland Ukraine. The Ukrainian government is likely using the supplies issue as leverage in its negotiations with Russia over stability in Donbas, the secure supply of gas at reasonable prices, and Russia’s withdrawal of regular troops from southeastern Ukraine.

Prior to the peninsula’s annexation, Crimea reportedly received 85 percent of its fresh water via the Northern Crimean Canal from the Dnieper River. In late April, Ukraine cut the supply after the occupying authorities’ non-payment at the new rates following bilateral negotiations between Kyiv and Moscow (ITAR-TASS, April 26). Kremlin representative estimate that solving the issue for Russia will cost $247–417 million (ITAR-TASS, April 28). Recently, Crimean media indicated that the problem has been partially addressed via an alternative channel built to carry water from the Biuk-Karasu River to the Northern Crimea Canal. But a Crimean official admitted that negotiations with Ukraine over the resumption of the supply intensified at the beginning of October 2014 (RIA News, October 21).

Another important subject of the confrontation is the energy supply to the annexed peninsula. Electricity is generated internally by Krymenergo, controlled by Rinat Akhmetov’s DTEK, but part of it is also transmitted from Ukraine’s grid, which is controlled by the Ukrainian government. Ukraine’s Energy Minister Yuriy Prodan stated recently that the supply of electricity to occupied Crimea had been halved (UNN, October 9). DTEK continues to operate its Krymenergo facilities, but there have been several emergency power shutdowns requested by the Ukrainian government–owned grid operator and explained by “technical issues” (dtek.com, March 25). Crimean authorities declared some questionable ideas to achieve “energy independence from Ukraine,” including the use of mobile gas turbine power stations. Apparently, no such plans have been implemented, and the situation could likely worsen this winter (Capital, September 4). Again, Crimean authorities cited ongoing “complex negotiations” and Russia’s proposal to supply energy to Ukraine in exchange for the resumption of electricity sales to Crimea (Capital, October 8).

Crimea is able to assure self-sufficiency in natural gas thanks to the seizure of the company Chornomornaftogas—but not in winter. As Ukraine no longer delivers gas to Crimea, local authorities likely tap up to 2 billion cubic meters (bcm) of stored gas belonging to Naftogaz Ukraine. Russia also announced some plans to build alternative gas supply routes from South Stream in two years, a 2-bcm pipeline through Kuban, or a 2-bcm route from Anapa by January 2016 (RIA Novosti, June 16).

Meanwhile, Ukraine legally banned the conduct of all state-regulated businesses in Crimea. As a result, Russian-owned Sberbank-Ukraine, VTB Ukraine and other Ukrainian banks exited the peninsula. The value of Crimea’s banking business was estimated at $1.7–1.9 billion by the National Bank of Ukraine (RT, April 15). Currently, Bank Rossiya and other Russian banks that do operate in Crimea have to incur higher operating costs necessary to address international sanctions and may thus be providing sub-standard service to Crimean clients.

An exodus of telecom companies from the peninsula has included mobile telephone operator MTS Ukraine, which had to sell its Crimea assets “to two private investors” (Ekonomichna Pravda, October 22). Ukrtelecom, a major fixed-line and Internet operator owned by Rinat Akhmetov, also divested its Crimean business (ITAR-TASS, May 8). Notably, some Transnistrian investors appeared among the new owners of Crimean cellular operators (Capital, October 24). Such deals were most likely not fair for Ukrainian owners. Nevertheless, large, sanctions-wary public Russian companies seem to be mostly avoiding doing business in Crimea.

For now, Ukraine continues to hold a firm grip over the land supply routes to Crimea. The Russian Federation’s only recourse is to continue using ferries across the narrow Kerch Strait, which are often disrupted by storms and bedeviled by long waiting times for customers. Yet, the overland supply of Ukrainian goods to Crimea has not halted entirely since March 2014. Indeed, the Russian Federal Customs Service twice lifted the ban on imports of Ukrainian food products to Crimea—currently, until 2015 (ipress.ua August 7). The leader of the Crimean Tatar Mejlis, Mustafa Cemilev, even complained that Ukrainian agricultural products were being re-exported to Russia from Crimea (Channel 5 via Glavcom, October 6).

While the pressing military-political situation in Donbas is rapidly evolving and raising the most attention, it is precisely the economic war around Crimea that may itself become a source of escalation in the Ukrainian-Russian conflict. President Vladimir Putin recently expounded his promise to defend the Russian Bear’s home in the “taiga”—thus indirectly pointing to Crimea (kremlin.ru, October 24). However, property expropriation issues and problems with private Ukrainian companies call into question the sustainability of Russian economic and possibly even political governance there. Ukraine’s sanctions against the occupied Crimean peninsula demonstrate the Kyiv government’s ongoing resistance not solely to Crimea’s annexation, but also to Russia’s possible further military expansion at Ukrainian expense.