April 13, 2018 / 2:02 PM / 12 days ago

Commentary: U.S. sanctions are an aluminium-tipped precision strike

LONDON (Reuters) - When it comes to U.S. sanctions, it seems not all Russian oligarchs are created equal.

President of En+ Group, Oleg Deripaska attends an agreement signing ceremony with the Krasnoyarsk region's government, in Moscow, Russia December 12, 2017. REUTERS/Sergei Karpukhin

Seven were designated by the Treasury Department for sanctions along with 17 Russian government officials.

But one has been singled out for special treatment: Oleg Deripaska, owner of the world’s largest aluminium producer outside of China.

Of the 12 companies subject to sanctions, eight are controlled by Deripaska.

United Company Rusal, which produces 6 percent of the world’s aluminium in any year, takes centre stage.

But the sanctions encompass the full length and breadth of his empire, from offshore entities such as the British Virgin Islands-registered B-Finance through the London-listed EN+ holding company to Russian power generator EuroSibEnergo, commercial vehicles producer GAZ Group and farming group AgroHolding Kuban.

The Treasury Department’s sanctions are aimed at allies of President Vladimir Putin in one of Washington’s most aggressive moves to punish Moscow for its alleged meddling in the 2016 U.S. election and other “malign activity”.

But why has Deripaska been specifically targeted with the sort of measures, including potential secondary action on non-U.S. entities, normally reserved for Mexican drug lords?

The answer is aluminium.

MADE IN AMERICA

Imports of steel and aluminium are “an assault on our country”, President Donald Trump declared as he signed executive orders imposing tariffs on both on March 8.

In the build-up to that moment, presidential rhetoric and media coverage focused on the flow of Chinese material into the United States.

Curiously absent was any public discussion of Russia, even though it has been the second-largest volume supplier of unwrought aluminium to the United States for several years.

Trump was even offered the option of draconian tariffs on Russian aluminium as one of five countries identified by the Commerce Department as operating “significant overcapacity” or being “potential unreliable suppliers”.

Instead, he went for a flat 10 percent duty with exemptions for allies, first and foremost Canada, the largest supplier to the U.S. market.

With hindsight, there was no need to single out Russia for special tariffs treatment since the administration knew it was about to slam the door on Russian aluminium imports via sanctions on Rusal.

The stated aim of steel and aluminium tariffs is to raise U.S. production to 80 percent of capacity.

The country’s aluminium smelters operated at just 43.2 percent capacity last year.

The removal of 700,000 tonnes of Russian imports combined with spiking aluminium prices, in terms of the London Metal Exchange and local U.S. premiums, are a powerful incentive to refire long-idled potlines.

Frankly, if the combined effect of price and sanctions doesn’t spark restarts, nothing will revive dormant American smelters.

VULNERABLE TARGET

At some stage in the U.S. administration’s study of the country’s dependency on aluminium imports, there must have come a realisation of just how vulnerable Deripaska’s empire would be to sanctions.

This is not just because he has two entities listed outside Russia - Hong Kong-listed Rusal and London-listed EN+, both of which have been unceremoniously dumped by investors.

It’s also because Rusal’s aluminium business is almost totally export-oriented, dependent on dollar-denominated debt and at the heart of a complex network of supply chains.

Of the 3.7 million tonnes of metal produced by Rusal last year, only 650,000 tonnes went to the Russian market, according to Goldman Sachs. (“Commodity Watch, April 12, 2018).

Everything else was exported and the United States was the largest single source of non-Russian revenue from external customers last year, as it was in 2016.

Rusal had debt of $8.5 billion at the end of 2017, just about all of it dollar-denominated, including three Eurobond issues totalling $1.6 billion, which are already being cut off from the bond market infrastructure.

The company’s alumina refineries and smelters, meanwhile, are dependent on external raw material supplies.

To take just one example, the Aughinish alumina refinery in Ireland operates on bauxite shipped by Rio Tinto.

How can Rio Tinto keep shipping to Aughinish without falling foul of secondary sanctions for “knowingly facilitating significant transactions for or on behalf of the individuals or entities blocked today”, to quote the Treasury’s April 6 statement?

Goldman Sachs’ view is that such overseas assets will have to change ownership before the May 7 sanctions deadline, but who will buy them and how will they pay without risking secondary sanctions?

STRATEGIC TARGET

The Rusal aluminium empire may have offered the United States an easy target, but it is also a strategic one.

The company is not only the major employer in far-flung cities such as Krasnoyarsk and Bratsk but is also the de facto government, another hark back to Soviet days.

As Rusal notes in its accounts, “the group contributes to the maintenance and upkeep of the local infrastructure and the welfare of its employees, including contributions toward the development and maintenance of housing, hospitals, transport services, recreation and other social needs of the regions of the Russian Federation where the group’s production entities are located”.

Rusal, in other words, is simply too big to fail from a Russian government point of view. Moscow will have to step in if the company can’t survive the sanctions.

This aluminium-tipped strike travels from the low-tax island of Jersey, where Rusal is incorporated, through assets in Ireland, Sweden and Guyana, to Russia’s industrial heart.

And here’s the thing.

What form will the next strike take?

Will it be nickel-tipped? There’s already speculation in the metal markets over Norilsk Nickel, another Siberian industrial giant, in which Rusal owns a 27.8 percent stake.

That’s probably too low a threshold for Norilsk to be caught up in these sanctions.

But its oligarch owner, Vladimir Potanin, has just been put on notice, as have all the powerful industrialists surrounding the Putin administration.

The opinions expressed here are those of the author, a columnist for Reuters.

Editing by Dale Hudson

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