How do sanctions work. The military industry of the occupied Crimea

It is clear that the Russian occupation of the Crimean peninsula did not have «the return of Russian lands» as its key purpose. First of all, it has been aimed at creating the giant military base.

Occupied Crimea became the location of troops and weapons, an important logistical element of the Russian military operation in Syria and comfortable place for the large part of military industrial complex based on the expropriated Ukrainian enterprises.

Composition of the military industrial complex of Crimea

The composition of the military industrial complex of the occupied peninsula is as follows:

Large enterprises seized by the Russian Federation in the first months of occupation (the majority has been expropriated in the first weeks);

Private industrial enterprises registered in accordance with the Russian legislation

Sergei Shoigu, the Ministry of Defense of the Russian Federation, declared the intent to include the industry of the occupied peninsula in the Defense Acquisition Order on April, 4, 2014. He emphasized the importance of the «effective use of industrial and technological potential of the military industry of Crimea».

The Ministry of Defense compiled the list of 23 Crimean enterprises the Ministry was interested in by the middle of April 2014.

13 Ukrainian state enterprises (SE) have been part of the Concern «Ukroboronprom»:

SE Feodisia shipbuilding company «More» \ «Sea»

SE «Feodosiisky optychny zavod» \ «Feodosia optical factory»

JSC «Zavod «Fiolent» (Simferopol) \ JSC «Fiolent» Factory»

SE «Konstruktorsko-tekhnologichne buro «Sudokompozyt» (Feodosia) \ «Construction-technological bureau «Sudokompozyt»

SE «Naukovo-doslidnyi instytut aeropruzhnykh system» (Feodosia) \ «Applied research institute of aeroelastic systems»

SE «Yevpatorijsky aviatsijny remontny zavod» \ «Yevpatoria avia repairing factory»

SE «Sevastopolske aviatsijne pidpryemstvo» \ «Sebastopol aviation enterprise»

SE «Skloplastyk», Feodosia

SE «Feodosijsky sudnomekhanichny zavod» of the Ministry of Defense of Ukraine \ «Feodosia ship-mechanic factory»

SE Tsentralny konstruktorske buro «Chornomorets», Sebastopol \ «Central designing bureau «Chornomorets»

SE «Spetsialna vyrobnycho-tekhnichna baza «Polumja», Sebastopol \ Special production base «Flame»

SE «Naukovo-doslidny tsentr «Vertolit», Feodosia \ Research center «Helicopter»

SE «Konstruktorske buro radiozvjazku», Sebastopol \ «The radio communication designing bureau»

Besides enterprises of the Concern «Ukroboronprom», the Russian Federation expropriated a number of other large enterprises capable to realize military orders; it is shipbuilding factory «Zaliv», JSC «Sevastopolsky morsky zavod» \ Sebastopol sea factory, SE «Vyprobuvalny tsentr «Omega» \ Testing center «Omega».

There are also several private enterprises which have been quickly reregistered in accordance with the Russian legislation, with the purpose to receive military orders.

The table below lists some of Sebastopol enterprises which already realized Russian defense orders or cooperated with Russian military enterprises:

Enterprises of the occupied territory undergo various changes: Crimean «trophy» enterprises change their organizational and legal forms, the form of the ownership, their property is transferred to other legal entities. Some enterprises try to «optimize» their structure, in order to avoid sanctions etc.

For example, Feodosia «Skloplastyk» has been attached to the shipbuilding factory «More». In its turn, «More» has been turned into joint stock company and included into the plan of the «privatization of the federal property» for 2020-2022. «Privatization» should be the final legal point in the transfer of the factory to the state corporation «Rostex» initiated by the Putin’s decree in May 2018.

Sebastopol «Chornomorets» does not exist anymore as it has been attached to «Sevmorzavod» as the design and engineering center. Since the beginning of 2015 «Sevmorzavod» became the branch «Sebastopol sea factory» of the JSC «Shipyard «Zirochka».

Founders of the LLC «Uranis» reregistered their enterprise in accordance with the Russian legislation and created two new legal entities: the first one (Open Joint Stock Company «Uranis-Radiosystemy») is for the work with the Russian Defense Acquisition Order and the second one (LLC «Uranis») is for the foreign economic activity.

Russian enterprises of the defense complex create their branches and subsidiaries on the occupied territory.

For example, Leningrad shipbuilding factory «Pella» registered LLC «Kaffa-Port» in January 2015 in Feodosia for the work on shipbuilding factory «More» leased by «Pella». Today «Kaffa-Port» completed its tasks and is being liquidated.

It is difficult to compile the exhaustive list of Crimean enterprises working with military orders. In accordance with the official data of the Russian Federation, there are 16 enterprises of the military industrial complex on the territory of the occupied peninsula. Ten enterprises work in the shipbuilding industry, three – aviation, two – conventional weapons, and one – in radio electronic industry.

In 2017 the Register of organizations of the military industrial complex of the Russian Federation included eight enterprises of the Republic of Crimea and four enterprises of Sebastopol.

Even manufacturers of the civilian goods try to work for the Russian «defense».

Not all of them are successful. Not all Crimean enterprises included into the above mentioned Register are successful in receiving military orders.

Russia has giant manufacturing facilities of the military industrial complex. There is the high competition for the money of the Defense Acquisition Order. International sanctions also play an important role.

The Ministry of the Industry and Trade of the Russian Federation appointed so-called «supervisors» for Crimean industrial enterprises from May 2015 till August 2017. «Supervisors» were selected from representatives of relevant Russian manufacturers.

«Supervisors» had to share defense orders with their Crimean partners and to modernize them. The «supervisorship» has been stopped in August 2017, after the update of the USA «Crimean» sanction list.

In October 2019 Sergei Aksenov, the so-called «head of Crimea», told that «as of September 1, 2019, the total value of contracts implemented by Crimean enterprises of the military industrial complex reached more than 21 billion rubles, including 17 billions – upon defense orders. Average workload on manufacturing facilities has been 40%».

Oleg Zachinjaev, the director of the Feodosia shipbuilding factory «More», commented the influence of sanctions on the work of the factory: «In accordance with the federal target program for Crimea, ships are built not by Crimean, but by enterprises on the mainland territory which won respective tenders». Besides that, «we lose procurement bids because of logistical issues and sanction restrictions. Sanctions ban direct acquisition of necessary equipment. It is not a secret that more than 50% of necessary parts and equipment for ships being built are imported. We have to buy them by using certain schemes and we lose competition as our partners are able to conduct the acquisitions directly. Consequently, nobody would like to participate in our tenders because they do not want to get under sanctions for the cooperation with Crimean enterprises».

What sanctions have the most impact on the military industry

The majority of Crimean enterprises in the military industrial complex are included into sanction lists of Ukraine, or Ukraine and USA whereas shipbuilding factory «Zaliv» is included into EU lists.

There is also general investment ban and USA and EU ban on export or import of goods, technologies and services to \ from the occupied Crimean peninsula.

However, as soon as there is very developed manufacturing cooperation in this sphere (see below), sanctions targeting only Crimean legal entities are not what hits Russia the most.

Significant number of large Russian enterprises of the military industrial complex cooperates with Crimean enterprises. Sanctions against them are perceived as far more painful. A number of these enterprises are included into the list of the USA Office of Foreign Assets Control (OFAC): in SDN (Specially Designated Nationals List) and SSI (Sectoral Sanctions Identifications List).

Depending on the type of the sanction list, various restriction measures are applied towards these legal entities: blocking assets, ban on various transactions; expanding sanctions on shares of these entities in other legal entities (if the share is more than 50%).

Export \ import restrictions on supply of goods and technologies for the industry turned out to be the most effective as continuous Russian efforts to avoid sanctions or to hid information about enterprises demonstrate.

First restrictive measures on export of defense products to Russia have been introduced by USA on March 1, 2014. The US Bureau of Industry and Security suspended the licensing of export and re-export of dual use goods to the Russian Federation. Earlier issued licenses on the export of military goods have been also suspended in March of the same year.

The USA introduced additional restrictions on the export of military goods to Russia in April 2014 whereas previous export licenses on supply of technologies to Russia have been cancelled. More to that, the Bureau of Industry and Security introduced additional export restrictions about 13 Russian companies in the OFAC list.

Since the beginning of the Russian aggression against Ukraine, the Bureau of Industry and Security expanded several times the Entity List about export restrictions.

The current List contains 244 Russian legal entities. 154 entities from the List are also included into SDN or SSI of the Office of Foreign Assets Control, and 90 legal entities of the List are not included into OFAC lists.

If the enterprise is included into the Entity List, then, it is obligatory to receive license for export, re-export and \ or transfer to the country of:

• Goods from USA
• Goods manufactured in USA
• Good manufactured abroad with certain components or technologies from USA

These enterprises have to receive export license on all goods, even if those goods not included into the Control trade list and usually not requiring the license.

According to its current rules, the BIS considers applications for the license on the basis of the presumption of refusal.

In 2020 the USA keep strengthening technological sanctions against Russia: more general restrictions on export to Russia of goods not requiring licensing and usually perceived as civilian goods are introduced (computers, bearings, semiconductors etc.). The presumption of refusal about export licenses on supply to Russia of all goods which can be used for military purposes has been enacted since October 29, 2020.

The European Union introduced restrictions on the export to Russia on July, 31, 2014.

Restrictions covered weapons and military equipment, dual use goods and technologies as well as technologies for the oil industry.

It is banned to sell, supply, transfer or export, directly or indirectly, dual use goods and technologies regardless of whether they originate in EU, to any Russian natural or legal persons, Russian resident or for the use in Russia, if these goods are or can be, fully or partially used for military purposes or for the final military user.

If the final user is the Russian military, then, any dual use goods or technologies bought by the Russian military are considered as intended for military purposes.

When considering applications for permits, relevant authorities do not have to issue permits for export to natural or legal persons, organizations and bodies in Russia or for the use in Russia, if there are reasonable grounds to believe that the final user may be the military user or if goods can have final military purpose.

Ukraine officially introduced restrictions on the export to Russia of the dual use and military goods by Presidential decrees in August 2014. Intergovernmental agreements with the Russian Federation about military technological cooperation and production and technological cooperation of the enterprises in the military industrial complex have been suspended by orders of the Cabinet of Ministries in 2015.

How does the Russian Federation attempt to avoid sanctions

Technological processes in the military industry to a certain extent differ from the rest of Crimean enterprises. They require cooperation with a great number of various companies. If Crimean enterprises in the military industrial complex would like to receive military orders, they should be built into Russian large technological chains.

In 2019 the Monitoring group of the Institute of Black Sea Strategic Studies identified not less than 150 Russian enterprises from all Russian regions which cooperated with Crimean enterprises on the execution of military orders.

Schemes to avoid sanctions in the military industry are no longer the headache of any given enterprise. Attempts to avoid sanctions in this industry are the governmental policy of the Russian Federation.

Secrecy is the most important component of this policy.

Since 2015 the Russian Federation undertook several measures to prevent the leakage of the information about production links with «toxic» enterprises:

• An access to the Register of organizations of the military industrial complex of the Russian Federation has been closed in September 2015 (the order of the government of the Russian Federation from 07.09.2015 № 944).
• Military procurement rules have been changed.
• The Russian government ordered key military enterprises (order # 858п-П13) to transfer their procurement to the closed electronic trade platform «АСТ-ДОЗ» («Automated trade system for the Defense Acquisition Order» created jointly by Sberbank-ACT and Rostex corporation) in November 2017. The governmental order targeted more Russian than Crimean enterprises. More to that, the order made it obligatory to hide information about names and locations of bid participants in bid protocols
• The federal law adopted in April 2020 exempted winners of military bids from the obligation to publish information about bids in the unified information public procurement system. Before they had to publish their procurement plans.
  The explanatory note to the mentioned draft law explained:
  «Given international sanctions against enterprises of the military industrial complex, the disclosure of information about their procurement de facto means the disclosure of the information about interaction of suppliers with the person in the sanction list. It causes negative outcomes for suppliers (discrediting suppliers; their inclusion into sanction lists, cancellation of export licenses) as well as for enterprises of the military industrial complex (in particular, their inability to buy goods under sanctions; failure to receive goods in accordance with concluded agreements; refusal of suppliers to work with enterprises of the military industrial complex). Indicated outcomes occur regardless of the category of proposed goods and are caused by international sanctions about enterprises of the military industrial complex.
• An access to the public information about enterprises in the military industrial complex has been also closed.
• In November 2017 the Russian government exempted enterprises of the military industrial complex from the obligation to publish information in accordance with a number of the following laws (the governmental order # 8583п-П13): «About Joint Stock Companies», «About the Market of Securities», «About Financial Leasing», «About State Registration of Legal Entities and Individual Entrepreneurs», «About Credit Histories», «About Consolidated Financial Reporting», «About the Accounting», «About Defense Acquisition Order». It should be noted that exemption has been made even before the introduction of amendments to the relevant legislation;
• A number of respective legislative acts and by-laws followed. For example, the governmental order from 06.06.2019 # 729 closed an access to some parts of the information in the Unified State Register of Legal Persons if:
  – the legal person is under international sanctions;
  – the legal person is the bank servicing the Defense Acquisition Order;
  – the legal person is located on the territory of Crimea or Sebastopol;
  – information is about branches or representative offices of the legal person on the territory of Crimea or Sebastopol.

How do sanctions work in practice

At the very beginning (2014-2015) in response to sanctions Russian authorities put forward the following thesis: sanctions were good for the Russian economy because they would stimulate the import substitution. Then, they abandoned it as the «import substitution» failed in spheres of instrumentation, machine building and engineering, military industrial complex, equipment for oil and gas exploration.

An example of military shipbuilding and aircraft construction is illustrative.

Shipbuilding

Open access to Western technologies, parts and equipment is the necessary precondition for the contemporary Russian shipbuilding to modernize the military fleet on time.

An absence of such an access has the following outcomes: the construction of many objects is significantly delayed and postponed whereas some projects of military ships are cancelled.

Here is the quote from the Strategy for the development of the shipbuilding industry of the Russian Federation until 2035 (it has been approved in 2019):

«Today the share of the cost of foreign parts in the total cost of the ship equipment varies from 40 to 85% for civilian sector, and from 50 to 60% for the military shipbuilding.

The main cause of such situation is the low competitiveness of the large specter of the national ship equipment. In its turn, the low competitiveness is shaped by the low quality and high cost of components, an absence of the warranty repair and services, inconsistency with modern environmental requirements. More to that, a number of ship equipments is not manufactured at all by the national industry.

[…] there is significant dependency upon foreign supplies of equipment and sanction policy of the foreign countries in the industry. It threatens the possibility of building certain types of ships and maritime equipment in the Russian Federation. High share of foreign products in ship’s equipment and fluctuations of the exchange rate increase the risk of the rising cost and failure to deliver ready ships and equipment on time. An absence of the national manufacturing of the electronic components, disrupted cooperation links, deficient management and difficulties to replace imported parts with national analogues also significantly influence manufacturing in the shipbuilding industry».

Today the main problem of the Russian military shipbuilding is caused by the inability to supply Ukrainian and German engines (main energy equipment).

As an example, let us take rocket frigates of the 11356 project. It was planned to introduce them to the Black Sea Fleet of the Russian Federation.

The project relied on the installation of engines manufactured by the Ukrainian state enterprise «Naukovo-vyrobnychi kompleks gasoturbobuduvannja «Zoria-Mashproekt» \ «Research and manufacturing complex for the construction of gas turbines «Zoria-Mashproekt». In 2011 the large scale modernization of the Russian army and fleet has been announced, and it has been planned to build six frigates.

The building of three ships has been completed and they have been transferred to the Black Sea Fleet in 2016-2017: «Admiral Grigorovich», «Admiral Essen» and «Admiral Makarov».

However, the factory did not succeed in installing Ukrainian engines before the introduction of sanctions. The government of the Russian Federation put the task to replace the import of Ukrainian engines by manufacturing the analogue at Russian enterprises. This attempt failed.

As a result, it has been decided that two hulls of frigates previously planned for the Russian Black Sea Fleet («Admiral Butakov» and «Admiral Istomin») would be completed at Kaliningrad shipyard «Yantar» and sold to India without engines. India intends to buy engines for them directly from Ukraine.

One more frigate, «Admiral Kornilov», will be completed in India, at Goa Shipyard Limited.

It is likely that further building of frigates of the 11356 project will be cancelled.

The construction of frigates of the 22350 project at shipbuilding factory «Severnaya verf» (Saint Petersburg) ran into the same problem.

The Ministry of Defense of the Russian Federation concluded an agreement with «Severnaya verf» on building of six ships of the 22350 project in 2010-2011. All of them should have been built and transferred to the Russian Navy by 2018.

Plans have been disrupted by the failure to supply engines of Ukrainian «Zoria-Mashproekt». «Objedinennaja dvigatelestroitelnaja korporatsia» \ «Unified engine building corporation» (it is part of «Rostex»). The supply of the first Russian diesel turbo engine for the project has been announced only at the end of November 2020.

When Volodymyr Putin participated in the «ceremony of initiating the massive building of ships for the Russian Navy conducted through video conferencing» in occupied Kerch on July 20, 2020, the shipyard «Severnaja verf» only began the building of two last frigates of the 22350 project. They should have been transferred to the Navy in 2018…

The building of small rocket ships (corvette) of the 21631 project also ran into serious difficulties caused by the absence of engines of the German company MTU Friedrichshafen GmbH.

A series of ships built by Zelenodolski factory named after Gorki should include 12 ships: three for the Caspian Fleet, six for the Black Sea Fleet and three for the Baltic Fleet. The factory succeeded in installing engines only on five ships.

After the German company cancelled further supply of engines for ships of this project, Russian «Kolomenskii zavod» and «Zvezda» factory (Saint Petersburg) has been given the task to make the import substitution.

After they failed, the Russian Navy decided to install engines manufactured in China on ships of this project. It is engines of the company Henan, manufactured under the license of the German company Deutz-MWM which left the market of ship engines in 1980s. According to Russian engineers, «Chinese product does not fully meet the exploitation conditions of the Russian Navy».

Today the Navy received eight ships of 21631 project (three – with Chinese engines), the rest is still being built.

It is very likely that Russia will have to cancel the construction of corvettes of the 21 631 project.

The list of problems of the Russian military shipbuilding caused by international sanctions can be expanded…

The phrase «deadlines are moved to the right» already became usual when Russian mass media and public officials talk about problems with the shipbuilding.

There is no doubt sanctions negatively and directly influence Russian attempts to develop military industrial complex of Crimea.

For example, Leningrad shipbuilding factory «Pella» suspended the building of rocket corvettes of the 22800 project «Karakurt» for the Russian Black Sea Fleet on Feodosia factory «More» and suddenly moved unfinished hulls of ships to Leningrad oblast of the Russian Federation. It is clearly an outcome of the threat of sanctions.

The work of «Pella» in occupied Crimea has been widely covered in media. It should be emphasized that factory «Pella» is the owner of J. J. Sietas Shipyard in Germany through the subsidiary Pella Sietas GmbH: Neuen-felder Fardeich 88, 21129 Hamburg (www.pellasietas.com) since March 10, 2014.

«Pella» left the factory «More» in autumn 2019, one year before the expiry of the leasing agreement.

All three incomplete ships (two of them – «Kozelsk» and «Oxotsk» – had to be transferred to the Navy in 2019) have been moved by rivers to the factory «Pella» in Leningrad oblast.

Two ships («Oxotsk» and «Vikhr») spent 2019-2020 winter at Rostov-na-Donu port.

Aircraft industry

The developer and manufacturer of aircrafts JSC «Taganrogskii aviatsionny nauchno-tekhnicheskii kompleks im.G.M.Beriev» (TANTK, part of «Objedinennaja aviastroitelnaja korporatsia» \ «Unified aircraft corporation») started cooperation with Yevpatoria aircraft repair factory after the occupation of Crimea. Few years later it ran into problems with the construction of its new amphibious aircraft BE-200.

Russian media informed in the spring 2019 that Ukrainian engines D-436TP (manufactured by «Motor-Sich») would be replaced by the Russian engine PD-10. There has been only one problem: the Russian engine did not exist, it had to be developed. It was informed only in October 2020 that the new engine (PD-8) would be ready by 2022 and it would be installed on planes next year…

Next generation airborne early warning and control aircraft A-100 «Premier» developed by Concern Vega (part of the holding «Roselektronika») has been planned to enter service in 2015. Shoigu, the Minister of Defense, declared in 2017 that «Premier» would be ready by 2020. The deadline turned out not to be final. It was informed this year that deadlines again «moved to the right», to 2024.

Various reasons for the «movement of deadlines» are announced. However, there is the high probability that the true reason is the introduction of international sanctions against Russia. The most problems Russia experiences with the import substitution lie in high tech industries, in particular, in electronics.

The new middle range narrow body aircraft MC-21-300 called «mainline aircraft of the 21st century» in the Russian Federation still cannot receive international certificate.

Start of the serial production has been initially planned for 2017. Then, there were «movements of deadlines» – 2018 and 2020. It was informed in February 2019 that the serial production has been again postponed for 2021. It is likely that it will be again delayed until 2025 as Objedinennaja aviastroitelnaja korporatsia (OAK) \ Unified Aircraft Corporation and «Rostex» have been put into sanction lists.

In autumn 2018, the USA introduced sanctions against JSC «Aerocomposite» (part of the OAK) and JSC «ONVP «Teknologia» im.Romashina» (part of «Rostex»). As an outcome, American company Hexcel and Japanese Toray Industries suspended the supply of materials for the composite «black wing» of MC-21.

Replacement of composite materials with metal made the whole project meaningless as MC-21 would lose its competitive advantages before Airbus and Boeing. Composite materials of other foreign suppliers had lower quality whereas the Russian Federation did not have necessary know-how. But later Denis Manturov, the Minister of Industry and Trade, told journalists in February 2019 that testing of new samples of materials for MC-21 from national components «demonstrated that the replacement of material would not influence the characteristics of the aircraft».

There are other difficulties. At the very beginning it was planned that the share of national parts for MC-21 would be 38% but later the government ordered increasing the share to 97% by 2022, in order to get rid of the dependency upon import supplies.

The director of the Department of Radioelectronic Industry of the Russian Ministry of Industry and Trade informed on September 30, 2020 that that a number foreign companies supplying ready systems for Russian civilian aircrafts cancelled their supplies and cooperation. Restrictions are mostly related to the microelectronics.

«They told they would not supply systems without declaration of sanctions. They try to stop our civilian aircraft manufacturing», said the director of the department.

It should be noted that the airborne early warning aircraft TU-126, the first in USSR, has been created on the basis of the civilian TU-114. Aircraft initially planned as civilian can be the carrier of various systems of weapons.

Conclusion: given the use by Russia of the occupied Crimean peninsula, «Crimean sanctions» cannot be applied only against Crimean enterprises. Only well developed system of international sanctions covering the wide range of technologies, equipment and parts, can reduce the Russian military threat and bring closer the de-occupation of Crimea.