USSR: THE ROLE OF COMPENSATION AGREEMENTS IN TRADE WITH THE WEST (ER 78-10660)

Created: 11/7/1978

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USSR: The1 Role of Compensation Agreements jln Trade With the West

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Key Judgment*

The USSR has increasingly looked to compensation agreements with Western firms to repay the costs of buying Western equipment andThe exports guaranteed under the more thangreements concluded over the past decade in fact willalue much larger than theillion

worth of agreement-related imports from the West

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Earnings from agreements signed thus far will boost Soviet hard currency exports inspecially. The rise in earnings0 million7 to nearlyillion inwill soften the impact of the expected decline in oil production in thend the resulting fall in oil exports to the West.

Although Soviet interest in compensation agreements with the West has intensified, the rate at which new deals have been concluded has fallen off considerably in the last four years. Internal Soviet problems and Western disenchantment stand in the way of negotiating new agreements. On the Soviet side, the policy of committing Soviet raw materials as the price for Western help in developing Soviet resources has been questioned. The Soviet bureaucracy, moreover, is ill equippedandle compensation agreements, while Soviet doctrine clearly conflicts with Western demands for equity participation and/or management control. Even If agreements can be reached in principle, the primitive level of Siberian infrastructure and the difficulties involved in taking on several large development projects simultaneously will slow the proliferation of compensation arrangements.

On the Western side, companies arc reluctant to accept many Soviet products. Unlikehen fuel and raw material shortages made long-term supplies of Soviet producis attractive to Western firms, they now regard compensation agreementsisagreeable condition for winning Soviet contracts. The depressed West European chemical industry is already worried about the chemical fertilizers and petrochemicals that the USSR soon will

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Hmontj Foretrn Atuument Center 8

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begin to export under compensation agreements. Deals involving energy-based exports, on the other hand, continue to interest Western companies.

Despite the reduced appeal of compensation agreements, the USSR is currently negotiating several large deals with Western firms. If concluded, they would increase Soviet raw material production and exports appreciablyhe negotiations now under way center on chemicals, wood and wood products, oil, natural gas, and aluminum. Over the longer term, compensation agreements tied to Siberian natural gas deposits in Yakutsk andajor steel complex, copper deposits, and exploitation of offshore oil reserves could materialize.

But Soviet ability to conclude these agreements will turn on:

willingness to modify its demands so as to enticeommercial interest.

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:The willingness of the West to extend much larger credits toJ

pace of Soviet internal development, especially in Siberia and the Far East

'Western requirements for Soviet raw materials coupled with ato rely on the USSRupplier.

The expected downturn in oil production and other economic problem: may make the USSR more accommodating as It tries to boost domestic energy production and develop alternative hard currency exports. The enthusiasm of Western firms will depend on the pace of economic growth and overall East-West relations.

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CONTENTS

' Key Judgments'

Background

Review of Existing

: Natural Gas

Chemicals

Other Major

Role of Compensation Agreements in Total Soviet Exports

Some Constraints on Soviet Use of Compensation

Domestic

Coolness in the

The Climate for New Deals

Outlook

Deals Likely in the Near Term

Possible Development

Extension to Manufactured Goods?

Tables

USSR: Scheduled Natural Gas

USSR: Scheduled Compensation Exports 5

Selected West European Countries: Dependence on Soviet Natural

Gas 9

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USSR: Existing Projects Under Compensation Agreements 3

USSR: Estimated Hard Currency Rows From Signed Compensation

7

Potential Projects Under Compensation Agreements 13

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Appendixes

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Agreements: What They Arc and How They Work .. 17

Compensation Agreements With the West 19

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USSR; The Role of Compensation Agreements In Trade With the West

The major impetus behind the rapid expansion of Soviet trade with the West ii.as been the desire to acquire capital, technology, and equipment to develop Siberia land to expand production in certain high-priority industrialThe USSR is counting on Siberia with its untapped deposits of oil, natural gas, coal, timber, copper, and other metals to support economic growth innd'beyond.help also has beenn expandingn several Importantchemical fertilizers, petrochemicals, motorand both ferrous and nonferrousin which Soviet technology lags the West or in which expanded capacity is neededargely because of the extensive use of long-term Western credits to accelerate theof capital goods from abroad, Soviet debt to the West has grown from less than S2 billion at the end0 toillion at the endoarge share of the foreign exchange required to meet debt repaymentthe USSR has sought compensation agreements with Western firms. Thesecover Soviet exports as well asestern firm contracts to supply equipmentoviet project, and the Soviels obtain guarantees from Western firms to purchase Sovietfrom the output of the project.1

Although Moscow concluded its firstagreements int was not until

' FoediKUiilon ot (he definition ind mechanic! of cornperna-Hon aareemeou, im apecftdli A. These iirccmcnu art alio culled "product payback" or "product buy-back."

Wett OcmMInvoMn* Soviet ihlpmcnu of rhaipJiat* rock la return foe phcupocnu furniccsaa-for-plpe deal withimber agreimanl wiih JapanSJ. Compe nail Ion iirremeou boartlailonahlp to thi oonoeulofla iraeicd to Wratarn flrmi Ina the latter cut foce-naretire for royalty payment! lo the Sovietllowed eicfqvtva rlfhti to develop and aiploll certain commercial opporluoltle*ihe USSR, Investing capital eoodi, lechnoloty, and Inlabor.

thehat the Sovietsajor push.everal massive projectsto Western firms called for productMeanwhile, compensation' agreements have received strong endorsement from theleadership. Brezhnev's6 report toh Party Congress stressed theof compensation agreements inlan. Inpate of articles in tbe Soviet press pointed to compensation agreementsew form of economic collaboration with the West. Several technical articles have set forth the theoretical criteria for assessing theof compensationoviet policy statements about trade with the West have usually given prominence to theof compensation agreements.

Compensation agreements indeed offer several advantages to the USSR. They are anway to obtain equipment from the West. Soviet purchases aru financed by long-termcredits with very lowince,iven project,exportsamatch debt service requirements, the real cost of the equipment to the USSR is essentially the alternative output sacrificed by assigningresources to building the projectproducing the portion of the output used as payback.

'Tho product payback form of tn auction it not limited to Soviet-Wetter*lmllareveloped foe Soviet project* In which Eait European comitrlea are Invcailni. Soviet aid project! with leai developed count rice reverie the flowi;ften repaid by liter delWe-lea from the project.

uO'yev andoroiin. "Oo thr Jvwilcn of Economic Bffectrvcncea ofrfH.ad V. Savin. "The EfTecihcven. oftlooompenutoryofign Trade. May IVT1.

* Lost* for the project! carry aa aveeatc rnterat rata of aboul" rerccnt. rouihly equal to the Inflation In world price* of the producti to be delivered by ihe Sovleti ni repayment.

Compensation agreements also reduce risk. The heavy reliance of the Soviet economy on

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planning makes reduction of risk important to Soviet managers, who have found foreign trade with the West particularly difficult to plan. The latest Western recession, for example, hit Soviet exports hard. Reduced demand5 virtually halted the rapid growth in Soviet hard currency exports, driving home to Moscow the dependence of Soviet exports on Western economicUnder compensation agreements Soviet industrial ministries and foreign tradeare guaranteed long-term export markets, providing protection from developments in the West that would otherwise reduce Soviet export earnings and hard currency-reserves.

The Soviet drive to conclude compensation agreements is an effort to placateat home and in theare concerned with the rapid growth of the USSR's debt. Soviet officials have emphasized the share (about one-half, according to one senior official) of the debt that has been incurred to import equipment for compensation projects and have pointed to long-term export contracts under these agreements as proof of the USSR's ability to service its debt.

' Compensation agreements, by providing formarket, will also help Moscowexport industries. Soviet enterprises willin producing for export whileestablish niches in Western markets.likelihood, the USSR hopes to renewafter compensation agreements!:! '

!of Editing AgrMfMntt

; 'SoyIoi omdili clilm man thanompeniaticMiith Weelern flrtru. Thli number probably Include! tornave not been alined, tome very amtll dealt, tome owiincuo not flI Ihe definition uaed ia thli paper, and tomoor cumpte, Ihe Sovieti Identify the Moecow World Tradeinanced by US Enlmbtnk eredllL ncom penIon ajfeementbecauM th* eompln will be rented to Western flrn.

'The USSR has concluded moregreements with the West in theThe agreements arc listed in appendix jB; project locations arc shown innder these agreements, almostillionestern equipment and technology will betalled in the Soviet Union. In some| naturalipe were imported to develop,exportexport earnings guaranteed underagreements far exceed the capitalized cost of project-associated imports. In other instances (chemical plant imports, forheSoviet goal has been to develop productive facilities to meet domestic needs, siphoning off only that portion of output required to repay project-associated debt.

Natural Om

The most important agreements in terms of boosting Soviet exports have been the gas-for-pipe deals, which provide for Western exports of large-diameter pipe to be installed in pipelines to carry Soviet gas to Western Europe. The gas-for-pipe deals will generate Soviet exports worth many times8 billion spent on Western pipe and pipeline equipment. Under some of the agreements, exports will continue intot century (seehe first gas deal was signed with Austriand similarhave since been signed with Italy, West Germany, and France. Soviet hard currency gas exports under these and fupplementary contracts5 billion cubic meters6 and are scheduled to reachillion5 aspipelines arc completed. Hard currency earnings from gas sates will account foroercent of Soviet earnings from compensation agreements signed so far (see

The earnings from natural gas sales willon hard-to-predict fuel prices. Thecall for prices to be adjusted in line with changes in prices of other fuels, assuring the Soviets of higher earnings as Western energy prices rise. Soviet trade data show that prices received6 were about halfer thousand cubic meters charged by other gas exporters. Prices probably rose substantially' largely because of Moscow's successful renegotiationas contract with Italy. The Italians paider thousand cubic metershe newly negotiated price for the second half7.

The Soviets will probably benefit from large gas price increases for the next several years.

' The USSR'i omUilofi of quantity data7 preclude, an eeetirate eetlmate of price*.

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1

USSRt Scbedukd Cornpaniotlon Export!

Millioo US

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Natural aa*

product*

will be strong upward pressure on gas prices becauseising energy prices inven faster increases in gas prices lo narrow ihe gap between oil and gai prices,oviet pressure to extract price Increases on their gas. Thus, wc project annual price Increases ofercent0 and IS percent thereafter. These prices would earn2 billion0 and nearlyillion5 under current gas delivery schedules,

The Soviet chemical industry has been the main customer for Western equipment over the past several yean,2 billion of the ordeis have been delivered under compensationUnlike the gas-for-pipe deals, chemical compensation agreements usually call for exports approximately equal to the value of imports or. to the value of credit repayments plus, interest.

In the only major compensation agreement with the United States,

3 are helping to build four ammonia plants at Tolyatti, an ammonia pipeline to Odessa, and port facilities to ship ammonia from Odessa to the Unitedart of0 million project is financed by US Eximbank credits,tcganammonia earlyhe port facilities were dedicated in

Most Soviet chemical compensationhowever, are wiih West European and Japanese firms. Italy, Japan, and France will also receive Soviet ammonia as the exportof compensation agreements for several ammonia and other chemical plants. There areumber of WestWestagreements for petrochemicals.

Othur Major Agrtttmunra

There haveew large deals inparticularly three timberthe Japanese. Under6 million inother timber-processing equipment, andgoods in exchangeillionof Soviet timber, wood chips, andwere delivered.1 agreement for anotherin Japanese equipment and SovietSerlH CfimkelIhc Writ: Impart on Froduttlon and Fortlin Tradr,Unci.uined.

ot counted at aCKhaoie wperphcapborie add fot

deHverica of Soviet ammonia, potath, and area. Thlite aireernenl It lo run19 and could be worth SI billion annually In two-way trade.

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merits of wood chips and pulpwood. According to the third agreement, signedapan will0 million in equipmentin consumer goodsnd will take delivery5 million cubic meters of logsubic meters of wood products from the

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Japan4 also agreed to help the Soviets develop the South Yakutsk coal fields0 million worth of equipment in exchange for coking coal. Scheduled coal deliveriesillion metric tons per year from the Kuznetsk depositsillion metric tons per year from Yakutsk beginning3 (when the completion of the Baikal-Amur Magistral (BAM) railway istonsnd continuing at lhat level

In tbe only major compensation agreementetallurgy project, Pechincy-Ugine-Kuhlmann of France agreed to supply an alumina plant and willons of aluminum barswhen the plant begins operation, probably

RoU of Computation Ac'iuvm'i hi Total Soviet Export!

Several of the projects financed, underagreements are now under waycoincident timetables. They werein the, signed in theand arc now in theProduction and exports from most ofwill begin in one or two years.exports in most cases willtraditional Soviet exports, they willsubstantial layer to the export base. Asagreements come on stream,thereforeajor boost locurrency exports. Compensationsigned deals will rise from7 to S2 billion0 andbillion5 and wilt constitute aof hard currency exports by

: An analysis of compensation agreements in

isolation shows that revenues from the deals will

AM flfvft* In corrmt dollan.

far exceed costs, yielding Moscow substantial increases in import capacity Inseeargely because of the profitable gas and coal deals, the Soviets will net nearly S4 billion annuallyhen most of the debt associated with Soviet imports will have been repaid.

Moscow will depend heavily on compensation exports in. Soviet hard currencyincreased rapidly in theecent export growth has beenannual increaseas about one-halfpercent average annual growth0he Soviels increased hard currency oil sales toillion barrels per dayercent of production. The amount of oil available for export to the West should fall absolutely in theecause of an expected decline in production. Although prospects for other raw material exports are brighter, they are unlikely to offset the loss of oil revenues.

Conitralnti on Sovietof Ccmpontatiori Agrtxrmonti

The impact of ihe looming oil crisis on foreign trade thus heightens the importance of compen--ation agreements. In the, thein compensation exports will rxsizable offset to the decline in oil exports. Nonetheless, the growth of hard currency export earnings will probably be lower than In the past. Despite greater Soviet interest, few major compensation agreements have been signedn that4 billion in such agreements were

two major resource development projects witli Japan, and three natural gas deals with West Germany and Austria. In Ihe following ihree years the annual average of dealswas roughly SI billion. The declineunctionh internal Soviei problems and disenchantment in the West.

DofMifi'. Conifrairitt

Compcns.ition deals thatontinuing Western presence. Western ownership, orcontrol over produclion are alien to Soviet doctrine. The USSR is reluctant to allow any

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Currency Flows From

of Wesiern ownership within Ihe USSR and, lo dale, has been unsuccessful in attempls to satisfy Western equity demands by offering to structure jointly owned holding companies in thehile the equity problem canbe circumvented, other issues associated with Western participation cannot. Moscow has yet to accede to on-site managerial and quality controls demanded by Western firms. It has also refused Western preseno of any; form inareas, making it difficult co take advantage of Western know-how associated with oil and gas exploration or to satisfy insistence^on confirming Soviet oil and gas reserve figures, j

j There is still high-level resistance within the USSR to increased dependencej on the West.

Ir the* thettiute of ibe USSR Academyattempted loead framework whichde ftCo foreapital and* rnannrernent participationmutt de jure remain wholly Soviet cMerprbee- Or*'be problem called for eiUbllihinj. Jointly owned firm*would hold controUlni block) of nock In domeatlc

Traditionalists like Suslov show much lesslhan Brezhnevarge-scale expansion of technological links with the West. EvenKosygin, the leading advocate of expanded economic ties in the, appearsby the extent of economic interdependence promulgated by Brezhnev and has been reportedigh State Planning Committee (Gosplan) official as being strongly opposed to exporting Soviet resources in return for WesternSoviet policy in general clearly hasthe views of the advocates of acquiring Wesiern help, but the opponents have won some individual victories. Inor example, rumors circulated that Minister of the GasOrudzhev would be replaced because of his resistance to foreign participation in gas projects. Two years later, however, Orudzhev is still in office and Moscow remains caulious

Torknolorloal trortii and Wtstttn Trthnoloty Tramftt io iht USSR: An Anatyiti ofSovut Alllmder, prepared for the Office of Fjlemtl Reiearch. Bureaa of IntetRfemee and Reaearch. US Department of State:.

regardino new gaa export deals pending areview of energy policy ic connection with theyear economic plan. At this point, the Soviets cannot be sure that they will have enough gas to enteride range of neW agreements.

Aside from differences over the desirability of compensation deals, the Soviet economy can take on only so many major projects at the same time. Soviet officials have estimated that compensation projects require three or four rubles .in Soviet resources per ruble of imports. Conslructionapparently have contributed th ain new agreements. The plan forof compensation projects8illionercent greater than actual construction on projectsonstruction efforts have not keptoviet construction official blames poor planning, leadingack of coordination among construction enterprises, end-user ministries, and foreign suppliers for the poorfterspr^-uction often starts slowly because supplies have not been organized properly. In some cases supply problems will persist because of shortages of high-quality Soviet human and material resources required by advancedtechnology and equipment. 1 J; i

All of these problems stem in part from the undeveloped nature of the Soviet economy,in Siberia. The Soviets obviouslyhat an accelerated construction of the BAM and its feeder lines will permit more concreteon large resource development projects; yet the line is not scheduled lo be completed. Evenransportation, net exists,for infrastructure'investmentbe formidable, sometimes raising the rroject- '. associated costs above the potential economic valueroject. In particular the lack of adequate housing and consumer amenitiest difficult to attract and retain the manpower :

"LA,tlanta br CoenpcOMUo* Ceaatrao tloarvmjttnmoyi SiMttl'irro. No.lmllarorelm Trade MrnUler Patolkhe*- told French offklili concerned about the lo*f Sorkt rder* thai the riluatlon would pentit for at kattoneo more

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required to build and operate major production facilities.

Finally, the Soviet foreign trade bureaucracy does not handle compensation agreements easily. The major problem is coordination: all foreign trade organizations (FTOs) responsible forimports and exports related to the project must be brought into the agreement. One factor that has limited the range of projects proposed by the Soviets is the desire to keepingle industry so that thewhich uses the imported equipment also produces the export goods stipulated in the agreement.he Ministry of Foreign Tradeepartment headed by Deputy Minister Vladimir Sushkovromote andcompensation agreements. Somein flexibility has resulted, but agreements cutting across industry lines still presentdifficulties. It is too early to predictthe current reorganization of the Soviettrade system will have any impact on the handling of compensation agreements.

Coolnrtae Wtmt

For their part. Western firms show littlefor most of the compensation deals proposed by Moscow. Western firms compare the potential projects in the USSR with similar deals available elsewhere where conditions regarding equity participation and managerial control are far more favorable and where the negotiating process is far less cumbersome. In addition, the Soviets have often tabled harshonj-term credits io finance equipment required to develop related infras'ruc-ture as well as the productionedium-term credits to cover consumer goods purchases needed to defray local costs,eferred payments on the credits during the full period of plant construction.

The large number of agreements signed4 reflected In part the eagerness of Western firms to ensure long-term access to raw materialsime of shortages. More recently the West has experienced slower economic growth, and excess capacity has appeared in some of the

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industries lhat produce products thewould like to export.esult, many firmsto enter into compensationthat do view tbem es competitiveSoviet negotiators make it clear that ifare roughly equal, the1 Westerntoompensation agreementtbe Soviet order.ji

he Western companiesumberitfalls in agreeing to accept deliveries of Soviet productsong period.;Westernnsist on favorable contracts under which prices arc discounted and also adjusted annually or semiannually in concert with changes in aagreed-upon Western market price.guaranteed access to raw materials and semimanufactures is thus attractive during periods of commodity shortages, it canisadvantage when demand is slack and the Western firm finds it hard to market theor lo use them in its own plants.

Some Western firms are also reluctant to conclude compensation agreements because they do not want to sponsor additional competition in theirhis iserious problem for lhc depressed West European chemicalwhich has been hurt by chemical exports from the Easl even ihough ihe largest increases in chemical exports from the USSR are still two to three years away. Soviet exports of ammonia

West, for example, are scheduled3 million tons in theequal to total free world trade inin recent years. The Europeanhas requested help fiomystem toagreements will probably

On the other hand, Western, concern over excessive dependence on Moscow for energyhas lessened in recent years, largely because of Western Europe's desire to find alternatives to

lhc Organization ofercent oftotal natural gas supply nowlhc Soviei Union;5 the shareto about II percent Of the! largest Soviet

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customers, only Austria will depend substantially on Soviet gas (seehe USSR will probably continue to be Austria's only foreign source of gas, which5 will constituteercent of Austria's total energy needs. For other Soviet gasFrance, and WestUSSR will provide an estimated one-fifth of gas supplies5 butercent of their total energy. The degree of danger in this dependence depends on (I) the likelihoodoviei cutoff of supplieshe availability of alternatives. The size of Soviet gas exports ineans that an embargo on gas to Western Europe would not have much impact on total energy supplies in the affected countries,oviet cutoff wouldubstantial reduction in gas supplies which would be difficult to replace in the short run.

Technical problemsreater threat to Moscow's reputationependable source of gas than the possibility of an embargo. Italy and Austria did not receive the Soviei gas ihey were promised7 andof declining produclion in Ihe Ukrainian gasfields that are the principal source of the gas.

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Moscow promised io make up for Iheincreased future'

Thefor Now Doali

The USSR's mounting economic problems clearly incline the leadership towardagreements. The need to develop Siberia and push up productivity increases requirements for Western capital, technology, and equipment. The same economic problems, however, cut Into the USSR's export base and the hard currencyfor purchases from the West. The number and scope of projects now under negotiation attest to the Soviet commitment to compensationas the preferred solution to the problem of financing imports from the West in. But'the pace at which new deals will be made wilt depend on bow effectively tbc USSR and fts potential partners in the West overcome the problems discussed above.

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: If the Soviets are to undertake and complete the projects now under discussion, they will first have totronger and more generalwithin the Soviet Government to attract Western participation. Moscow will have tobureaucratic inertia, cut negotiation times (possibly by abandoning the past hard line on price, guarantees, credits, and other contractnd soften restrictions on the Western presence in the domestic economy. The latter condition is particularly important in energy projects. Without on-site inspection by Western experts, exploration times to prove !up reserves will be longer than necessary, and Western firms will refuse to participate. Although.the Soviets seem to be moving in this direction, they are not moving decisively or quickly. ; II

The Sovicu also willreat deal of Western financing. The credits for the projects now considered likely could runillionillion; cxdits for projects that have been suggested would perhaps amount toillion. The Soviet hard currency debt is nowillion.illionillion in credits necessary for these projects spreadyear period compares to the level of export credits Ihe Soviets, have been receiving for all of their equipment purchases. Although the West would thus have to provide the Soviets with greater amounts of credit than in the recent past, private bankers andtending agencies appear to be moreto Soviet credit requests that are backed by export agreements.M

The current state of certain Soviet bilateral relations complicate Soviet attempts to move ahead on compensation agreementspecial way. For example, the Soviets would like the United States to take the lead in manyagreements. Despite the greater distances involved, Moscow views the United Stalesuge potential market for Soviet compensation exports. Moreover, the United Stales possesses unique technology and production capacityewoil exploration andthe Soviets badly need. The Soviets want US Government approval implied by the granting of Eximbank credits, and other sources of capital are insufficient to finance the multi-billion dollar projects the Soviets want. Without EximbankUS Eximbank window has in effect been closed to Ihe Soviets by legislation sinceprospects are poor for conclusion of major compensation agreements in the near term. Moreover, uncertainties regarding the control of oil and gas equipment exports to the USSR cloud the prospects for energy projects that the Soviets have discussed with US firms.

Soviet-Japanese relations also pose obstacles to Moscow's development plans. Japanatural partner for the USSR in the development of Soviet resources because of iu proximity to Siberia and because of iu own weak rawresource base. The Japanese, however, have hesitated at limes to cooperateig way in the development of Siberia because of China's opposition and Tokyo's desire lo avoid depen-

Lender* tend to overlook ihc fact that tbe USSR'i debu are obElf nioni of the ttate aiwhole, not of the Individual project or cnterprUe which receive* ihe roodi on credit. Export* from (be individual project roceMni the fininclrm.covering ihe repayment of project auociated debt, nukerrultW overall Soviet export potential-the key element of creditworthlneM

dencc on (he USSR for raw materials. Theeight-year trade agreement signedand China in8 callsto export oil and cokingofcommodities the Soviets would like to

i Outlook

Doari Ll. .i, In ft* Noor

Negotiations between Western firms and the USSR are far advanced on several important projects. These deals could be signed within the next year or two. Given the lead times on these projects, some could be operational (andexports; by thend almost all could be on streamhe largeagreements most likely to be under way befor- Ihe start of the next five-year plan1 include the following (see

Yenesei River Timber. The existing forestry development agreement with Japan, dueill probably be followed by an agreementulp and paper project on the Yehesei River. The Soviets have discussed this project with Japanese and US firms for several years. Moscow originally wanted lo include the project inlan, but hard currency stringencies forced postponement until the next five-year period.

New Gas-for-Pipeecent energyindicates that Western Europe will need an additionalillion cubic meters of natural gas annuallyoreover, the expectedin Dutch gas exports in1 thewhich now supply one-fifth of the Westgas market) will provide tbe Soviets even greater opportunities for gas sales. The USSR could conceivably supplyillion toillion cubic meters per year more than theillion already scheduled. But Moscow hasrecent effortsumber of Westcountries to boost Soviet deliveries because of current uncertainties regarding futurerequirements. Nonetheless, Moscow has found gas-for-pipe deals to be extremelyand the need to boost nonoil exports inhould rekindle Soviet interest in compen-

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sation agreements for natural gas once the long-run energy picture is clearer. Valves andrather than pipe, will constitute tbe major bottleneck in pipeline construction, and the Soviets will have to turn to the West for these.

Sakhalin Oil.4 the USSR and Japan agreed to joint development of oil depositsfrom Sakhalin Island in tbe Okhotsk Sea north of Japan. The agreement also called for development of natural gas in tbe area, bul the project has concentrated on oil so mall share in the company established to carry out the project Japan0 million credit for exploration; if reserves justify full development several billion dollars in credit will be needed. Japan would receive one-half of theercent discount from worldbeginning aboul thend continuing forears after the credits areccordingrovision unique among compensation agreements, theneed not repay the credits if recoverable reserves are not found. The area was surveyed in Ihe springnd test drilling began inwo months later the Japanese and Sovietsromising oil strike off the northeast coast of Sakhalin, claiming that four lest wells flowedombined ralef high-quality crude. Recently the Soviets have appeared anxious to push the projecta stepped-up exploration effort in the summer8 yielded one commercially promising gas discovery.

Tomsk Chemical Complex. The biggest chemical deal now under negotiation is acomplex al Tomsk inhe project has been recently stretched out because the Soviets now plan to havef Siberian crude oil available as feedstock rather lhanriginally planned.

Ut* ditominlend "hen Ihe accumulated proTiUe oIvxhm double iheor crediu encoded for upleeatkM.

" Aa earlier propoaal caBcd for coral ructionipeline from ihe TyumenHeidioviet pet toapan. The deal teemed dote lo fruit looul Ibe Soviet! reduced the amount of ofl offered. and the J backed oat.

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The cur tent five-year plan allocates funds foron-pcr-ycar plant probably worth about SI billion. The Soviets hope loecond ethylene plant in thehen more crude oil is available. Another problem is that thencsc and German firms bidding* oroject do' not want the chemical products the Soviets are offering to export.

Sayansk Aluminum Smeller. The Soviets want toon-per-year aluminum smelter ut Sayansk in Siberia, Pcchincy-Ugine-Kuhlmann of Pranceonsortium of Kloeckner of West Germany rj

re the leading contenders for0 million0 million contract. The Soviets may award the contract by the endhe deal would involve annual,exports ofons of aluminum bars to Western Europe and the United Slates.

On balance, we think new agreements might add more than S2 billion per year toillion of compensation exports already contracted forhe calculation assumes: sales of anillion cubic meters of gas to Western Europeillion0hird timber agreement withillion0il exports ofo Japan from the Sakhalineveral smallerchemical plants at Tomsk, the Sayansksmelter,ew other plants.

PtniibUPrajvcn

The Soviets are pushing several other projects that are either less likely to come to anything or less imminent than those discussed above. These addilional projects, which could boost export earnings by several billion dollars per year, arc concentrated in the energyut otherinclude development of metal ore deposits and timber resources. With many of Iheselocated in Siberia, (heir implementation is likely to be tied to the completion of the BAM railroad, which is still about five years away.

LNG: Yakutsk. In thehe Soviets proposed Ihat the United States join Japan in the Yakutsk liquefied natural gas project. Asenvisioned, the project wouldilometer pipeline from Vilyuisk to the port of Olga on the Sea of Japan, liquefaction facilities, and three LNG carriers for Japan and eight for the United States. Japan and the United States each would receiveillion cubic meters of gas annually. According to estimates presentedeeting of the US,-Soviet..participants, machinery and equipment will cost S4 billion (split equally between the Japanese and USnd the carriers and regasification9 oillion,

Yakutsk gas reserves must be confirmeddevelopment can begin. Proved reserves arc nowillion cubic meters, andrillion cubic meters required for fullwill probably be provedhe three parties will then decide whether to undertake the development phase. Delivery of Soviet gascould not begin until the. The Japanese have indicated that they will notwith the Yakutsk project unless the United States participates.

LNG: North Star. The North Star deal calls for development of the Urcngoy gasfield inSiberia, which (unlike the Yakutsk deposits) already has adequale proved reserves. Theproposal calledilometer pipeline loas liquefaction plant atand purchase ofNG tankers lo carryillion cubic meters of gas annually to the US east coast forears. North Star first was conceivedS-Soviet compact. When US Government approval and Eximbank financing were not forthcoming, the US consortium6 turned to Western Europeource of financing andustomer forercent of the gas. which would be shipped by pipeline. By that time, however, it was loo late to include the project inlan, and in7 the Soviets and the US parties agreed to shelve the project indefinitely. Although both sides arc still interested in seeing the project through, further progress will be contingcnl on theof the US Government to allow large-scale imports of Soviet LNG.

Kurskonsortium of West German firms signed an agreement with the USSR in

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o supply an iron ore pclletizingirect reduction plant, two rolling mills, and an electric steel plant at Kursk. The deal originally called for the Soviets to pay cash for the SI billion project, and supply West Germany with unspecified amounts of sponge iron pellets and semifinished steel in. The project has barely limped along: design changes andhave pushed the cost to betweenillion andillion so that the project will probably be scaled down drastically; the first majorcontracts were not signed until7 and then apparentlyash basis; and the Germans now show little interest in exports from the project. Even if final agreement is reached soon, the first stage of the project could not be completed

Udokan Copper. The Soviets have discussed development of the copper resources at Udokan with Western firms since the.he Soviets requested proposalsilot copper processing plant from US, British, and Japanese firms. Thenoscow decided to postpone the entiretohe BAM isThus, the Soviets may include theproject inlan.

Offshore OiV.'The Soviels are also interested in developing offshore oil deposits in the Caspian, Barents, and Kara Seas. Activity so far has mainly involved straight equipment purchases rather than compensation agreements that would provide for oil exports to theecent proposal

a"sexploration andArtie and offshore oil reserves and exportsto the West as repayment. The Sovietsheld discussions with British andconcerning the joint development ofbut apparently no concretemade. Moscow wants to keepaway from some of these areasreasons, and technology to developArctic deposits is not yet available even!

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ExUntJon t* Manufoxhtrcd Ooactt?

Moscow has touted compensation agreementsew form of collaboration with the West. So

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far, the projects arc being carried outurnkey basis, in which the participation of lhc Western firm is essentially completed once the equipment is installed and production is under way. The plant and facilities are owned,and staffed by the USSR. The Western firmlaim on part of the output, but no equity in the project or control over product quality.

The Soviels have expressed interest indeals involving manufactured goods, bul have failed to conclude such agreements.increasing manufactured goods exports for hard currencyongstanding Soviet goal,ods still representercent of Soviet exporu to tbe West. Thb, disappointing performance has been the result of severalinsufficient :ncentives for Soviet enterprises to produce for export; shabby qualily; poorknow-how; inadequate distribution and servicing systems; and inability to adapt quickly to changing Western tastes. These problems also apply tovcred under possibleagreements, and to them must be added the skepticism of Western firms regarding their ability to market the productsong-term basis.

The Soviets thus far have refused Western demands for continuing participation to ensure quality. The question, however, is clearly still being considered in lhc Soviet Union, with strong support for each side. Deputy Minister ofTrade Sushkov and the leadership of the Institute of the USA and Canada arc apparentlyrive to win Council of Ministers approval for increased Western participation while some sections of the Ministry of Foreign Trade opposeove."

If approval is given, the test case couldoint venture to design andew Soviet automobile. Sushkovoviet delegation to the Big Three US automakers in8 that proposed thai the Western partner provide lhc design and production technology (withupdating)odern small front-wheel

"Ye. S.Sc-ict-American Fxanomle Ccopcralica: Probtemi aadSA: Eto*omiei, rotaki. Ideology.'. V, Swihkov. XoropcrtMlory Loni-Tarm Trade and Industrial Cooperation Bet-eert the USSR and the Induitrial CapiutlitT.

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drive car to be produced at the Moskvitch autoortion of the output would be sold in thein Westernthrough the Western firms* marketing system. Sushkov, who presented the proposal,that the deal docs not have the full support of the Soviet leadership, and at least one of the companies has already withdrawn fromOther deals proposed to US firms for joint ventures to produce and export spark plugs, diesel engines, truck axles, and computerhave foundered largely because offailure to agree to Western firms* demands for an ongoing roleoviet enterprise.

The author of this paper

Office of Economic Research. Comments and queries are welcome

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APPENDIX A

COMPENSATION AGREEMENTS: WHAT THEY ARE AND HOW THEY WORK

A legal analysis of compensation agreements shows that it Is veryrecise and versatile definition because of their great varietyj

A. Bclov, Deputy Chief of the Treaty and Law Department, USSRof Foreign Trade, in

Belov's remark indicates, there is some confusion in the USSR about how to define compensation agreements. The confusion in the West is even greater, with the usageumber of terms to describe and differentiate among various types of agreements:eneral term often used synonymously withagreements, usually refers towhich call for both exports and imports; in eounteipurchase deals, the exchanges are made more or less simultaneously andash basis; barterrimitive form of counicrpurchase in which the exchanges are balanced and nopayments are involved; product paybackare compensation agreements which specify that exports come from the project which receives the imports. These terms are often used incorrectly or interchangeably. j; !j

In this study, all of tho above are described as either counterpurchase or compensationAlthough counterpurchase: arrangements are most prevalent in Eastern Europe, the USSR has some major counterpurchase agreements, of which the best known is the barter; portion of the ^agreements. Two other prominent ones arc the Pepsi Cola deal, involving shipments of Pepsi concentrate to the USSR in exchange for equal quantities of Russian vodka for the United States,4 agreement withof Italy under which Finsiderons of large-diameter pipe to the USSR each yearnd receives Soviet coal, iron ore, and steel scrap.

In contrast, compensation agreements provide for Soviet exports well after the imports to the USSR have been delivered. The exports usually (but not necessarily) originate in the project for which the Soviets are buying Western equipment and technology. The Soviets view the purpose of the exports at least partly as repayment of the credits extended to finance Western equipment imports.

A compensation agreement generallylncludes three separate contracts. An equipment contract is negotiated by the Soviet importing foreign trade organization and the Western firmthe equipment and whatever other licenses, training, and services the Soviets choose toA creditommon but not essential componentompensationdefines tbe transactions between the Soviet Foreign Trade Bank and the Western creditor,ommercial bank or credit agencyestern government. The third contract, the export contract, is the distinguishing featureompensation agreement Under the exporta Westerndifferent from the

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: -equipment" for theto accept long-term deliveries ofThe export contract in most cases islinked to the credit contract, theof the credit is not conditional onof the export contract, and Sovietnet directly pay for the imports.length and value of the exportdo not coincide with the credit 4

. Compensation agreements generallyhrough; three distinct stages: (I) proposals and negotiations leading tomports and installation of equipment duringxports of goods andof credits. The first stage usually takes several years. The complexity of negotiations, the scale of the projects, and the number of parties involved on each side, together with frequent changes in Soviet specifications, all complicate and prolong the negotiations.

The secondcontract signing until productiontakes three to five years. The Soviets prepare the site, erect the plant shell, and install imported Westernwith the help of WesternThe Soviets draw down Western cr**ditsas the equipment lis delivered.

Once productionubstantialoercent according to Soviet statements) is exported to the West while the rest is available for use in the Soviet economy. The exports generate the hard, currency the Soviets need to repay the Western credits and more since the value of the export stream is often much greater than the interest and principal payments. The export contract can run for as long asears but usually corresponds roughly with the length of the credit.

Original document.

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