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Chocolate factory, trade war victim

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From the Baltic to the Black Sea, a chocolate wall has descended across the continent of Europe.

The output of the sprawling brick factory formerly known as the Karl Marx chocolate works, has never before been so hard to sell in Russia. Since July, when Russian regulators banned all chocolate, cake, cookie and candy imports from its Ukrainian parent company, Roshen, ostensibly over health concerns, production at the plant here has plummeted 14 percent.

(Read more: Raisin the bar: Chocolate's ingredients get harder to come by)

"It's not pleasant at all to be in this situation," Viacheslav Moskalevskyi, the president of Roshen, Ukraine's largest confectionery company, said in an interview.

The Ukranian chocolate factory shares a problem with many businesses in the countries that lie between the European Union and Russia. It is caught in a no-man's land for trade, a place increasingly precarious as each side tries to recruit countries into exclusive trade deals. The European Union wants Ukraine and Moldova to sign so-called Association Agreements while Russia wants these nations in its Customs Union.

Ukraine and Moldova must decide by a Nov. 28-29 summit meeting in Vilnius, Lithuania, whether to sign the Association Agreement.

And Russia is willing to play rough to ensure that does not happen. Russia banned wine from Moldova. This fall, after Russia banned milk imports from Lithuania as part of a struggle for economic influence, yogurt and kefir piled up at checkpoints. Lithuania is already in the E.U., but the Kremlin restricted dairy imports anyway, apparently in anger that the former client state was being a strong advocate of bringing in the other former Soviet states.

When Lithuanian authorities said they might complain to the World Trade Organization, Russia's former chief sanitary inspector, Gennady Onischenko, replied that if that happened, the restrictions would remain in place "for an incredibly long time." Members of the European Parliament expressed theireys solidarity with Lithuania by eating a type of Lithuanian sweetened cottage cheese dessert in front of photographers, but the economic dividing line in Europe is hardening.

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It was this nearly same landscape that Winston Churchill in a 1946 speech heralded the Cold War, saying, "from Stettin in the Baltic to Trieste in the Adriatic, an iron curtain has descended across the Continent." The line of contact in this trade war has taken a twist on that name, sometimes being called the Milk Curtain.

The zone separating the European Union from the Russian-backed Customs Union, a mini-rival trade bloc, has become a hazard for businesses, as the case of Roshen indicates. The ban on Roshen chocolates is widely understood to have resulted from its owner, Petro Poroshenko, advocating for Ukraine's integration with the European Union, rather than the Customs Union.

The company had recently invested in a robotic assembly line for a crushed hazelnut and dark chocolate candy that is popular in Russia. But since the ruling, the line is underused, though still making reduced quantities of a devilish little sweet, called Evening in Kiev, only not for the Russians.

And all of Ukraine is stuck in the same sticky box. Moody's, the bond rating agency, downgraded Ukraine's sovereign debt rating last month, in part over concerns the country will not obtain a gas price discount from Russia while this trade war persists. Ukraine's economy contracted in the first half of 2013.

Ukraine's economic woes are deepening. Just on Tuesday, Aleksei B. Miller, the chief executive of the giant Russian energy company, Gazprom, appeared to escalate the standoff by threatening to invoke a clause in the Ukrainian gas contract demanding payment in advance for winter heating.

"This is a dire state of affairs," Mr. Miller said in a statement, whose tone recalled warnings that Gazprom had issued before shutting off gas to Ukraine in energy embargoes in 2006 and 2009.

The Customs Union of Russia, Belarus and Kazakhstan, a pet project of President Vladimir V. Putin, will never truly rival the E.U. The output of the Customs Union states was $2.3 trillion in 2012, compared to $16.6 trillion for the European Union, according to the International Monetary Fund. Ukraine's economic output of $176 billion last year would only modestly bolster the Russian bloc.

But bulking up with Ukraine's 46 million consumers would narrow the population gap with the European Union. A Customs Union that included Ukraine would have a total population of about 215 million people, compared to the total population of the 27 nations in the European Union of about 501 million people.

(Read more: Sugar: The food industry's tobacco moment?)

"Putin and his team are pressuring Ukraine because Eurasian integration cannot happen without Ukraine," Mikhail Pogrebinsky, a political analyst in Kiev, said of the tactics such as those being brought to bear on Roshen.

Russian officials have suggested they are merely conveying to business owners in the region what loss of market access would result if their country's officials choose to remain outside the Russian-backed trade group.

With that sentiment conveyed, what is known here as the chocolate war began.

The company, one of Eastern Europe's largest candy makers, had sales of $1.2 billion in 2012, up from $1 billion the year before. The company exports 320 different types of candies to 30 countries, but specializes in treats preferred by residents of the former Soviet Union.

(Read more: Chocolate puts market for sweets on a sugar high)

Until the ban, Roshen exported 8,000 tons of sweets to Russia monthly, even during the world recession. "Recession affects real estate but not chocolate," Mr. Moskalevskyi, the director, said. While the company has been able to redirect some chocolate to Ukraine, the drop in output shows Ukrainians can't eat it all.

Ukrainian businesses are also squeezed from the other side. The European Union's high tariffs on agricultural goods such as those contained in cakes and chocolate all but rules out sales to Western Europe, at least until any easing of tariffs takes place under the Association Agreement. Also, European confectionery companies and candy makers have themselves been investing in Russia, seen as having a higher potential for growth than Europe, which is saturated with sweets, Mr. Moskalevskyi said.

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Tastes for chocolate vary by region and Roshen specializes in former Soviet consumers. Hershey's, for example, had little success selling its Kisses in the former Soviet Union — they were too sweet and milky. Retooling for exports to Western Europe would be costly for even a company like Roshen.

"The money I made in Russia cannot be made up somewhere else," Mr. Moskalevskyi said. Roshen had 5 percent of the market in Russia, competing well with the likes of Kraft, Mars and the dominant Russian domestic candy maker, the United Confection Company, a sort of Gazprom of sweets.

Roshen was doing so well in Russia partly because it introduced a Russian Classic line of chocolates, reviving 18 Soviet brands like the Seagull bar, a plain milk chocolate slab with a Socialist Realist style beach scene on the wrapper. But this year, Roshen has missed Teacher's Day in Russia, a big day for giving chocolate gift boxes.

(Read more: The Chocolate Indicator: Using Hershey to predict the market)

Mr. Moskalevskyi is hoping the dispute will resolve itself before the New Year's holidays —payday for chocolate makers everywhere east of the Danube River.

"All of this is leaving a very negative impression," Anatoly Radchenko, a chocolate factory worker, said glumly of the Russian trade restriction. "It seem Russia is against us. I don't want to think it, but I do. We are brother Slavs. They should never have started this chocolate war."

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