Market Eyes More Sanctions On Russia

Look out below, Russia investors. Sanction threats from Europe are the latest headwind for all things Russia-related.

The German government confirmed that opposition leader Alexey Navalny was poisoned by Novichok, a nerve agent deployed previously in the English town of Salisbury against former Russian military officer Sergei Skripal and his daughter Yulia. German Premier Angela Merkel said only the Russian government could explain the poisoning and called for a global response to the incident, “increasing the risk of sanctions levied against Russia,” says Gustavo Medeiros, an emerging market analyst for Ashmore in London.

Sanctions from the German side do not yet target Nord Stream II, the sister gas pipeline to the already existent Nord Stream I, but Washington could increase pressure. It’s a risk for VanEck Russia (RSX) holders.

RSX has been a dud all year thanks to the double whammy of bad news from the pandemic and oil prices, two things totally out of Russia’s control. Russia was one of the hardest hit by the pandemic, along with Brazil, India and the U.S.

But compared to everyone else, Russian investors have been rewarded for buying low. RSX is up 44.8% since March 23, beating its BRICS peers and the MSCI Emerging Markets Index. It probably won’t last. Russia is underperforming them all over the last month, down over 6% now.

“The threat of sanctions, while always present, seems likely to intensify,” says Luiz Eduardo Peixoto, an emerging markets economist with BNP Paribas in London.

For Russia, this is a “here we go again” moment.

Strong fundamentals indicate that Russia has a huge war chest to absorb geopolitical uncertainty. Years of sanctions mean the country’s economy is relatively resilient to such threats, and investors too, so long as owning the main equities in the RSX portfolio does not become outlawed.

Russia’s net foreign reserves, which total a whopping 34% of GDP, have increased during the pandemic.

Most of the country’s state-owned companies, including Gazprom, the majority owner of Nord Stream II, have healthy finances with no pressing liquidity issues. There will be no bankrupting Russian state owned enterprises this time.

The Nord Stream II natural gas pipeline connecting Russia to Germany has largely absorbed the financial shock of U.S. sanctions anyway thanks to Gazprom’s money. There has been limited practical impact on sanctioning the European pipelayers so the only way to really stop Nord Stream II would be to slap sanctions on German firms Uniper and Wintershall, and British giant Royal Dutch Shell, for example.

Media reports suggest that Washington is trying to coordinate action with Brussels, namely Berlin, on this issue of Nord Stream as Navalny punishment.

Project partners have self censored themselves on the issue.

With about 40% of Europe’s natural gas coming from Russia – a share likely to grow over time as local EU production falls in favor of wind and solar — Russia will just end up becoming Europe’s baseload energy supply. A study by the Energy Institute at the University of Cologne suggests Nord Stream 2 could cut even EU natural gas prices by 5% when fully operational, because supply will be immense.

“The perennial threat of sanctions will keep (Russian) markets jumpy over the coming months due to the fear of economic damage and uncertainty regarding the time and scope of (new) measures,” says Peixoto.

The U.S. took almost six months to impose sanctions related to the Sergei Skirpal poisoning in 2018. Moreover, the presidential election calendar may further delay actions against Russia, a country which has faced constant criticism from the Democratic Party and Joe Biden. But what will Biden doe about Navalny and Nord Stream II if he wins? Every option ticks off the Germans, unless he was able to convince them to can the project altogether. Trump couldn’t do it. Germans cited national sovereignty. Would Navalny be the breaking point? Gazprom would be the hardest hit, if so. But it does not need Nord Stream II to remain a global national gas giant.