As we noted in our first article in this series, the Russian Federation has annexed part of a neighboring country. Russian troops are occupying Ukrainian bases in Crimea and massing troops along their shared border with Ukraine. In the first article of this three part series about investing in Russia and the Crimea fallout, we looked at the historic backdrop to events in Ukraine and the annexation of Crimea by the Russian Federation. In this second article we will look at the Crimea fallout over the short term as it will effect investing in Russia (or not), the value of the Ruble and political and economic relations with the European Union and the USA. In the third article we will analyze how to proceed at investing in Russia in what is being characterized as the worst situation since the end of the cold war. Now the G 8 economic group has kicked Russia out and both the USA and EU are ramping up selective economic consequences for those involved.
Europe, Russian Oil and the US Oil Boom
One of the issues that concern the European Union is that they have been dependent on Russia for lots and lots of natural gas and oil. Another is that the largest part of that oil and natural gas moves by pipeline through Ukraine. Meanwhile sustainable fracking technology has resulted in an oil boom in the USA. To the extent that the EU and especially Germany want to reduce their dependence of Russian oil, they will likely look to the USA for exports. To the extent that the USA wishes to make Russia feel the impact of their annexation of Crimea without taking military action it may find ways to further ramp up production and meet any shortfalls that Europe may experience.
Kicked Out of the Club
The major economic powers (USA, Japan, Germany, France, Great Britain, Italy and Canada) met as the Group of 7 until they invited Russia to join fifteen years ago to create the Group of 8. Now Mr. Putin’s government is out of the club. To quote the G7 annexation of the Ukrainian republic of Crimea was not consistent with the group’s shared beliefs and responsibilities. The G8 was going to meet at the site of the recent Olympic games in Sochi, Russia but the meeting has been moved to Brussels and Mr. Putin will be alone if he goes to Sochi. It is clear that the USA and NATO are not going to intervene militarily in this matter and it is unlikely that Mr. Putin will back down and give Crimea back to Ukraine. But being kicked out of the club is only the first of a series of measures meant protect Europe from a Russian Bear reminiscent of the Soviet Era.
Investing in Russia
As Mr. Putin flexes Russian military muscle against a virtually defenseless neighbor, anyone investing in Russia needs to be concerned. There appears to be an escalating tit for tat going on that could end up damaging the Russian economy and the interests of anyone with money invested in the Russian Federation. We already mentioned the issue of oil and natural gas but there is much more to trade between the EU and Russia. According to the European Economic Commission annual report, in 2012 the EU imported 212.9 Billion Euros worth of mostly raw materials from Russia and exported 123 Billion Euros worth of finished products.
Russia is the third trading partner of the EU and the EU is the first trading partner of Russia.
EU exports to Russia are dominated by machinery and transport equipment, chemicals, medicines and agricultural products.
EU imports from Russia are dominated by raw materials, in particular, oil (crude and refined) and gas.
The EU is the most important investor in Russia. It is estimated that up to 75% of Foreign Direct Investment stocks in Russia come from EU Member States.
In the short term, foreign direct investment in Russia may be risky and investors should probably adopt a wait and see attitude. The Ruble is down versus all major currencies, wealthy Russians may find it hard to move their money through Western banks, and President Obama has taken to calling Russia a regional power as he seeks agreement on further sanctions against the Russian Bear.