Worst-Ever Russia Sanctions Set To Become A Business, Market Nightmare

Russia’s war against Ukraine has resulted in the worst-ever sanctions against the country. The table is set for a fast deteriorating business and investing climate in Russia.

The VanEck Russia (RSX) exchange traded fund fell over 50% in a week. It is unclear if this fund will even exist in the weeks ahead.

What comes next is anybody’s guess.

The weekend of February 26 saw an escalation of economic choke hold moves on Russia. From banning some Russian banks from the SWIFT international bank communications system to holding the Russian Central Bank’s dollar and euro currency reserves hostage, the message is clear: Europe and the U.S. are livid with Russia’s unprovoked attack against Ukraine.

A worst-case scenario has begun.

“Further escalation can’t be ruled out. Markets will be jittery,” said Jeff Grills, head of Emerging Markets Debt at Aegon Asset Management.

Russia x Europe: What Now?

On Sunday, February 27, 2022, Aeroflot and other Russian planes were all banned from European air space. Russia returned the favor on Monday, forcing Russians that are looking to get out of Russia for whatever reason to have to do some serious airport hopping.

Also on Sunday, oil giant BP said it will exit its joint venture with Russia’s state owned oil company Rosneft. The company had a 19.7% stake in Rosneft.

Additionally, BP CEO Bernard Looney will resign from the board, effective immediately. The other Rosneft director, former BP CEO and long-time friend of Russia, Bob Dudley, will also be resigning from the board. He has not commented on this personally. Dudley has many friends in Russia.

And then on Monday, Shell Oil followed its British counterpart and said it will leave its joint ventures with Gazprom, including the now dead Nord Stream II.

Norway’s Equinor also plans to exit Russia, according to a Reuters article.

Much to the chagrin of some, President Biden has not sanctioned Russian oil and gas transactions. That business continues as usual despite all the majors, including Rosneft, being unable to sell dollar denominated bonds to U.S. investors. Insurance rates on tankers hauling Russian product have skyrocketed.

Joint venture deals have been poisoned since the first Russian military action in Ukraine – the annexation of Crimea in 2014, where Sevastopol, the old Russian Navy port deemed critical to the Kremlin, is located. Those Obama-era sanctions put an end to Exxon’s offshore Arctic drilling partnership with Rosneft, a deal that was worth around $700 million at the time.

Traffic flow for Russian ships transporting goods will also be greatly inhibited, likely leading to some supply chain bottlenecks for a while out of Russia. Merchant marine vessels flagged in Russia were banned from the U.K., the country’s Secretary of Transport, Grant Shapps, requested of British ports in a letter on Monday.

This is a real war, with boots on the ground, missiles fired, and bombs being dropped from Russian jets. Putin – once sold as an info war mastermind in the Trump era due to Russian Facebook ads against Hillary Clinton – has completely lost to his much younger rival, comedic actor turned Ukrainian president Volodomyr Zelensky, in the battle for hearts and minds.

Even Russians are protesting against the attacks on Ukraine.

Most Russians despise the idea of NATO expansion into Ukraine, but a considerable number of them have family and friends there and do not want them turned into enemies. This is the world’s ugliest divorce.

Ethnic Russians in the Donbas region, in cities like Luhansk and Donetsk, often hail the arrival of Russian troops. But further west, in cities like L’viv and Kyiv, Russia is vociferously hated right now.

All this is going to be increasingly difficult for international business relationships, including those between Ukraine and Russia.

For the West, Rosneft and Gazprom are state owned and easy to vilify, but the prospect of doing any business in Russia – including apolitical business — is fast becoming too risky. Long time business ties might be torn apart if they can’t last the uncertainty of the days ahead.

So far, the American Chamber of Commerce in Moscow has been silent on this disaster in the making.

“If oil prices were to rise to $125 a barrel or higher for two quarters, it would result in roughly half a percentage point lower in global GDP growth and higher inflation affecting consumer spending power,” Mark Haefele, Chief Investment Officer at UBS Global Wealth Management, wrote in a February 24 note to clients. WTI crude is around $95 per barrel currently. Oil futures rose 4.6% on Monday.

Higher inflation could cause the Fed to act, raising interest rates.

“Should Russia’s energy flow be disrupted, higher risk premiums and lower global earnings estimates would likely trigger more long-lasting losses for equity markets,” Haefele wrote. “Heightened volatility on the escalation of the conflict shows markets did not fully price in the likelihood of deeper conflict.”

Big Business to Biden: “Get the Details Right”

Before fighting broke out, the Biden administration and Congress were asked to “get the details right in case they must follow through on the threat of sanctions,” Jake Colvin, president of The National Foreign Trade Council, told Reuters on January 26.

This month, the American Petroleum Institute discussed sanctions with a super hawkish Congress, led by the Democrats, who see Russia as the guys who elected their arch nemesis Donald Trump in 2016.

“Sanctions should be as targeted as possible in order to limit potential harm to the competitiveness of U.S. companies,” an API spokesperson said.

Sanctions can have a serious boomerang effect on U.S. companies working in Russia, according to people interviewed by the WSJ in late January. “The dialogues between business, the White House and the Hill are important to soften the unintended impact on business,” said Cari Stinebower, a partner at law firm Winston & Strawn LLP in Washington who focuses on sanctions and export controls.

It’s not that every American and European company is doing business with Putin, the Russian state, or a Russian oligarch sanctioned by Washington.

Often, these are decades old relationships trading in everything from workout supplements to software, Ford automobiles to Boeing
BA
airplanes. Yet, judging by the exit of European oil companies, Exxon may be feel the pressure to follow.

“Survey Says!”

According to American Chamber of Commerce in Russia, the total volume of direct investments of American companies in Russia is around $100 billion.

A survey by Ernst & Young (EY), conducted in the spring of 2021, found that of the 92 U.S. companies in Russia, Russia was considered “a strategically important market” for most of them. Some 40% of them have been in Russia for 20 to 30 years, with 14% being there for even longer. The percentage of American companies that said Russia was a key market is the highest it has been in four years. American businesses are welcome in Russia. But the political animosity will be a hurdle.

As uncertainty caused by the pandemic subsides, tense relations between Washington and the Kremlin have become the real “new normal” – a term everyone has heard bantered about regarding life post-pandemic.

Prior to the Russian military operations in Ukraine, 84% of companies told EY that they had planned to launch new projects in Russia in the near future – the highest level in the survey’s history. But sanctions will undermine this, another 78% of respondents told EY. The restrictions put American business at a disadvantage compared to companies from other countries – namely China and India – and will create reputational risks: how dare you work with a country bombing another country, unprovoked?

U.S. businesses will likely face counter-sanctions and legal actions in Russia. Such moves are likely be announced any day now.

Russians who support people living in the Donbas region of Ukraine, and are largely pro-military action, have called for boycotts of McDonald’s.

There is an estimated 1000+ U.S. companies in Russia, including household names like Apple
AAPL
, iHerb, and the entirety of the back office of Veeam Software. Their lives are more complicated because of sanctions and travel bans.

For the U.S. and Europe, the partners of those companies might as well be Vladimir Putin himself, or some sanctioned oligarch.

California health and beauty retailer, iHerb, thinks its relationship with the Russian market will worsen. Almost a quarter of its sales come from Russia, and in 2019 the company’s revenue in the country were around $90 million, business daily Vedomosti reported. iHerb has been in Russia since 2010, before the country was even a member of the World Trade Organization. Millions of Russians began to use dietary supplements during the pandemic and California’s iHerb became one of the easiest ways for them to buy without leaving the house. The company recently decided to open a local office. This spring, they were the target of an investigation and were put on a blacklist, under threat of being shut down.

Companies like iHerb might be an easy target to pick off. But it’s not just their business, it’s the reputation of U.S.-made products at stake – tainted as the bad guy, just like the Russians are being tainted.

Washington to Apply, or Threaten, More Sanctions

Last week, some Democrats in the House of Representatives and some Republicans in the Senate said they were considering stripping Russia of its Permanent Normal Trade Relations status (PNTR), which grants it near duty free access to the U.S. This would mean that every Russia export to the U.S. would be hit with higher tariffs. Russia would likely do the same.

“You should not forget that along with its products, American business brings our culture, health standards, political values, and promotes our way of life,” said one company executive who wished to remain anonymous. “Levi’s, Marlboro cigarettes, Coca Cola all played no less of a role in the fall of the Soviet Union than did the Reagan administration. In defending the interests of democracy and security, the Biden administration is forgetting about the interests of American business in the region, and they are definitely under threat.”

On February 25, ZD Net’s senior technology editor, Jason Perlow, listed tech companies like Veeam, started by a Russian named Ratmir Timashev and sold to Insight Partners in 2020, as being on shaky ground.

Perlow said well known Russian tech companies like Kaspersky Lab could be out of favor with Western clients.

“World governments do not need to levy Iran-style isolationist sanctions against Russia for a snowball effect to start within U.S. corporations that use Russian software or services,” Perlow wrote. “The escalation into full-blown conflict in Ukraine will make C-suites within global enterprises extremely concerned about using software that originates from Russia or has been produced by Russian nationals. The most conservative companies will probably ‘rip and replace’ most off-the-shelf stuff and go with other solutions,” he wrote last Friday.

This Time it Really is Different

The Biden administration believes that the sanctions policy has borne fruit. The Russian economy has been stagnating since 2014. Capital flight since the onset of the Ukrainian crisis has mounted to over $200 billion. Foreign direct investment, which averaged $50-60 billion per year from 2006 to 2013 despite the global impact of the Great Recession, is now hovering around just $20 billion.

Since 2014 some of the largest U.S. companies left Russia, including Ford, and private investment giants Blackstone and Carlyle Group
CG
.

The resilience of the Russian economy to external shocks, including the sanctions, has taken many by surprise.

This time will be different. Very different. And very difficult the longer this lasts.

Monday’s meeting between Russian and Ukrainian officials did not make things better, but there was an agreement to meet again this week. Barring Zelensky saying no to NATO and no nuclear weapons ambitions, this meeting is a non-starter

The Russian Market: Rough Month Ahead

On July 6, 2021, on the sidelines of the Innoprom 2021 conference, a delegation from the American Chamber of Commerce in Russia and the heads of large American companies met with Russia’s Minister of Industry and Trade, Denis Manturov. During the meeting, Manturov announced his willingness to keep lines of communication open with American business to ensure healthy ties.

“Our American business community is one of the most numerous,” he said, adding that in the first quarter of last year, Russia and the U.S. saw an increase in mutual trade. It increased by 4.8% to $7 billion, most of it due to U.S. exports to Russia, which accounted for over half of that number.

That was last summer, though. The only thing anyone was worried about then was inflation, supply chains, and Covid.

Now American companies are faced with losing markets due to Russian retaliatory sanctions, and political pressures that companies in Brazil, China, India, Korea and elsewhere do not face.

Russian investors are in for a wild ride.

VanEck’s Russia fund is in trouble as MSCI said removing Russia from its indexes is the “natural next step.” There is over $920 billion in emerging market ETFs like VanEck Russia. Some 2.7% of it is in Russia, or around $24.5 billion.

For the gamblers, the only advice is to program tight stop-losses.

“We’re all shocked and saddened by events in Ukraine,” Johanna Kyrklund, group chief investment officer and co-head of investment at Schroders wrote in a blog post. “Although we are talking here about the impact on markets, we acknowledge first and foremost that this is a human crisis with potentially awful consequences. We have moved one step closer to peak uncertainty.”