Markets had already been pricing-in geopolitical risk linked to the insurgencies in Iraq and Ukraine ahead of the downing of Malaysian Airlines MH17. But the seeming intransigence of Russian officials in the wake of the outrage has raised the stakes from an economic angle, if not a security one.
Ambassadors from the 28 member states of the European Union (EU) gathered in Brussels this week to finalise plans for ‘phase three’ sanctions against Russia. These are designed to target whole sectors of the economy, as opposed to existing measures aimed at individuals and quasi-state organisations. The new measures will include an export embargo on arms sales, restrictions on access to European capital markets, and export of equipment for Russia's oil industry. On that basis alone the sanctions would have negative impacts on the UK and French economies disproportionate to that of other member states in the EU, although some sensitive high-tech exports from Germany to Russia are also on the line.
The City of London, including the wider advisory industry, would bear the brunt of any substantive curbs on Russian financing activities, but some global investment banks like France’s Societe Generale have a relatively high degree of exposure. David Cameron’s early call for an arms embargo on Russia was derided for its hypocrisy by French politicians, who, quite rightly, pointed out the number of active contracts that the UK had in place with Russia. In reality, however, large UK exporters such as BAe Systems (BA.) and QinetiQ (QQ.) have considerably fewer ties to Moscow when compared with French contractors such as Thales SA and DCNS SA. The French arms industry collectively generates five times more revenues from Russian receipts than its UK counterpart.
You would think that some problems would stem simply from the fact that a London listing has long been the preferred option for Russian companies. But we suspect the IC readership has limited exposure, no doubt cognisant of the corporate governance issues that have plagued a number of Russian/CIS stocks in recent years. There are, however, some home-grown resource companies that could suffer if the sanctions begin to bite. Chief among them, of course, is the beleaguered UK oil major BP (BP.). If battling US litigators over the 2010 Deepwater Horizon disaster wasn’t enough, BP is now effectively in the dock over its 20 per cent stake in Russia’s state-controlled energy giant Rosneft. With oil & gas central to the Russian economy, BP finds itself in good company; Royal Dutch Shell (RDSB) is in partnership with Gazprom on the giant Sakhalin-2 offshore project in the far reaches of Russia’s east, while Exxon Mobil is also in bed with Rosneft in Siberia. In short, big oil is all over Russia, particularly in light of the unbounded prospects opening up in the Federation’s Arctic regions. Even Norway’s Statoil - commonly held up as an industry exemplar from an environmental perspective - has signed a deal with Rosneft to exploit offshore prospects in the region.
There are some UK resource companies with production bases located in Russia that could be subject to fall-out from the ‘phase three’ sanctions, but it’s too early to quantify the risks. Some - some as gold miner Petropavlovsk (POG) - could even conceivably benefit from a falling rouble and a rise in precious metals prices. (Precious metals and Brent Crude ETFs have recorded ever stronger inflows as the crisis escalates). In the case of iron ore producer Ferrexpo (FXPO), its operations are actually based in Ukraine. Therefore, one suspects that any perceived risk attached to recent events is already reflected in the share price.
Without wishing to sound cynical, it’s still far from certain whether the measures in train from the EU have any teeth. The devil, as ever, is in the detail - and that’s somewhat lacking at the moment. Perhaps that will change, but given central and Eastern Europe’s dependence on Russian gas supplies, particularly in light of Germany’s switch-away from nuclear, is there really a serious concerted campaign in prospect - or is this just simply gesture politics at work?
There are conflicting signals. The reluctance of Russia to engage in any tit-for-tat measures could imply that the Kremlin thinks that there is little appetite for an energy-hungry Europe to up the ante. On the other hand, the previously reluctant Federation of German Industry is now backing the sanctions. The support of such a powerful trade body is all the more significant when you consider that German trade with Russia comprises about one-third of the EU total with annual sales around €36bn (£28.5bn).
