How Long Can Russia Hold Out? (Revised)

As the US and other leaders of the now G7 group of nations have shunned Russia and its antics in Ukraine, a clear message is being sent to the former Soviets: change your actions or there will be severe consequences. A few weeks ago the G7 agreed to economic sanctions of Russian energy, finance, banking, and weapons industries until the country backed off of its annexation of Crimea. Instead of the G8’s annual meeting in Sochi this upcoming June, the now G7 will instead travel to Brussels and have their meeting there. (WSJ)

The question now I believe is to what extent will these sanctions be successful and how does that compare with other economic damage being done purely due to the political and economic unrest created by Putin’s actions. What I am getting at here has to do with the cost benefit analysis of the sanctions. For the US, as explained in this WSJ article, sanctions against Russia really would not have much of an effect as only 1% of annual US trade occurs with Russia. The meat of the sanctions would come from European countries and as shown by the following graphic, could hurt Europe as much as they do Russia:

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With almost 160 billion euros worth of oil and gas sent to the European Union in the first 9 months of 2013, there is substantial demand that would have to be gotten elsewhere if the EU were to in fact, sanction like the G7 is talking about. It is also unfortunate for the EU that over 15% of their gas needs come through Ukrainian pipelines that Russia could feasibly have some sort of control over now as well. Russia is the EU’s 4th largest trading partner and has substantial banking and automotive ties in the EU countries to boot. So obviously the G7 has something much more complicated than just sanction and wait going on here.

The good news here though, is that the G7 may not even have to impose as extreme of measure as are being talked about due to the unrest in the financial markets in Russia. As news broke of the tense situation back towards the beginning of March, Russian stock indexes dropped as far as 10% in a single day and have continued falling since. These are accompanied by massive losses in value in the Russian Ruble and the MICEX Russian Index (not hedged against losses in currency value) has fallen to almost 30% losses on the year at points. Accompanied by massive capital outflows from Russia and it becomes feasible that Russia could enter a recession without the US or the G7 ever having to do anything more than threaten to sanction. (Bloomberg) This is the most interesting part of the whole story I think, that while these threats of sanctions can be quite complicated as well as costly, there is really nothing as clear as Russian oligarchs losing over 20% of their wealth as quickly as Putin can send troops to the Ukraine.

Another factor, albeit a longer term issue, that stands in front of Russia is the shrinking cost of oil with the US becoming energy independent as well as the continual development of new alternative fuels. In a recent Barron’s article, economists from Citigroup talked about how the continual rise of production of oil in the US and elsewhere and this decreasing demand due to the ability for engines to run on alternatives, could lead to oil price averages around $75 a barrel rather than the traditional $90 to $100 range (Barron’s). This alone should make Russia think twice about its aggressive political movements of late, because alternative fuels like LNG exportation and solar energy just became a much bigger threat to Russia’s future monetary prospects. The lasting implications of aggressive moves such as these for the country are the expedited development and use of other fuels. This would leave Russia’s economy in complete shambles as that is their primary source of revenue.

The next time Mr. Putin asks his friends for a little money from the private sector and they do not have it, he may come to regret the path he has taken here on the Ukraine. The implications of his actions could be longer lasting than he realizes and the stakes for the Russian economy could be much higher than just a few months of sanctions.