Economic, financial, and commercial sanctions against Russia are a reaction to President Putin’s unprovoked military assault against a sovereign nation posing no threat to Russia. The historic economic response of the EU/US/G20 is the only tool available to avert predication of World War III but capable of imposing harsh circumstances on Putin over time. The world has now settled into a war of attrition, with investors pondering the circumstances and timing of de-escalation or worsening global economic drag.
The questions we get most often about the policy action/reaction function in Ukraine revolve around de-escalation and energy market fundamentals. Focusing on these inquiries, the past few weeks underscore we are a fossil fueled world, which Putin will use as a pain test. How well the world deals with the Ukraine test will inform everyone, especially Putin, about how well the world will deal with future pain tests. This supply shock to energy markets harkens back to the 1973 episode with Saudi Arabia.
How the US and OPEC deal with short-term supplies to the EU is important to the current pain test and future strength of alliances against autocrats. The Saudi government seems unwilling to publicly separate from the Kremlin, a dynamic so important President Biden reportedly will add a stop in Riyadh to his spring/summer travel schedule.
According to the US Energy Information Administration, US shale production is at a run rate equivalent to 2019 levels after recovering from a COVID hit. US petroleum rig counts remain historically low, as shown below. Tapped out wells and insufficient prospects reportedly have investors discouraging companies from new drilling activity. Oil field fundamentals, even at current market prices, would appear the impediment to higher production, not policies of the current Administration. This fact likely is a compelling consideration within the White House on Russian energy sanctions.
Investors have plenty of information about current impacts in Ukraine, Europe, and the West, but we are deprived of real-time Russia information. This naturally leads to assumptions it’s going worse outside of Russia than inside. There are reasons to question if not doubt this scenario. Mohamed El-Erian writes in Project Syndicate that Russia’s economy could shrink “by about a third, owing to the unprecedented severity of the sanctions it is now under.” It is “headed toward severe foreign-exchange constraints, massive goods shortages, a collapsing ruble, mounting arrears, and the expectation among households that things will get worse before they get better.”
Despite generally acknowledged mistakes in prosecuting the campaign against Ukraine, Putin would appear willing to bet that his opponents outside the ones on the battlefield won’t withstand much more pain. Europeans understand that acquiescing to Putin’s terms to end this war would merely embolden him the next time he decides to fabricate reasons for invading another country on his border. Most of those are NATO member countries, a fact that ratchets up risks of Putin’s next war – surely an element of his Ukraine strategy. ‘Pain me now or pain me later’ applies to this test.
US Treasury’s Financial Crimes Enforcement Network (FinCEN) on Monday afternoon sent a notice to financial institutions advising vigilance against attempts to evade the long list of sanctions against Russian, Belarusian individuals and entities. The notice strongly implies the US, and its allies are not softening on sanctions despite direct and indirect pain for populations in Europe, the UK, and the US. A European colleague mentioned his mom’s utility bill this month is nearly treble what she paid the same month a year ago.
This war tests everything upon which democratic principles are built. Quite regrettably it is too early in the standoff to gauge which side will prevail in any dimension. Putin will allow Russians and Ukrainians to absorb plenty of pain. The less certain question is how long will Brussels, London, and Washington use their economic fighting tools to deter him now and in the future.
Zachary Rozen, a sanctions expert with Pillsbury, Winthrop, Shaw, Pittman, will join me for a 22V client webinar today, March 8 at 10:00AM ET (Register HERE). I will moderate a discussion focusing on the events in Ukraine, including questions about the duration of sanctions, implementation schedule, and short-term and longer-run effects. Zach will discuss these issues and take questions during this 30-minute webinar. Please join us.
