“Down the Rabbit Hole”

February 24, 2022 will go down in infamy as the day Russia invaded Ukraine. In response, the West has never been more united in a coordinated effort to isolate and punish Russia for its so called “special military operation” in Ukraine. In a few short days, many countries have transitioned from the decades-long policy of trying to make peace with Russia to hitting it with sanctions the likes of which have never been seen before. They have frozen Russia’s foreign assets. They have removed many of its major banks from the Society for Worldwide Interbank Telecommunication (SWIFT) network. They have also confiscated the mansions and yachts of some Russian oligarchs. Additionally, some of the world’s largest companies have been cutting ties with Russia. Even Mastercard and Visa are reportedly blocking Russian transactions. Indeed, Russia is currently the subject of some of the harshest economic sanctions ever imposed upon a country.

To add further fuel to the fire, the U.S. has imposed a ban on Russian oil imports. However, so far, no other country has accepted the challenge. This is quite understandable given Russia’s importance in the energy sector.

Russia is the world’s third largest producer and second largest exporter of oil and accounts for about 10% of the world’s oil supply. Most of Russia’s oil exports go to Europe. Countries such as Finland and Hungary import virtually all their oil from Russia. Poland reportedly gets more than 55%, while Germany and the Netherlands receive more than 40%. In addition, the European Union get almost half of its gas from Russia, a dependency which has been growing in recent years.

Imposing large scale energy sanctions on Russia would therefore risk adding more pressure to an already supply constrained market. This would mean even higher oil and gas prices worldwide which would fuel even higher inflation thereby causing central banks to deploy tighter monetary policies and likely halt the ongoing global economic recovery from the covid-19 pandemic. Hence, most countries have carefully crafted their sanctions to avoid targeting Russia’s energy exports.

The U.S. however is far less dependent on Russian oil than Europe. For instance, less than 10% of U.S. oil imports came from Russia in 2021. As such, the U.S. is much better equipped to wage an energy war against Russia than its European allies and as such it remains unlikely that they will impose a full oil embargo like the U.S. Germany for instance, given its influence as the biggest economy in the Euro-area and the world’s fourth-largest economy, has so far resisted calls from the U.S. to impose a ban on imports of Russian oil and gas. Nevertheless, the European Commission has been emphasizing the need for Europe to be less dependent on Russian oil and gas and shift towards more environmentally friendly energy alternatives.

The collaborative effort to immediately impose sanctions on Russian oil and gas could potentially cripple the Russian economy and hasten the cessation of hostilities in Ukraine. However, given Europe’s heavy reliance on Russia for energy supplies it is unlikely that the E.U. will follow the U.S. down the metaphorical “rabbit hole”.

Eugene Stanley is the VP, Fixed Income & Foreign Exchange at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm

Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm