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Summary

  • Recent sell-off of Russian assets based on geopolitical concern out of step with current reality.
  • Russian companies like Gazprom likely to experience increased demand for gas exports because of new opportunities to sell in Asia.
  • There are real concerns with Russia's economic performance potential, which is what markets should focus on when evaluating value. The threat of gas shipment disruption due to the Ukraine situation still possible.

Market Vectors Russia ETF (NYSEARCA:RSX) is down by roughly 14% year to date. The slide started at the end of January as Yanukovic was forced to flee Ukraine and it became clear that Russia had no intention of remaining idle. It is a very good gauge of the broad sell-off of Russian assets. Given the global importance of Russia's energy exports, especially when it comes to the EU, it makes absolutely no sense to have such a huge Russian sell-off based on geopolitical concerns, while the rest of the world's financial markets did not react at all. As I pointed out in previous articles on the subject of the Ukraine crisis, there is no such thing as a one-sided economic war when engaging Russia. It therefore makes no sense whatsoever to have Russian assets down for the year due to the crisis, while the rest of the world is acting like it is business as usual. If people are betting on an economic confrontation, then it only makes sense to bet on a global sell-off.

Symbolic Sanctions:

As I pointed out in a previous article, there is no need to worry about an economic war breaking out. Just as is the case with the prospect of a military confrontation that everyone wishes to avoid due to fear of mutually assured destruction, the escalation of an economic war carries with it dire consequences for all sides, it is therefore undesired. The West has been talking tough, but never actually crossed the line by applying truly meaningful sanctions. The sanctions on individuals have no actual effect on Russia's overall economy, they only serve to slightly annoy a few individuals.

The decision taken by the European Commision to delay decisions on the South Stream pipeline may only end up hurting the European Union in the long term if the situation is not addressed soon. In fact, the EU may get hurt by this decision if it will not show signs of collaboration on this deal by May at the latest. In May Putin will go to China where the main topic of discussion will likely be a 38 billion cubic meter (1.2 trillion cubic feet) per year capacity pipeline (link). Other potential major customers which may also sign a deal if Russia wants to pursue are Japan and South Korea, both of which currently pay far more for LNG shipments than EU pays for Russian gas. Japan expressed interest last year in having a pipeline from Russia to Japan. It is in fact possible that Russia will lose interest in the South Stream if deals are signed in Asia. In the meantime the dilapidated and politically unstable route through Ukraine which provides 15% of total EU gas needs to remain an option for trade. If this is the case, the EU will have to make do with more expensive LNG, further harming EU competitiveness once the pipeline infrastructure in Ukraine which is in desperate need of repairs goes down. As a long-term play it is the EU that should be sold due to the current crisis, not Russia.

Private sector continues to remain interested in doing business:

Even as Europeans and the United States were contemplating how to respond to Russia after the annexation of Crimea, the CEO of Siemens (SI) went to Russia to discuss business (link). Daimler also announced that it is interested in investing in production facilities there (link). The clear message being sent by the private sector especially in Europe is that it does not desire a worsening of economic relations.

Oil & gas exports not affected in any way:

It is interesting to watch the sell-off of Gazprom (OTCPK:OGZPY) as a result of the Ukraine crisis. It is understandable in a way, given that a disruption of gas deliveries to Europe via Ukraine would have deprived the company of a very large portion of its export revenue. But so far no disruption happened and the overall situation is more calm than it was a month ago. Furthermore, the gas subsidy that Russia gave to Ukraine is now gone, therefore Gazprom can now get the full price for its gas deliveries to that country, potentially increasing revenue (assuming Ukraine will pay its bills).

Assuming that for the longer term Russian oil and gas exports will in any way be affected as a result of this conflict is a mistake. As I pointed out already, there is no shortage of potential customers that Russia can switch to in the long run. I don't think we are likely to live in a world where customers will ever say no to oil and gas supplies. There is a reason why oil prices increased by over 400% since the beginning of this century. Russia's export volumes of these two important commodities are important at a global level and cannot be replaced with substitutes or other sources of supply. In fact, Gazprom may find itself in a situation where it will have a very hard time to satisfy both the EU and new Asian customers by the end of the decade. Within this context, the recent sell-off of the stock and talk of downgrading the company by Fitch seem to be very much out of step with reality (link).

The real dangers to consider if looking to invest in Russia:

Russia does have some real problems when it comes to economic performance, which people should pay attention to. First on my list is the reliance developed over the past decade on increased revenue coming from oil and gas exports, as a result of increased production and rising prices. That trend has pretty much played itself out now as both prices and production volume are pretty much stagnated and the Russian economy needs to re-adjust to losing this important engine of growth. It remains to be seen how well they can adapt. Much depends on their ability to improve productivity. They also have to improve the image of the Made in Russia brand for goods other than commodities and military hardware.

The Ukrainian situation can still pose a threat due to likely disputes over natural gas payments which should be expected to intensify as Russia increases the price of gas over and above the EU average (link). Internal conflicts made worse by a very harsh IMF policy towards Ukraine, which will further intensify the political and ethnic divisions have the potential to throw Ukraine into chaos, which could result in a brutal, uncontrollable and prolonged civil war. These are all potential threats to investments into Russia which people need to keep an eye on. Having said that, the recent sell-off is out of step with reality and therefore an opportunity to invest based on a return to fundamentals.

Source: Russia Looks Attractive