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Why the Russia-Ukraine crisis could affect energy investments

Part 2
Why the Russia-Ukraine crisis could affect energy investments (Part 2 of 8)

Will the Russia-Ukraine tension affect world energy supplies?

The Russia-Ukraine crisis

The geopolitical situation between Russia and Ukraine began to intensify late last year.

Ukraine’s economy had been under intense strain, and the government had been seeking external funding and aid to provide economic stability and maintain the country’s standard of living. While the EU had offered some measure of financial help (which also came with stipulations about how Ukraine should govern itself), Russia had proposed a multi-billion–dollar loan package as well as lower prices for Russian natural gas to Ukraine. Many Ukrainians were opposed to stronger ties between Ukraine in Russia, preferring instead to see Ukraine enact pro-Western reforms. Rallies against Yanukovych and his Russia-friendly policies eventually turned violent.

Russia vs World vs US ETFEnlarge Graph

In Kiev, intensifying violence between protestors and police created a state of emergency. In late February, demonstrators had taken control of Kiev’s government district. Soon thereafter, the Ukrainian Parliament voted to impeach President Yanukovich. An interim president and government assumed power and issued a warrant for the arrest of Yanukovich, who fled the country.

Russia strongly condemned the protests in Ukraine. Meanwhile, reportedly, Russian troops moved into the Crimean Peninsula, an area that had been formally under Ukraine as an autonomous republic but that is heavily populated with Russian speakers. Russia denied involvement, though most experts believe the invasion was carried out by Russian special forces. In March, the Parliament of Crimea voted to secede from Ukraine. Currently, Crimea is under Russian control.

In recent weeks, tensions in Eastern Ukraine have continued to intensify. The area borders Russia, and parts of it are also dominated by native Russian speakers. There, pro-Russian demonstrators have clashed with Ukranian authorities. Meanwhile, Russia has built up its military presence on its border with Ukraine.

Western powers, such as the U.S. and EU, widely view Russia’s actions as a land and power grab executed by President Vladimir Putin. In March, in reaction to Russia’s aggressive measures, the EU and the U.S. imposed sanctions against the country. This first round of sanctions, which targeted a list of officials and individuals from Russia and Ukraine with asset freezes and travel bans, was seen as mostly benign, with little economic effect. However, as tensions between Ukraine and Russia continue to increase, Western powers have been weighing more severe sanctions, which could target Russia’s energy industry with implications for the global energy supply.

As expected, Russian equities have lost significant value through the crisis. The Market Vectors Russia ETF (RSX), which tracks the Market Vectors Russia TR Index, has returned -22% year-to-date (as of April 15, 2014). Meanwhile, the iShares MSCI Russia Capped ETF (ERUS), which tracks the MSCI Russia 25/50 Index, has returned -21%. The SPDR S&P Russia ETF (RBL), which tracks the Russia Capped BMI Index, has returned -22% year-to-date.

Meanwhile, world equity markets have generally been flat to up this year. The Vanguard FTSE Emerging Markets ETF (VWO), which tracks the FTSE Emerging Markets Index, has returned roughly 0% year-to-date. The Vanguard FTSE All-World ex US Index Fund (VEU), which tracks the Vanguard FTSE All-World Ex-US Index, has also returned roughly 0% year-to-date. For reference, the SPDR S&P 500 ETF (SPY), which tracks the S&P 500, has returned roughly 1% year-to-date.

Continue to the next part of this series to see how stronger sanctions against Russia could affect the world energy markets and how Western Europe might wean itself off Russian natural gas.

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