Black Swan in the Black Sea

Posted by on March 27th, 2014

The recent conflict in Ukraine and the Crimean peninsula have grabbed headlines around the globe. While the world watches what develops in Ukraine, I’m interested to see how saber rattling and economic sanctions could have a larger impact than the conflict itself.

Ukraine was governed until February 28th, 2014 by Victor Yanukovych, who was a staunch supporter of Vladimir Putin and the Russian Federation. On November 21, 2013 Mr. Yanukovych and his cabinet abandoned an agreement on closer trade ties with the EU in order to receive benefits from the Russia Federation, including economic aid and reduced gas prices.

Ever since, conflict in the region has dramatically escalated with a popular uprising removing Mr. Yanukovych from power and potential armed conflict with Russia in Crimea raising concerns about the affect a disruption in the area would have on economic recovery worldwide.  While we have not yet seen a significant impact to the US economy, we have seen some hints of what could happen if there is sustained unrest in the area. On March 3rd, 2014, when President Putin received authorization for armed force, the price of wheat rose 4.5%, oil jumped more than $2/barrel, and gas jumped 9.5%.

Relations between Russia and the West continued to deteriorate after the Crimean Referendum, when the US imposed economic sanctions and travel bans against government officials, business owners, and military officials. In a familiar tit-for-tat  move, the Russian government has imposed sanctions on congressional leaders, and their advisors. Senator John McCain even had to cancel his spring break plans.

While such sanctions can be dismissed as harmless slaps on the wrist, there is the potential for the situation to devolve into a trade war which would lead to deeply negative consequences for financial markets.  Currently, sanctions have been primarily imposed on cronies of President Putin but there is the high probability that sanctions will escalate and widen their scope to affect the greater population.

The next G8 meeting, which was to be held in Sochi, has been suspended and will be held instead in Brussels without Russia. Additionally, President Obama is pushing for the expulsion of Russia from the G8 and further sanctions against Russian banks and oligarchs. While the US is keen on pushing stinging economic sanctions, the EU on the other hand has much more to lose in an economic war with Russia.  Roughly 30% of the natural gas consumed in the EU is imported from Russia.

Additionally, Germany, Russia’s largest European trading partner with more than 6,000 companies doing business in Russia,, has a lot to lose by increased economic sanctions. A 100€ million contract with German defense company, Rheinmetall, has been already been indefinitely suspended and Russia is notorious for banning business in retaliation.

For now it seems that Russia is content with its annexation of Crimea and there are doubts that the conflict will extend further in the region. But what would happen if cooler heads do not reign? Will the looming threat of economic sanctions come to fruition and dampen the economic recovery in Europe and globally? Or will leaders step back from the edge? What are your thoughts?