Macro/energy update (Russia/Ukraine)

Recent/upcoming developments…  President-elect Trump said during the campaign that he intends to immediately negotiate an end to the war in Ukraine.  He said this week that a meeting with Russian President Putin is being arranged.  Shortly after Trump’s comments, President Biden imposed a new raft of sanctions on Russia’s energy industry.

* Trump’s envoy Keith Kellogg is set to travel to Ukraine after he is sworn into office, with the goal of ending the war.  This summer, Kellogg proposed a framework to end the war, which would start with Ukraine and Russia agreeing to a ceasefire along current battle lines.  Russia would be offered limited sanctions relief.  Ukraine would agree to use diplomacy to regain its lost land.  To ensure the ceasefire is not violated, the U.S. would continue to arm Ukraine, which would be contingent on Ukraine agreeing to participate in peace talks with Russia. Ukraine would also put off NATO membership “for an extended period” in exchange for a verifiable peace deal with Russia that would include security guarantees from the U.S.  The plan stipulates that reconstruction of Ukraine would be paid for by levies on Russian energy.  Under the framework, the U.S. would only fully lift sanctions on Russia after it signs a peace agreement that is acceptable to Ukraine.

* Meanwhile, in December, NATO Chief Mark Rutte said Ukraine should put off any peace talks with Russia until Western allies can send enough military aid to help Ukraine push ahead on the battlefield and garner a stronger negotiating position.

* Biden’s action today involves sanctioning ~200 ships that transport Russian oil and Russian oil companies Gazprom Neft and Surgutneftegas along with energy officials, drilling, construction and insurance companies that provide services to Russia’s energy sector.  Biden administration officials say one reason they imposed sanctions was to strengthen Trump’s negotiation position.

Our outlook… In order to meet the high expectations Trump has set on his ability to end the war, we expect that within days of taking office, he will make an announcement of some sort that at least at an optical level fulfills this commitment, without necessarily achieving an immediate substantive result.  As Kellogg has signaled, the U.S. removing sanctions on Russia will be a key first step in any U.S.-led peace talks between Russia and Ukraine.  The most likely initial offer Trump could make is the removal of personal sanctions on Russian oligarchs, which would allow them/their companies to transact with U.S. firms again.  A more impactful move would be for Trump to remove financial sanctions on Russia, which he could do unilaterally.  Given the significance of U.S. financial sanctions, it is unlikely that the lifting of these sanctions would be included in the early stages of an agreement.  Trump could also try to reverse sanctions on Russia’s energy sector, but those sanctions, as well as the freeze on Russian central bank reserves, involve other nations, which makes it more challenging for Trump to change course on them.  While Trump’s advisors have floated sanctions relief as a means to lure Russia to the negotiating table, Trump could instead increase sanctions if Russia is intransigent.

* Throughout the course of the war, the U.S. has blocked transactions with Russia’s two largest banks, Sberbank and VTB, whose assets make up more than half of the Russian banking system. The U.S. has also imposed full blocking sanctions on five other crucial Russian financial institutions: Alfa Bank, Bank Otkritie, Promsvyazbank, Rosbank, and Sovcombank, and debt and equity restrictions on Credit Bank of Moscow, Gazprombank, and Rosselkhozbank.  Additionally, the U.S. sanctioned the Russian Direct Investment Fund and VEB, a Russian state development fund. Overall, U.S. sanctions restrict dealings with 80% of Russian banking sector assets.  The Biden Administration also sanctioned Russian sovereign debt by banning U.S. financial institutions from processing debt payments from the Russian government to foreign investors.

* The U.S. holds ~$5b in Russian central bank assets, while the lion’s share are held in the EU, including ~$200b in Belgium. Europe is unlikely to unfreeze the assets, but Trump could offer to unfreeze Russian assets held in the U.S. in order to advance negotiations.  For Trump to unfreeze Russian assets, he would have to follow the procedures set out in the aforementioned REPO Act.  That bill states that frozen Russian assets cannot be released until “hostilities between Russia and Ukraine have ceased;” and either (A) full compensation has been made for harms; or (B) the Russian Federation is participating in a bona fide international mechanism for all compensation owed.

* Fully enforcing the sanctions Biden announced this week would significantly escalate the burden on Russia by clamping down on the existing G7 price cap on Russian oil exports.  Russia has evaded those sanctions by using a so-called “shadow fleet” – services that are subject to non-Western jurisdictions.  By imposing secondary sanctions against the companies that make Russia’s sanctions evasion possible, the U.S./G7 could squeeze Russia’s ability to profit from energy exports.

Watch for these developments… Any hawkish comments from Kellogg or other influential policy players such as Sen. Rubio (R-FL), his nominee for Secretary of State, or others could suggest that Trump is considering escalating against Russia to coerce it to the negotiating table.  We are also watching the reaction of European nations to Trump’s actions, as their cooperation is a key element of what will be necessary to bring Ukraine to the negotiating table, and to provide relief on various sanctions mechanisms outside of the unilateral control of the U.S., such as the oil price cap and freeze on central bank reserves.