Geopolitics and new opportunities in the Russian financial market

The sovereign risk premium before the recent geopolitical events averaged 10% based on the USDRUB oil ratio and now exceeds 20-23% based on a conservative estimate, taking into account the long-term geopolitical risks which are permanently associated with the Russian assets. The country risk premium across all Russian asset classes averages 25%. The rouble’s strengthening to at least ₽65/$ at the current oil price is justified if the situation de-escalates (see table below).Our base case scenario is contrary to investors’ fears and assumes de-escalation, no additional sanctions against Russia and diplomatic agreement that will lead to market rebound back to pre-selloff levels of October 2021 and higher.Prior to the escalation on October 26, 2021, when Brent oil traded at $86/bbl, the USDRUB was below ₽69/$, Gazprom and Sberbank traded ₽370/share with sanctions risks and geopolitical premium at the time.Oil is now approaching $90/bbl and is likely to reach $100/bbl by the end of the quarter on the back of strong demand in Asia and limited supply from exporting countries, and recent tactical factors such as a drone attack on oil storage facilities in Saudi Arabia.We assume that chances of mild sanctions like sanctions against Russian banks that will also be market supportive leaving room for postponed/delayed diplomatic talks stand at 30% and tough sanctions at 10%, that is sanctions against the president, sanctions related to exclusion of Russia from SWIFT and economic embargo which is interrelated and hence permanent cut in diplomatic relations between Russia and the West that will not just lead to massive Russian assets dislocation but globally as well especially with respect to commodities.Mild sanctions will concern.