Global energy markets got a big dose of seemingly bad news on Monday and Tuesday, with the EU announcing sweeping sanctions on Russian oil and Russia cutting off natural gas shipments to the Netherlands and some suppliers in Denmark and Germany.[i] And in response, oil and natural gas markets … didn’t freak out. Brent crude oil prices and Dutch TTF natural gas prices (Continental Europe’s benchmark) inched higher but remain below their recent peaks, which they set shortly after Russian troops invaded Ukraine and the US and UK unveiled their bans on Russian energy.[ii] Notwithstanding the potential for further volatility from here, the relatively muted reaction doesn’t totally shock us. As we will discuss, whilst the latest developments probably aren’t great from an economic standpoint, we don’t think they appear likely to result in outcomes worse than the widespread warnings from commentators we follow, which we think markets have already incorporated into share prices. Moreover, we think both moves will likely help put an end to questions over what will happen, which we suspect likely reduces uncertainty and helps markets move on.
Based on our reading, the EU’s measures, announced Monday, were both worse and milder than many commentators we follow suspected. Milder because whilst the EU announced it will ban all seaborne imports of Russian crude oil, the sanctions exempted shipments via pipeline in order to avoid handicapping landlocked nations, like Hungary, that don’t have the infrastructure to replace Russian crude.[iii] That gives the most Russia-reliant nations—and the bloc overall—some needed flexibility, in our view. But we think the measures are also heavier than more forecasts we saw projected, as they will ban all EU insurers from covering seaborne shipments of Russian oil—a provision that wasn’t a part of the initial public debate. Given European insurance companies presently insure the vast majority of tankers carrying Russian oil, this restriction aims to prevent Russia from continuing to sell discounted crude to China, India and other Asian nations.[iv] As we saw many observers note, this is likely the more important of the measures. If it worked exactly as intended and stranded Russia’s oil, we think it would probably have a material impact on global oil supply.
But that is sort of a big if, in our view. For one, these actions don’t take effect immediately, giving room for the global oil trade to readjust.[v] The insurance ban doesn’t come into force for six months. Two, it is unclear to us that banning EU insurers from covering tankers ferrying Russian crude will really take its oil off the market. European insurers may cover the majority of shipments for now, but they aren’t the only game in town. Insurers from nations that aren’t participating in sanctions, including India and China, could fill the void.[vi] Some observers suggest the Russian government could write its own insurance.[vii] Then too, Russia could simply ship more oil and gas to these nations via pipelines and rail, as these links are already established (and the former are expanding).[viii] Black and grey markets could even flourish, in our view. Maybe Russian crude makes its way to refiners and ports in other nations and takes to the sea in disguise. It isn’t even clear to us that Russian oil products are sanctioned, provided the refining or blending takes place in a third-party country like India.
As for markets, whilst the insurance provisions theoretically make the sanctions tougher than commentators we follow deemed probable, we don’t think the broader outcome will likely be worse than what markets have already priced in—even if they prove more enforceable than we suspect they will. For months, commentators we follow have warned of Russian crude leaving the global market entirely, causing a severe supply shortage. If markets are at all efficient—and we think they are—then it stands to reason those warnings are largely baked into prices by now. The insurance ban mechanism may be a different route to this endgame than observers anticipated, but if it works as intended, the outcome would theoretically match expectations, in our view. Whilst the tactics may surprise, we don’t think the outcome would be a shock to markets. Rather, we think it would be a classic case of the thing that seemingly sparked widespread fear, if commentary we follow is a reliable indicator, actually happening. Perversely, far from being a massive negative for markets, in our experience, that tends to enable the world to move on.
The same goes for the latest Russian retaliation, in our view. On Tuesday morning, Moscow cut off natural gas shipments to the Netherlands’ state energy supplier, effectively cancelling a contract to continue delivering gas until October. Later in the day, it severed links with key suppliers to Denmark and Germany. In all cases, the rationale matched the rationale for severing shipments to Poland and Bulgaria—Russia announced the entities in question had refused to abide by its requirements to open foreign exchange accounts at Gazprombank and pay for gas in roubles.[ix]
Here, too, we don’t think this is great news for the affected nations, which will now likely have to scramble to fill natural gas shortfalls. So far, all three say there is minimal risk of shortages. The Netherlands says it has already contracted replacement supply, and the Danish and German suppliers anticipate they can easily find what they need on European wholesale markets.[x] At the same time, a supply interruption is a supply interruption, and we think it is important to look modest headwinds in the eye.
Yet from a market standpoint, this, too, doesn’t appear to be unexpected. Commentators we follow have warned of a sudden cessation of Russian gas flows—and associated economic trauma—for months. In our experience, markets deal efficiently with this sort of thing, pricing observers’ forecasted events well in advance, without waiting for confirmation. We have long observed as a result, the uncertainty in the run-up to a widely discussed disruption is often the main source of market negativity. In our experience, once said disruption happens, it often ends that uncertainty. Investors no longer have to consider whether something might happen. Instead, we think they can quickly see the impact and move on. In our view, this can clear the way for markets to improve when everyone least expects it.
Mind you, we aren’t dismissing the risk of energy shortages causing recession (a decline in broad economic output) in some EU nations or even the bloc overall. We think that remains possible, and we are watching closely. Yet recent history shows even that outcome doesn’t ensure a global recession. The regional recession in 2011 – 2013, tied to the eurozone’s sovereign debt crisis, didn’t go global.[xi] Nor did the European double-dip recession that erupted from the end of the European Exchange Rate Mechanism in the early 1990s.[xii] On both occasions, the world eventually pulled Europe along. Same goes for high oil prices, which tested investors’ sanity from 2011 – 2014 but didn’t bring a global recession or bear market (a prolonged, fundamentally driven broad equity market decline of -20% or worse).[xiii] No two time periods are exactly alike, but we think these precedents show you disaster isn’t assured, even if Europe’s economy broadly contracts (and that is still an if).
Markets have swallowed a lot this year, and we think energy market disruptions are a major contributor to the uncertainty that has roiled returns to date.[xiv] But, in our view, markets look forward, not backward. From here, we think it would take something much worse than what stocks have already dealt with to cause deeper, longer declines. For now, we don’t see a high likelihood of this happening. Instead, we see policymakers gradually crossing questions off global investors’ list of uncertainty, which we think will likely help eventually clear the way for sentiment to improve.
[i] “Opening Remarks by President von der Leyen at the Joint Press Conference with President Michel Following the Special Meeting of the European Council of 30 May 2022,” European Commission, 31/5/2022, and “Russia Cuts Gas Supplies to Netherlands and Firms in Denmark and Germany,” Joanna Partridge, The Guardian, 31/5/2022.
[ii] Source: FactSet, as of 1/6/2022. Statement based on Brent Crude Oil and Dutch TTF spot prices.
[iii] “EU Agrees Oil Embargo, Gives Hungary Exemptions; Zelenskiy Vows More Sanctions,” Kate Abnett, Jan Strupczewski and Ingrid Melander, Reuters, 31/5/2022. Accessed through MSN.
[iv] “Russian Oil’s Achilles’ Heel: Insurance,” Jonathan Saul, Nidhi Verma, Yuka Obayashi and Carolyn Cohn, Reuters, 25/5/2022. Accessed through the Internet Archive.
[v] “EU Agrees Oil Embargo, Gives Hungary Exemptions; Zelenskiy Vows More Sanctions,” Kate Abnett, Jan Strupczewski and Ingrid Melander, Reuters, 31/5/2022. Accessed through MSN.
[vi] “How Russia Has Remained One Step Ahead of Western Sanctions,” Staff, OilPrice.com, 2/6/2022.
[vii] “Russian Oil’s Achilles’ Heel: Insurance,” Jonathan Saul, Nidhi Verma, Yuka Obayashi and Carolyn Cohn, Reuters, 25/5/2022. Accessed through the Internet Archive.
[viii] “Russia, China Agree 30-Year Gas Deal Via New Pipeline, to Settle in Euros,” Chen Aizhu, Reuters, 4/2/2022. Accessed through the Internet Archive.
[ix] “Russia Cuts Gas Supplies to Netherlands and Firms in Denmark and Germany,” Joanna Partridge, The Guardian, 31/5/2022.
[x] “Russia’s Gazprom Cuts Gas to Germany, Denmark Over Ruble Fight,” Caitlin McFall, Fox Business, 1/6/2022.
[xi] Source: World Bank, as of 2/6/2022. Statement based on annual percent change in World GDP and Euro Area GDP in constant 2015 USD in 2011 – 2013.
[xii] Ibid. Statement based on annual percent change in World GDP and Euro Area GDP in constant 2015 USD in 1992 – 1993.
[xiii] Source: FactSet, as of 2/6/2022. Statement based on Brent Crude Oil spot prices and MSCI World Index return with net dividends in GBP.
[xiv] Ibid. Statement based on MSCI World Index return with net dividends in GBP, 31/12/2021 – 1/6/2022.
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