The events of the past few weeks merit some discussion. When Russia invaded Ukraine, we refrained from commenting initially, since so much was unknown. At the initial invasion it was expected by many that Ukraine would fall in a matter of days and that at most a few sanctions would be placed on Russia and Vladimir Putin. Rather, we have seen a combination of incredible tenacity from the Ukrainian army and people and what can only be considered as incompetence from the Russian military. It has become clear over the past few weeks that while negotiations are proceeding slowly, it has and will be a much longer struggle than most expected. This protracted war and the incredible unity of the West in sanctioning Russia to a greater extent than many thought possible brings up many questions for investors. We are providing our insight after attending CERAWeek in Houston which is the world’s premier energy conference.
The biggest and most immediate impact for investors has been in the energy sector. Russia is a major producer of both oil and natural gas. It produces around 10% of the world oil and 17% of world natural gas. The most pronounced economic impact of the invasion has been a large jump in the price of oil globally. While not sanctioned, the purchasing of Russian oil has become challenging for those countries still looking for Russian oil. The result is 3 million barrels per day of oil currently stranded in tankers around the world as Russian oil looks for buyers. Nonetheless, buyers are returning to the market for Russian oil. A number of developing nations have arranged purchases for Russian crude at a deep discount to Brent which makes up for the higher insurance and tanker rates that are being charged to Russian customers. Also, despite the rise in oil prices, for purposes of clarity, there is not a major shortage in the oil markets. The challenges of buying Russian oil combined with the rerouting of global seaborn oil trade has created the recent spike in oil prices. This disruption will likely be worked through over the next few months or quarters as major emerging nations determine how to process transactions and the oil markets settle into new trade patterns. A more serious supply disruption would be manifest in much more movement in the longer dated contracts in oil, which has only occurred to a limited extent at this point.
On the natural gas price front, there is less pressure in the United States since the US is the world’s largest producer, by far. The technical aspect that natural gas is easier to recover than oil also helps limit price pressures for natural gas in the United States. Asia has also seen limited impact since most LNG imports are on multi-decade contracts. On the other hand, Europe has seen an incredible increase in natural gas prices that will be harder to immediately bring down since they have a combination of very low inventory levels and a need to cut reliance on Russia. Yet, even in Europe, several factors are coalescing in favor of reducing pressure on European natural gas prices including substantially increased levels of LNG imports, increased production from major gas fields in both the Netherlands and Norway, increased use of coal, and increased spending on renewables and storage that will likely serve to mute the impact of the spike in natural gas prices as the heating season nears its end in a few weeks.
On the other hand, elevated prices remain in a number of other major Russian exports. Grain prices are still up substantially, since Ukraine and Russia are major grain exporters. This makes sense since the Ukrainian’s grain harvest, while still weeks away, is very uncertain and Russia has limited export of grains as well. Lumber has also stayed elevated since Russia has banned the exports of timber products for now as retaliation. The limitations on exports of both grains and lumber are set to expire later this year.
The Russian invasion of Ukraine from an investing perspective has created a short-term shock but not shortages. It has not stopped economic growth in the rest of the world. While Russia could announce new export restrictions, it would start hurting itself since it is in desperate need of hard currency to prop up its economy because of sanctions. Also, any more export restrictions would likely be more painful for countries that have currently stayed neutral such as China and India since commodity inflation is a much larger percentage of the average citizen’s budget in those countries. We believe that any more export restrictions should, limiting the economic impact on global trade.
The Russia and Ukraine economies combined represent slightly more than 1% of total global GDP; insufficient to stall global growth. While the past few weeks have certainly created stress in markets, it is unlikely to lead to a major negative economic event such as a recession in the United States. Also, the uncertainty of the Russian invasion of Ukraine will likely lead to the Fed being more careful in its path to slow inflation with its rate increase strategy. Despite all the headwinds, we expect earnings growth to continue in 2022. As we get through what is hopefully the other side of both the COVID and the supply chain disruptions, we could likely see more upside surprises than negative. Many factors have pressured the market already, and we think most will dissipate or resolve in the coming quarters.