Springtime for Putin - Analyst Blog

Investors may yet get another crack at the energy complex. Alternatively, for risk-averse investors, the U.S. Treasury Bond ploy has regained its allure, as funds seek safety in the wake of the past several weeks of alarming developments.

The escalating political risks around the world just went into the realm of actual armed conflict, as Ukrainian forces shot and killed some armed occupiers of an airfield in the east of the country.  

Russian special forces have infiltrated Ukraine, as they did in Crimea, and orchestrated inauthentic separatist ‘movements' in order to provoke armed retaliation and then official Russian army intervention to ‘protect' linguistic or cultural kin in almost half of what remains of Ukraine, in the east and south.  This strategy may yet be successful for Russia -- in the short term, anyway.

This is exactly what Hitler perpetrated in the Sudetenland crisis of 1938, leading to the Munich agreement with Britain and France, which he subsequently abrogated, taking over the entire nation of Czechoslovakia, and, the following year, after the contrived armed conflict over the Polish Post Office in Danzig (now Gdansk), attacked Poland on September 1st, 1939, plunging Europe and the British Empire and Commonwealth into World War II.

The bankrupt and ill-armed Ukrainian government has, thus far, been reluctant to hand Vladimir Putin, the president of Russia, an excuse to invade and occupy eastern and southern Ukraine.  However, several city and town administration buildings and police stations in those areas have been occupied by armed, uniformed, and masked men claiming to be local independists, but show all the signs of the sorts of covert forces that were used in Crimea in March.  The central government in Kiev has now declared that it will not accept this situation, nor allow it to expand or intensify.

Despite their desperate wish to avoid action, the members of the European Union and the members of the North Atlantic Treaty Organization (NATO) -- which are not the same countries, but have considerable overlap -- will be compelled to follow through on their stated promise to enact severe sanctions against Russia, should the invasion and occupation take place.  

Russia's main exports of any consequence are oil and gas.  Oil is readily available on international markets, although it may be harder to ship it to certain Eastern and Central European nations via tanker and thence pipeline from Western Europe versus the pipelines that come from Russia.

So, while there will be practical, logistical problems in dealing with changes in oil suppliers, aside from a likely jump in prices, the actual accommodation to the oil sanction may not be too severe.  Gas, though, is a knottier issue.

While it is far from clear that the EU or NATO have any motivation, resolution, or imagination for a substantial pressure tactic against Vladimir Putin, they have the means to do so, not just on oil, but even on gas.

Winter is now past, heating demand, even in the northern nations, is now low.  There are at least another five months, perhaps six or seven, before they become high, again.  Should Russia threaten to cut off or at least slash gas shipments to Central and Western Europe, and raise prices, just as they already have to Ukraine, the EU can call that bluff, at least temporarily.  

To prepare for winter, interconnection pipelines can be approved for construction, reducing the dependence on Russian gas in some states.  Low interest loans, grants, loans, tax credits, and other measures can be taken to encourage major steps toward higher insulation levels and smart metering in homes, offices, factories and other buildings.  

Insulation and smart metering alone, even if it were to just reduce natural gas use for heating by 50%, would virtually eliminate supply deficit from having no Russian gas.  Gas in pipelines from Algeria and Libya can be expanded, and a new one from Israel's big new offshore field can be built to Greece, but it will take a few years.

Plans to take nuclear power plants in Germany can be suspended.  If there were to be sensible energy and environmental policy, France and other nations would remove their moratoriums and restrictions on hydraulic fracturing and other techniques that could bring abundant shale gas and liquids to waiting consumers.  Europe as a whole is estimated by the U.S. government to contain shale oil and gas reserves of almost North American magnitude, and still nearly entirely untapped.

Latvia, alone among the Baltic states, all of whom also have substantial Russian minority populations at risk of Vlad the Invader's ‘protection' strategy, has a huge gas storage capacity.  Potentially, this could be expanded, and shared with Estonia, Lithuania, and even Poland.  Other storage capacity can be constructed over the next several months and years elsewhere in Eastern and Central Europe.

Most of these things would not be brought to full fruition by winter, or even before the end of the season.  However, they could make a difference in redistributing the temporarily scarce natural gas flow to Europe around to those nations that are uncomfortably dependent on Russian gas.  This will moderate the price rises, which will inevitably occur with the increased scarcity of the commodity, but will not eliminate those increases.  

These price rises will not fully lift or put a floor under prices in North America or Asia, but they could help accentuate the idea that natural gas is a valuable product, and should become more fungible across oceans and continents.  It is interesting that gas has not fallen below $4.00 per million BTU in the past several months, and that storage levels in North America remain much more depleted than usual at this time of year.

The crisis in Ukraine and the confrontation with Russia will not automatically bring new U.S. Liquified Natural Gas, ‘LNG,' projects through approval, development and commercialization, even in the medium term, let alone substantial, lucrative exports to Western, Black Sea and Baltic LNG import terminals.  Nor is such gas entirely available, although politicians, and producers, on both sides of the Atlantic wish it were already so.

Fortunately, many of those import terminals already exist, and could be expanded to accommodate more imports from abroad:  Africa, the Middle East, and Latin America, along with (eventually) North America.  There is also enough North American supply to send overseas at a profit at the current price differential.

The probability, and the opportunity of more U.S. LNG plants being constructed have certainly increased.  The good thing is that there is abundant North American shale and coal bed gas, several pipelines to the Atlantic coast, and many motivated companies with capital eager to fund such projects.  However, political support has been lukewarm, particularly in New York State, Quebec and in Washington, DC, but the geopolitical situation could change minds and attitudes, or at least reduce some of the obstacles.  Ottawa and Mexico City are entirely onside.

The main beneficiaries continue to be the best shale operators, for example,

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It takes a year or more to get environmental and other approvals, and another two to three years and billions of dollars to construct new LNG liquifaction plants and export terminals.  Some players have been burned in the past, and there is no assurance to them that these projects will be as lucrative as they appear on paper.  However, nearly twenty of them are already mooted for the U.S. East coast.  

Thus far, Canadian action on the Atlantic side has been muted, but two oil pipeline projects with high chances of approval and actual construction are in the works.  None of these plans nor the U.S. gas plants, will be fully realized before 2018, at the earliest, so, in the short term, the EU, and the Ukrainians, will be mostly on their own.  Nevertheless, as indicated earlier, they are not without options, or bargaining power and resources of their own.

Ronald Reagan and Margaret Thatcher warned West Germany, France and other European nations against becoming dependent upon what was, in the 1980's, the alluring appeal of cheap, very abundant and clean-burning natural gas from what was then the Soviet Union.  After the Berlin Wall came down and the communist regime collapsed in Russia, it appeared that such fears were exaggerated.

Preliminary geopolitical signs in the invasion of Georgia, the intimidation of Armenia and Moldova, and machinations in Central Asia have been joined in recent years by economic and commercial risks, as the BP-TNK rupture, the Yukos expropriation, and Gazprom's use against Europe and Ukraine in recent years.  Russia has proved to be unreliable, dangerous and now entirely untrustworthy.

Venezuela, Ecuador and Bolivia in the Western Hemisphere have already taken themselves out of the running for reliability or stability.  Some Central Asian, Middle Eastern and African oil and gas producers are also showing signs of erratic policy and potential undependability.

If matters do not become too violent and extreme in Ukraine, this whole episode may be salutary if it compels the EU, NATO and other players such as the U.S., Canada, and Mexico, to take political risk, intelligent energy deregulation, and extensions of energy cooperation seriously in the future.  

Then, repressive despots will not find it so easy to impose their will on peaceful neighbors.  The side benefit will be increased security and prosperity for those who pursue rational development and commerce.  In the meantime, oil and gas prices are unlikely to fall, unless tensions ease substantially.  Investors should remain exposed to this long-term attractive sector.