Weighing Russia’s Gas Halt to Poland and Bulgaria

After threatening for weeks to cut off gas flows to European countries who don’t pay in rubles, Russia has officially halted flows to Poland and Bulgaria. Several pundits warn this raises the likelihood of a European recession, especially if it is a prelude to stopping flows into Germany and other big Russian clients. Let us take a look and assess the impacts—for the affected countries, Europe and stocks.

Russian President Vladimir Putin has jawboned for over a month about requiring his “unfriendly” customers to pay for gas in rubles rather than euros or dollars, signing a formal decree mandating this at March’s end. This might sound like a strange move for a country that needs dollars and euros to continue servicing its foreign debt and can’t access most of its international reserves. But Putin and Central Bank of Russia (CBR) head Elvira Nabiullina are also trying to put a floor under the ruble. Those purchasing Russian gas in rubles will have to buy those rubles. Or, more specifically, it seems most are opening foreign currency accounts at Gazprombank (the state-owned financial offshoot of Russian gas giant Gazprom), depositing euros, converting those euros to rubles, and paying. So instead of the CBR spending down its reserves to buy rubles, it gets to import hard currency via Gazprombank while forcing European clients to effectively support the ruble. Putin then gets to use those same rubles to continue funding the war effort without having to fire up the printing presses and risk hyperinflation.

That naturally raises the question: Is this legal under sanctions? Gazprombank is subject to British and American sanctions, but not EU sanctions.^[i] Where the EU has sanctioned other large Russian banks, it exempted energy-related transactions—largely to keep the gas and oil flowing. Gazprom has told customers its preferred payment mechanism doesn’t violate EU sanctions. Some EU leaders say it does, but Bloomberg reported today that 10 European energy companies had opened the required accounts and 4 had already paid in rubles.^[ii] Given the huge political and business risks at stake, we have a hard time seeing companies opening these accounts and completing these transactions without consulting EU regulators, but stranger things have happened.

At any rate, Poland and Bulgaria apparently said nyet to Gazprom and skipped payments, so their gas got turned off Wednesday. For Poland, this isn’t a huge economic headwind, or even much of a surprise. The country’s gas contract with Russia expires at yearend, and it had already announced its decision not to renew. Instead, it plans to purchase gas from Norway via the soon-to-be completed Baltic Pipeline, which is scheduled to open by January 3. In the meantime, Poland’s gas storage reserves are 75% filled, with volumes about 130% greater than normal for this time of year, and Russian gas accounts for only about half of Poland’s consumption.^[iii] Polish officials say the impact of Russia’s decision will be minimal, and based on these stats, we agree. Bulgaria will have a harder time, though. About 90% of its total gas consumption comes from Russia, and its storage is only about 17% filled.^[iv] Officials estimate that amounts to about one month of consumption in the warmer months, leaving them scrambling for alternatives. The country is now in talks to import liquefied natural gas (LNG) via Turkey and Greece, but with European natural gas prices spiking again, it won’t be cheap. Bulgaria probably faces a near-term energy crunch and recession.

No one is arguing tiny Bulgaria will be enough to tip Europe into recession. Its pre-pandemic GDP was just $57.4 billion, compared to nearly $14.8 trillion for the EU.^[v] What really has people on edge is the possibility that more countries will have their Russian supply shut off, possibly when the next round of payments is due in late May. In that scenario, the bloc could experience a sharp enough energy crunch to cause a recession.

But there are some potential cushions that we aren’t seeing get much notice. While LNG flotillas from the US and Qatar are getting a lot of attention, the UK has quietly amassed quite the natural gas glut and has nowhere to store it. That is a load of supply just waiting with bated breath to cross the English Channel or North Sea. If Japan buys more from Russia, that frees up additional supply to journey from the Western Hemisphere to Europe. We aren’t saying this will be a perfect substitution with no collateral damage, but the substitution effect could help things go moderately better than people seem to fear now.

If the EU or eurozone do enter a recession anyway, there is ample reason to believe it wouldn’t drag the entire world down. We have three occasions in the past 30 years where a recession in a major region hasn’t gone global—or driven a bear market in world stocks. EU GDP dropped in 2012 and 2013, during the eurozone’s sovereign debt crisis, but global GDP still grew.^[vi] Nor did the recessions that plagued the Asia/Pacific region in 1998 cause a global contraction. And when EU GDP contracted in 1993 as the European Exchange Rate Mechanism collapsed, global GDP didn’t. In all instances, growth outside the affected region was strong enough to pull the world along.

As things stand now, we think that is quite likely to be the case this time. We have detailed the US economy’s energy efficiency and ability to weather high fuel and energy prices before—and won’t belabor that here again. As yesterday’s article showed, consumer-focused businesses are reporting robust demand despite high food and gas prices eroding people’s pocketbooks. While rising living costs are a headwind, sharp wage growth has helped offset the impact to a degree, and cash-rich household balance sheets provide additional cushion. Plus, the economy—not just in the US, but also in Europe, Australia and developed Asia—is getting a strong tailwind from the end of COVID restrictions. Yes, China’s widespread lockdowns are a headwind, but that is a supply issue, not a demand issue—and the global economy has spent most of the last two years proving it can overcome supply constraints.

So we will continue watching this situation closely and updating you. But for now, we don’t view the cessation of gas flows as reason to be bearish on stocks—European or globally. Markets are forward-looking, and several European benchmarks have hit or flirted with technical bear market territory (-20% from a relative high) during this global correction. We see a strong argument that they have been pricing in recession fear. If no recession materializes, as data currently suggest, the relief should buoy markets. If a European recession actually happens, stocks will likely rebound before the economy does. That was the case back during the aforementioned eurozone crisis. European stocks suffered a bear market, and the eurozone endured a recession from 2011 to early 2013. Yet global stocks’ correction ended in October 2011, and European stocks rallied from May 2012 onward. Mind you, that was a long, grueling European recession. If a recession now is sharp but fleeting, similar to what lockdowns wrought in 2020, European stocks could rebound even faster.

In general, when stocks have already digested a given outcome, we think it isn’t wise to try to reposition for it. You can’t avoid what already happened—only move forward. Resisting the temptation to act on an event stocks have likely already priced in is one of the most difficult tasks in investing, but we think it reduces the risk of getting whipsawed—selling after a sharp decline and missing the rebound. When the going gets tough, try to remember these first principles.