The Latest on Russia and Europe’s Energy Battle

Another week, and another flurry of news in European energy markets—much of it bad. Between warnings of power rationing and plans to restart idled coal-fired plants, the landscape is changing rapidly. Yet developments outside Europe just might help cushion the blow a bit, potentially helping things go at least a tad better than feared later this year. Not that European businesses and households will have an easy time of it, but stocks don’t need them to. Rather, when markets are pricing in worst-case scenarios, reality proving to be modestly less bad than feared can be a big relief. In our view, the surprise potential here skews more to the upside than the downside.

The latest trouble started brewing last week, when it became evident that Russia was throttling natural gas flows to the EU through the Nordstream 1 pipeline. Russian state-run Energy giant Gazprom, which operates the pipeline, cited maintenance issues for the cutbacks. The company claims sanctions are preventing it from importing needed components from Canada. EU leaders say that is hogwash, arguing the move was more retaliation against their developing plans to curb their dependence on Russian oil and gas. But apportioning blame doesn’t change the fact that summer is when EU nations traditionally fill their gas reserves ahead of the winter heating season, and Gazprom’s move ratchets up the risk of winter shortages. EU officials believe Russia could cut supply outright when cold weather hits, using the risk of blackouts in frigid weather to strong-arm the EU into backing off its economic response to Vladimir Putin’s war in Ukraine.

That is the backdrop for a flurry of emergency warnings throughout Europe this week. The Dutch government declared an “early warning” of a natural gas crisis, which clears the way for utilities to fire up coal power plants in order to curb demand for gas. Germany took similar steps by activating “phase 2” of its emergency response plan, which enables more coal use and is a step toward permitting utilities to pass increased wholesale costs to consumers. The hope there is that higher prices will better regulate demand, abating the need for “phase 3,” which would entail formal rationing. Austria, too, reverted to coal. Ideally, these nations would be able to import some nuclear energy from France to help fill the shortfall, but deferred maintenance at several nuclear plants has caused energy shortfalls there, too, risking rolling blackouts this winter if state-backed power provider EDF can’t fix the problems.

Now, it isn’t all hopeless on the natural gas front. Global supply lines continue readjusting, and Israel just signed a deal to boost liquefied natural gas (LNG) shipments to Europe. The amount in question is small and probably won’t offset the shipments temporarily lost to an explosion at the Freeport LNG export terminal on the US Gulf Coast, but every bit helps. Azerbaijan is also ramping up gas exports to Europe and planning investments in additional capacity.

Longer-term, North African producers, including Algeria, are also signing new European contracts, and interest in a potential trans-Saharan pipeline that could deliver shipments from Nigeria and Niger has resurrected decades after initial talks stalled. Oh, and American producers have inked several deals with Europe to supply more and more LNG, with a major supplier investing in boosting liquefaction capacity 20% by 2025.^[i] While these aren’t an immediate salve, they show market forces are working well and businesses are responding to incentives.

There are also reasons for hope on the oil front, with reports that China and India continue gobbling up discounted Russian crude. From a sociological standpoint, this isn’t great, as it helps Russia skirt sanctions and continue getting the hard currency needed to finance its military adventurism. But from a global oil supply standpoint, it mitigates the risk of a shortage. Russian oil isn’t off the market—it is shifting to supply new customers. The more oil China, India and other non-sanctioning states purchase from Russia, the more they aren’t buying from the Middle East and North Africa. That frees up more oil from this region for Europe to buy and blend into an approximation of the Urals oil blend European refiners are most equipped to process. As the new landscape becomes clear, it should help counterbalance shortage fears, preventing runaway oil prices from here.

With that said, we know the present situation is far from rosy. Europe faces a tough energy road, and we don’t dismiss the potential for rationing. Nor do we dismiss the potential for that to cause severe economic problems. We know the history of the 1970s’ three-day workweeks. It isn’t good. However, cold-hearted markets don’t deal in terms of good and bad in the absolute sense. Rather, they price fears and expectations real-time, then move on the gap between those expectations and whatever reality unfolds. We think it is fair to say that stocks have been pricing in European disaster. Perhaps they haven’t done so fully yet. But markets likely reflect fears of a pretty awful economic situation in Europe now, so a downside surprise creating material declines from here would seem to take a new, powerful negative shock. In our view, it is more likely things aren’t as dire as feared. If so, that is the recipe for a recovery.

Still, we will keep watching. But for now, we don’t view the latest energy news as reason to radically downshift your view of stocks from here.