Predicting economic outlook is presently akin to chart analysis. The are so many variables and moving parts that it is as easy to come up with a sanguine projection as with a depressing one. The shaky foundation of forecasting is somewhat logical. After all, what markets have been dealing with in the last three years is an untested macroeconomic experience rooted in a devastating health crisis and in a war in Europe. The unpredictability was laid bare during an eventful last week, which was characterized by a plausibly temporary detachment: equities fell and oil rallied.

Depriving the US of its top credit rating was the main financial event of the week. Whether the repercussions will be catastrophic remains to be seen but the underlying backdrop is probably still upbeat. Stuttering global factory activity is countered by revived service sectors, inflation is being mitigated, headline more than core, the job market in the US is resilient (although nonfarm payrolls rose less-than-expected in July unemployment fell to 3.5%) and peak interest rates in the US, the EU and the UK might be close. In other words, price pressure eases without developing recessionary pressure. It is reflected in the stock market performance, which, despite last week’s retreat, has gained 14% this year.

Solid equities foresee resilient economy and therefore auspicious oil demand. Throw in the seemingly co-ordinated effort of Saudi Arabia (the Kingdom upped its September OSP to most destinations) and Russia to provide additional support by keeping their production/export cuts in place as long as necessary together with estimates of significant depletion in oil inventories in coming months, a foretaste of which was conspicuous in last week’s weekly US stock data, and the fundamental backdrop becomes blatantly encouraging. It appears that currently the sacrosanct indicators that keep investor’s mood buoyant are falling inflation, peak rates and perceived supply deficit for the balance of the year. Unless there are material changes in any of these yardsticks (and of course, such reversals cannot be ruled out) the mantra from chart analysts -the trend is your friend- seems the most reasonable modus operandi to follow.

Threat Ostensibly Removed

After February 24, 2022, the world, as we knew it, ceased to exist. Russia’s unprovoked invasion of Ukraine sent shockwaves throughout the world, and this includes our market. After all, Russia is one of the biggest exporters of crude oil, refined products, and natural gas. Although Russian oil exports were significant it was natural gas that could really cause considerable damage to traditional buyers. 

Fears were growing that the weaponization of Russian exports would significantly hinder the fight against inflation and would create an unbearable economic backdrop, especially in Europe.

As it turns out, Russia did weaponize its gas exports. In 2021, the 27 EU countries of the European Union consumed 412 bcm of gas for power generation, household heating and industrial processes.
 
Half of it came from Russia, the dependence on Russian gas was dangerously high. In the spring of 2022 anxiety about energy security ahead of the upcoming winter rose tangibly. The price of the European benchmark, the Dutch Title Transfer Facility (TTF) rose from €36/MWh in January 2022 to above €340/MWh. It was anything but unequivocal that European storage can be filled to the desired level before cold weather arrives.

Something had to be done as Russia’s pipeline gas exports to Europe plunged from 146 bcm in 2021 to 62 bcm last year. The EU reacted quickly to mitigate the impact of falling Russian supply, which included a considerable reduction in deliveries via the Nord Stream 1 gas pipeline whilst the approval process on its younger brother, Nord Stream 2 was halted in February 2022. Firstly, member states collectively targeted a 15% reduction in gas consumption between August 2022 and March 2023 (it was exceeded as consumption dived by 19%). Secondly, significant efforts were made to replace Russian supply and by November 2022 only 13% of the required volume was covered by Russia. 

Another eloquent fact is that US LNG exports to Europe tripled between November 2021 and April 2022. The net result was an EU gas storage level of 95% by 1 November 2022 and stockpiles 56% full by the end of the 2022/2023 heating season, which is refreshingly above the 5-year average of 34%.

Europe reassuringly weathered the Russian gas storm last winter and attention is now cast to the upcoming heating season. Judging by the current price the panic observed a year ago is nowhere to be seen. ICE TTF for October delivery is currently around €34/MWh, for December it is priced around €48/MWh. Nonetheless, there is work to be done. Think-tank Bruegel estimates that gas storage facilities in the EU must be 90% full by 1 October 2023 to avoid shortages. To achieve this goal demand must be cut around 13% under the previous 5-year average. Additionally, liquified natural gas supply must be ensured and that can only happen by rapid deployment of regasification units.

According to the IEA, the success of mitigating reduced Russian gas deliveries in 2022 can only be repeated this year if potential problems are addressed. The agency recommends the introduction of minimum gas storage obligations, co-ordinated demand reduction measures, strengthening partnership with key natural gas and LNG suppliers and the expansion of regasification terminals together with building new floating storage regasification units.

Whether the upcoming winter will pass without significant damage also depends on the severity of winter and LNG demands from elsewhere, namely from China and India. Last year, however, was the glaring example that Europe can survive without Russian gas and its medium-term target of eliminating all Russian fossil-fuel imports by 2027 is actually more than plausible. In fact, one can go as far as to conclude that whilst energy can be an effective weapon in gaining geopolitical leverage it has spectacularly backfired in the hand of Vladimir Putin. It also foreshadows that eliminating dependence on Russian energy supply as much as possible by implementing a coherent energy security strategy is one of the most potent tools to force Russia to the negotiating table. It is perhaps no coincidence that the Russian President, just a few days ago, did not reject the idea of peace talks on Ukraine. The greater the independence from Russian energy, the tighter the noose.

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