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This past week, we’ve seen a lot happen in equity markets. But what’s looming in the background of all of this is geopolitics. And so, in this episode, we talked about the long tail of Europe’s energy crisis. We also looked at the impact of US Dollar strength on the EU and to a lesser extent EM. Lastly, we discussed the growing US-India tensions over the Russian oil cap.
1. Long tail of Europe’s energy crisis
2. Impact of USD strength on EU & EM
3. US-India tensions over Russian oil cap
This is the 33rd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
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Tony Nash: Today we’re focusing on geopolitics really. We’re joined by Albert Marko and we have a special guest, Velina Tchakarova, joining us from Vienna. Velina, thanks so much for taking the time to join the Week Ahead this Week.
Velina Tchakarova: Thank you, Tony. And it’s great to discuss with Albert as well.
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So this past week we’ve seen a lot happen in equity markets, but what’s looming in the background of all of this is geopolitics. And so really what we’re talking about this week, since we’re focusing on geopolitics, is the long tail of Europe’s energy crisis. We’re looking at the impact of US dollar strength on the EU and to a lesser extent EM, but mostly on the EU, as well as the US-India tensions or growing US-India tensions over the Russian oil cap.
So Velina, Albert. Let’s really get started. I’d like to talk a little bit about the energy crisis. And of course, we understand there’s been a lot of talk about kind of the coming winter and what’s happening the coming winter, and that’s well covered. We’ve done that for the past few weeks here. But I’m really curious about how long is this expected to last and what do you think will be the long term impacts of the energy crisis in Europe?
VT: Well, that is definitely a question that is hard to answer, but let me give you a try. Now. First and foremost, as we know, the energy crisis in Europe has been already ongoing before the war was launched on February 24 and it still has structural factors, structural causes, and of course, with the war being inflationary, these causes have been further amplified.
Now on the side of the fossil fuel dependencies, because I need to answer the question whether it’s going to be short or long. And I am actually inclined to think that this energy crisis is here to stay and it’s going to have a long term impact not only on European markets and European economies, but also in general, we have to also think of the global context of the energy crisis. So, on the side of the fossil fuels, you have a serious situation how to cut off an individual energy supplier.
Only to give you the idea, in terms of gas, it’s not easy in the short term to diversify away from 170 billion cubic meters of Russian gas. So that already shows you that it’s a tough scenario. Of course there are some opportunities mostly coming from the United States in terms of LNG. The European countries have also reached out to other potential suppliers. But as we know, this takes time. And I argue that two thirds of Russian gas being cut off for December, as this is the plan, is going to probably not work out the way it was planned.
But still I also don’t see a scenario in which there is coming back to Russian gas. When it comes to the oil, 90% of the oil should be cut off. That worked better in a sense because most of the economies were diversified.
Now, what we are observing, of course is on the one side that of course there is a main narrative to go, let’s say to speed up the decorbonization. That means to transition towards renewables, which of course is going to have effect also on economies and on all these relevant networks. Why? Because on the one side you’re going to have a surging demand for commodities.
And by the way, when we talk about decarbonization, you know very well that processing and production of critical raw materials is more or less located in China and also in other not like minded partners, partially also in Russia. So in a sense you end up in a similar scenario. When it comes to also the plan of, let’s say to use nuclear energy, once again we see a bifurcation within the European members because some of them are vehemently against it, including Austria. Germany is considering to close the last three nuclear plants even now in a situation of crisis. And then again we have countries like France which are rooting for nuclear energy as part of the energy portfolio. And of course, finally you have also the dirty coal, which once again is now going to be used as a transitionary energy source. Why? Because there are not many options on the table.
So to summarize, the situation is critical. It’s going to be a lot of political, let’s say messaging in terms of cutting off consumption, reducing electricity consumption, cutting off gas consumption, oil, so on and so forth. But then again it’s going to be also about diversifying and it’s also going to be finally about decarbonizing. So obviously, all of these goals are long term oriented and I’m not expecting any short term outcome.
Albert Marko: Yeah, that’s interesting, Velina, I had read just recently that the European grid is very complex where all the member states, not just within the European Union, but reaching all the way into Eastern Europe and the Ukraine is all connected. I can see a situation where the French might use this as a political power play against the Germans or the Dutch or so on and so forth because they can basically corner the market and the output for power because I think they have like 57 nuclear reactors. There could be situations where there could be political discourse within the European Union going forward for the coming years.
VT: Well, when it comes to the grid systems, it’s also important to understand that in general, the grid systems of the European states are not at the level that they can operate in a scenario of, let’s say 40 to 50% share of renewables. So maybe with few exceptions right now, like I think immediately of the exception of Sweden, some countries managed to speed up the process of increasing the share of renewables, but still we are not there yet, which means of course, that going towards increased share of renewables in the energy portfolio of each individual European state is going to affect the grid system.
As Albert said, the grid system is also interconnected. So that means a lot of ripple effects. In the case of Austria, blackouts are actually on the agenda in our national risk scenario for the next three to five years. So the anticipation for blackouts in the case of Austria at least, and I think that in other countries is a similar picture, we are going to witness with the proceeding towards decarbonization also scenario in which there will be more blackouts.
Then again, of course, here the question is when it comes to electricity, right? We are still not diversified to the point and I once again have to use the example of Austria. Austria is a front runner in terms of electricity that is being produced based on renewables, and yet 25% is still dependent on Russian gas. So you could imagine what it means in the short term. Even for the scenario of electricity production and consumption. If one important. One critical supplier is cut off. How this is going to affect not just the country, Austria, but of course the neighboring countries. Because in the moment where we are going to have a significant crisis. There will be also the expectation that other neighboring countries come to the risk.
TN: Okay, so there’s a lot to dive into here and I wish we had about 3 hours with you guys, but I guess the question that comes to mind for me is as you talk about decarbonization and as you talk about blackouts,
does that also mean deindustrialization of parts of Europe over, say, the medium term to accommodate the energy crisis?
AM: Of course. That’s a simple answer. Never mind just the simple part of the electrical output being lower, but the cost being exponentially higher. You’re not going to sit there and build an item that’s 300% more to create than you can actually sell. It just doesn’t work like that.
I mean, even the German Economic Minister came out with an absolutely astonishing comment saying some companies might stop making things and they’ll be not really insolvent, but it’s just only for a short time. Well, if you stop making things and stop producing money, you’re going to solve it and you’re going to be awarded the state.
So the European countries are going to have to flood the economy with money, whether it be the energy companies or the manufacturing companies, that they don’t go under.
TN: And I could see that for a transition period. But does this mean that let’s say over three to five years or longer, kind of France becomes the industrial heartland of Europe because they have the energy supply with nuclear? Will France be the place where, say, German or Austrian or other manufacturing migrates to to have affordable and continuous electric supplies?
AM: Yeah, I think so. And I’ll push it over to Velina because she’s more of an expert of it. But from my perspective, yeah, of course, you would go to a grid system that’s more stable and cheaper. That’s going to cause problems within the European Union, because other countries are not going to like this. They’re not going to like their corporations flying over, moving over to France. It’s the way the game goes.
VT: Maybe just to add something to the picture. First and foremost, I think that I agree with what Albert said. But then again, we have to think of the complex political box that is the European Union decision making, because it’s not just about the states. We have also European institutions. They’re going to pump a lot of liquidity. If you take a look at all these programs that have been announced by the European Union, by the European institutions, we talk about trillions of Euros that are going to be invested in the European recovery.
On the upside of the story, we see that there is a readiness, political will to do whatever is necessary decision-making, to use another famous quote from another famous political figure in the European political decision making. That means and that is my anticipation that is what’s going to happen. We are going to see trillions of Euros being pumped into the European states, into European industries, and into European institutions within the states to save whatever possible.
Then again, we are going to witness, of course, a situation in which, still fossil fuels will be on the table. That is the story and I think that politicians should be honest with citizens. We are going to see a lot of LNG coming.
The problem once again is infrastructure, interconnectors. So that kind of things are going to be built in the next three to five years. A country like Germany doesn’t have even a single LNG terminal. But now they are planning to build three of them.
So this kind of very awkward pipeline system, gas pipeline system going from east to the west that has been built over decades is going to be useless as we see and is going to be replaced. This is how well economic mindset works, right?
So in a sense it’s going to be not only nuclear, just to answer the question, it’s not going to be only about France. If the industrial heart of Europe is destroyed, that is obviously Germany. I just don’t see, because Germany is trade partner number one of all member states. So it’s going to have ripple effects for all of them if Germany is crushed, if Germany collapses. So I argue that it’s going to be both. It’s going to be nuclear, it’s going to be renewables, but it’s going to be also a lot about fossil fuels in the next three to five years.
TN: Okay, that’s interesting guys, we could dive into this for an hour and I would love to do it, but let’s move on to strong US dollar and the impact on Europe. And I’ve got a chart up showing our Complete Intelligence forecast for EURUSD and it shows a continuing deterioration of the value of the Euro over the next six months.
So we’ve seen devaluation of the euro. We’ve also seen the ECB come out with a 75 basis point rise this week. So what do we expect? Given the headwinds that Europe is facing and say high commodity and energy prices that are largely dominated in US dollars, what do we expect?
First of all, what does Europe kind of generally think about a strong US dollar? How is that playing and how do we expect Europe to react over time to compete and to be able to afford some of these factor inputs both for manufacturing and for energy?
AM: I think Tony, it’s a double-edged sword for Europe. On one hand, lower euro helps their exports. I don’t know how much exports are actually going out right now, but it does help the exports.
On the other hand, high dollar is creating inflationary problems for the Europeans and on top of that, they have to service any kind of dollar debt. It’s a problem. I think it’s a manageable problem for the Europeans right now. I think they can deal with the dollar at 110, 112, maybe 115 better than any other emerging markets can absolutely take the dollar that high. But for right now the game is to hit inflation globally and they’re a key player in that component with the Fed working tangent.
So right now, I don’t think it’s a dire problem, but it’s certainly something that needs to be addressed in the coming six months.
TN: Great. Velina, what’s the feeling on the ground? Do European policymakers kind of resent a strong dollar?
VT: Not really, and I completely agree with Albert. I think that the European Union countries, these are the 27, are well equipped to handle this compared to many other fragile economies all over the world. And I argue also that the ECB is going to continue with its copy paste policy, basically following what the Federal Reserve is doing, just to tackle the inflation and to really limit the demand as much as possible in the short term. And in that sense, I just don’t see a real kind of panic mode, to be honest with you.
On the side of political decision makers and just to add probably a final sentence. Probably a little bit of cynical one. But I still argue that the ECB fills or sees itself on the safe side because they know that the Federal Reserve will always offer the swap lines as a last resort just to keep the system afloat.
AM: Right? Yeah, they do have swap. Not only does the Fed have swap lines, but even US banks to key European banks have swap lines. So they don’t have to technically report it. But the United States is in no way in the mood to allow Europe to fail. They are our key allies, and they’re a buffer for the Russians and the Chinese. So they will be suffering, but they will not fail.
VT: I think this is a good point that Albert made. I think this is a critical point because in a bifurcated global financial system, if we refer to the last statements of the Russian President Putin in Vladivostok, where he explicitly pointed to this scenario, bifurcating the global financial system and creating two alternative networks based on our, let’s say, euro dollar system against the system of Chinese traded or Russian traded currency or whatever third country you want to take as an example that is allying or siding with them.
So I think that even looking from this scenario, you see that there is readiness, political will. Wherever there is a will, there is a way, I would say.
TN: Very good. Okay, let’s move on to kind of the US. Russia, India Triangle and Russian petroleum exports to India. So if we look at Russian seaborne crude exports, India is taking about half of Russia’s seaborne crude exports right now, and China is taking the other half. There are some others, but for the most part, India and China are splitting that.
And as we look at the G7 proposed price cap, we’ve had India’s petroleum minister come out a couple of days ago saying, we will buy oil from Russia, and we will buy from wherever we want. He said this in a CNBC interview a couple of days ago, and he’s saying,
“I have a moral duty to my customer.” So he is focused on Indian citizens. India has a very independent foreign policy, and they’re showing that. So that’s creating some tension between the US and India.
So what do you think is going to happen there? How does that play out?
AM: This is nothing new. The Obama administration had a disdain for Modi in India over multiple issues, and this is carried over into the Biden administration. The Biden administration is just not realistic. I don’t know what they’re thinking about trying to isolate India and pressure them into joining this anti-Russian crusade because they need the Russians as a counterbalance towards China. They need the Russians there, they need, their energy. And there’s a counterbalance to the US, to be honest, right?
Well, I mean, of course. They have their own national interest in ours. Every nation, every nation on earth cares about their voters and their citizens before anything else. And that’s what foreign policy is based on, is the needs of the nation. And the Indians are doing exactly what they need to do. They need to solidify their energy imports and their exports and have their economy stable. And I don’t blame them one bit.
I think this is all about the United States overreaching at the moment. And it’s just silly to me.
VT: I absolutely agree with Albert, and I will just add the following several points. First point, fertilizers, arm sales, cashmere. These are the three pillars, actually, of India-Russia relationship. So long as no other external actors, including the United States, is able and willing to replace Russia on these three topics, I just don’t see how the Indian foreign policy position is going to move away from it.
Second, this is not the whole picture, of course. Right now, the oil supply is increasing, but who has been financing the war in Ukraine? It has been solely the majority of European powers. The majority of oil and gas profits for more than six months have been actually due to the dependence of Europe on Russian supply.
Okay, so what was miscalculated right from the beginning was actually the international isolation of Russia. This is not going to happen.
As also Albert pointed out, India is going to pursue its own interests. If you have to feed 1.3 billion people, and if you are projected to become the Third World economic power in this or next decade, and you have already overtaken UK as economy number five, I think that you are going to look after your own interests. This is my reading of the Indian position.
And final point, if you are getting a discount from the Russians, why would you actually agree on oil price cap? And this is what is going to happen. The Russian oil, I’m sorry to be so cynical, but the Russian oil is going to find the markets, the gray markets, the black markets, the one way or the other. It was an important gesture coming from the G7. But like I said, the G7 miscalculated in the sense that international isolation of Russia for 2022 is not possible. And this is what is going to happen.
AM: Yeah, I made this point last time I talked to Tony about it. The United States, the Biden administration specifically tried to put a foot on the Russians throat is just back far. You already won. Having them defeated from taking Kiev and losing so many soldiers in Ukraine, there was no need to push the envelope and put yourself in a situation where Russia can use their commodities as an asymmetric weapon against the west, which they’re doing fantastically right now. It’s just miscalculated all over the place.
TN: Yeah. So there are two things that I come away from this. First of all, the US couldn’t necessarily keep Iran from selling oil internationally or Iraq or anybody else. So how could they keep Russia from selling oil? It’s just not possible.
AM: No, it’s not. We have ship to ship transfers. You have ports like Freeport, Bahamas, where they mix Venezuelan oil with whatever. The documents are easy to get.
TN: Naive, impossible policy. Right. It’s simply for the optics of it,
not necessarily for the reality of it.
AM: Well, these are academics that don’t really understand real politics until the prices.
VT: Let me give you one final example because you made a very good point. How do you think 4300 km border between China and Russia is going to be observed if the Chinese are actually not sending chips or any technologies or whatever you like with the Russians right now?
So that is the whole point that in the real world, of course, we have this gray area where we cannot verify, but that means that absence of evidence is not evidence of absence and we should really be mindful of the real motives and interests of the main actors.
So what we are saying with Albert does not mean that we are normatively agreeing with these policies, but we are just pointing to realities the way they are.
TN: Yeah, of course. And I’m going to make one last comment and close out with this. It’s interesting to me how Russia has inserted itself in between the India China relationship and it’s a fantastically strategic position to be in. And I think that’s one benefit that Russia has come out with over the past, say, nine months of this conflict is they’ve become an interlocutor for that relationship.
So guys, thank you so much for your time today. Thank you so much for your thoughts on this.
We could talk for hours on this and I appreciate this and I look forward to the comments that people are going to bring to this because I’m sure there’s going to be a lot of discussion on this. So thanks very much and have a great weekend.