- Increasingly dangerous ideas are gaining traction in the Western World, as the financial sanctions on Russia seem to have a somewhat limited impact, with the ruble recovering above pre-war levels recently.
- Various forms of total sanctions on Russia's energy exports are now being floated, including an EU ban on Russian oil.
- Within the context of an already tight global commodities market situation, there is every chance that such a scheme will plunge the world into an unparalleled economic crisis.
- Russia's countermeasures, including potentially choking off oil flows from other countries risks an unprecedented oil price spike that will potentially do nothing to curb money flows to Russia, as the price will more than make up for lost volume.
- If the expected global market mechanism will not kick in to spread the effects of the oil shortfall from the EU to the rest of the world, the EU economy could shrink by as much as 1/3.
Investment thesis: As the Ukraine war drags on, there seems to be a growing mood for an escalation of the economic war. The latest proposal is for a Russian oil export ban by the EU, which is by far Russia's largest customer. Aside from a number of EU governments, which are well-known anti-Russia hawks, there is also a growing MSM drumbeat that advocates for what could be the most irresponsible action one can think of, within the current context, short of advocating for an open military conflict with Russia. The irresponsible aspect of one-sided, moralizing anti-Russia rhetoric is that the other side of the equation, namely an honest analysis of what such a move would do to the EU, as well as to the global economy, is most often left out. If such an action were to be ever taken by the EU, my intention is to try to preemptively sell most of my non-energy and non-gold investments in my portfolio. The true economic effects of losing a large proportion of Russia's oil export volumes for a prolonged period, in addition to some secondary oil export volume losses, would be catastrophic for the global economy. With the drumbeat of ever more confrontational and aggressive positions getting louder, brushing all reasonable opposing views and concerns away, the odds of such a disastrous outcome have grown dramatically.
Opposition to self-harming actions keeps retreating in the EU
If we think back to those first few days when the Russian invasion of Ukraine started, we might remember what now seems like a distant reality, with the likes of Germany's government setting up some clear red lines in regards to the kinds of sanctions and other actions it was willing to take. It was mostly a position meant to avoid self-harm, which ought to be considered a reasonable position if we still lived in reasonable times.
Since then, Germany agreed to the SWIFT bans, including on Russia's central bank, which as I recently pointed out in an article, could spell the end of the euro as a viable global reserve currency. It agreed to scrap NS2, which will have significant long-term negative ramifications for Germany's energy security. It is progressively signing off on creeping energy import bans, including the coal ban that was recently agreed upon. It has recently signaled it is more and more willing to consider an oil ban as well. I picked Germany as the leading indicator in this regard for two reasons. First and foremost, it is one of the most exposed EU economies to a potential loss of Russian energy supplies. Second, it is the largest and most powerful member of the EU, politically and economically. If it fails to hold the line, so does the EU.
A worst-case scenario outcome is a total collapse of the EU economy, best case scenario will be a global economic crisis that will rival the 2008 and 2020 downturns
One of the latest articles I read that has been advocating for an EU embargo on Russian oil, that I found to be emblematic of the flawed thinking that is being disseminated and spread throughout society appeared on Politico recently. To summarize this proposed version of the EU ban on Russian oil, EU imports of Russian oil will stop entirely as a first step, potentially depriving Russia of a market for the greater part of the roughly 4-5 mb/d of crude and refined products that Russia sells to the EU. The argument goes that Russia's oil export infrastructure is mostly geared toward selling to Europe, therefore it would be very difficult logistically speaking to divert such large volumes of oil to Asia. The next step is to force Russia to sell the supposedly stranded oil for far less, creating a win-win for the EU.
Of course, no analysis was done of what will happen to the EU economy and more broadly to the global economy if Russia does not agree to sell its oil for near-free as is envisaged, but opts to shut in production instead. We have seen some recent analyses of the effect that a ban on Russian gas would have on the German or EU economy. A slight recession is seen as the worst-case outcome that is being envisaged, which I find to be very unrealistic. An economic depression is a more likely scenario if the cessation of Russian gas to the EU will occur going forward. I am not sure how such calculations were done in order to arrive at the conclusions that were produced but in my view, such unrealistic forecasts are feeding into the now dominant argument, namely that the economic sacrifice of such actions is a small price to pay in order to confront evil.
OPEC has been warning the US and the EU in the past few months that there is no way to replace Russian oil supplies on the global market. Key members of the group like Saudi Arabia and the UAE have been sending rather strong signals that they have no intention of raising production in order to make up for lost volumes of Russian oil being exported. It is not entirely known just how much they could do even if they wanted to, given the uncertain state of those presumed spare capacities they are supposed to be sitting on. This leaves us with the demand destruction option. There are two aspects of it to consider in this regard, the global aspect as well as the EU aspect.
A formula for the global oil supply/demand relationship to global economic growth that I came up with, mostly for my own personal use since I started investing over a decade and a half ago, is perhaps the best we can do for an estimate of the impact of the loss of up to 5 mb/d of Russian oil would have on the EU economy and more broadly on the global economy. I will assume that the world will find 2 mb/d in extra supply, via strategic reserve releases, increased supplies from certain major producers, Russian supplies diverted to other markets, and so on, therefore the net loss for the global economy would be 3 mb/d.
My formula that calculates the amount of oil supply growth needed to accommodate any given level of global economic growth is as follows:
1.5 (percentage efficiency gains every year) + (% increase in oil supply x 2) = Average yearly potential GDP growth
Over the years I found that this formula more or less provided an approximate forecast of global oil demand growth. For instance, according to the World Bank, average global GDP growth by year in the 2010-2019 period was about 3%, while the total average yearly oil supply growth was about 1%. In other words, the global economy expanded just under the potential growth rate that oil supply expansion would have allowed for. The formula is therefore approximately in line with real-world conditions.
Working a 3% decline in global oil supply into the formula, we get a negative drag on the global potential GDP growth rate of about 4.5%. Given that the current rate of global GDP growth is estimated at around 4%, we would see a slight global decline in GDP as a result of such a ban on Russian oil.
Note: The calculation for the above situation is as follows:
1.5 + ( -3 x 2) = -4.5
Calculating the damage of such a sustained Russian oil ban on the EU economy, we get a far more shocking result. Assuming that the EU would be able to source half of the lost Russian oil flows from elsewhere, it would still experience demand destruction for roughly 2.5 mb/d of oil that its economy would be left without, which is equivalent to about 18% of the total EU + UK demand. We would be looking at an economic contraction of roughly 32% for the period that such a ban would be sustained. We should keep in mind that the EU economy is currently forecast to expand at a rate of about 3%.
Note: The calculation for the above situation is as follows:
1.5 + ( -18 x 2) = -34.5
There is a chance that my formula is perhaps not best suited to the EU situation in particular, given that it is a formula that deals with the global demand for oil relative to economic expansion, rather than just the EU. The economic structure of the EU is different, therefore my calculation is probably significantly off the mark. There are other factors to consider, including the possibility that once we reach a certain level of decline in oil supply, the formula I used breaks down. There is no recent real-world precedent that we can test the formula against, therefore we have no way of knowing to what extent it is accurate. Having said that, I doubt that we would be looking at the kind of minor impact that analysts produced in regards to the potential loss of Russian gas imports in the EU. I suspect that the potential impact of such losses in energy supplies tends to be closer to my approximate forecast, rather than the ones currently circulating, courtesy of establishment forecasts.
The assumed factors that lead me to believe that the EU will suffer an outsized shock relative to the rest of the world if it imposes an oil ban stem from the fact that certain assumptions in regard to the global oil markets may be somewhat outdated. The going established assumption is that the EU would simply enter the market, and try to bid up the price of oil until the oil from elsewhere will flow, with demand destruction occurring more or less uniformly worldwide due to the price effect.
If we think back carefully to what OPEC has been saying, there is a chance that no such thing will happen. The Western World used to be by far the most prized market for OPEC many decades ago.
OPEC used to work closely with the Western World on most issues relating to the oil markets. Things have fundamentally changed in the past few decades. The US is no longer dependent on OPEC oil, while the EU still is, but it is also an economy that is very committed to steadily reducing oil consumption as part of its efforts to fight climate change. The EU is therefore not exactly a prized customer for OPEC members anymore. The relationship with the US was always the more important factor that kept OPEC aligned with the Western World, but the shale revolution helped to put an end to that geopolitical dynamic.
Emerging economies in Asia on the other hand are still increasing their oil demand and they are increasingly importing from OPEC. Those economies are now OPEC's new prized customers and OPEC members will most likely act accordingly in order to secure their long-term market interests. They will probably work to sell oil at a discount for those customers, relative to the price that EU customers will pay. OPEC members will also work to ensure that an adequate volume of oil will flow to their important Asian customers, leaving just a small fraction of what they export to be diverted towards the EU market.
A geopolitical rather than a market outcome may seem far-fetched in this regard. After all, decades of precedent would suggest it would be an unlikely scenario. I personally think that there will be many events and trends that we will observe and experience this decade, which will break with decades-old precedents. The world has changed, and this decade will be one of adjusting to a number of new realities. One of them, as I mentioned above is the fact that OPEC no longer regards the Western World with the same importance as a trade partner as it used to.
The other obvious assumption that we can make is that many OPEC members view the increased use of economic sanctions by the West as a potential threat to their own well-being. It, therefore, makes sense for OPEC members to support Russia's position, to both gain an ally that could help them in the future, and to also blunt the future desire of the West to continue with such sanctions in the future. If Saudi Arabia were to be targeted in the future, Russia could lend some support by reducing its own oil output, providing Saudis with much-needed food supplies, weapons systems, and potentially in other ways as well. For all these reasons we can expect key OPEC members to continue refusing our demands to help with our economic war against Russia.
The support that Russia is receiving from outside the Western World, whether the help comes in passive or direct form is making it far more likely for it to reject any sanctions regime on its oil that the EU is now increasingly likely to implement. It may correctly calculate that the resulting economic damage done to Russia will be far less severe and far less permanent than the damage that will be done to the EU. This will be the case, especially since we are seemingly in a sustained global commodities boom cycle, which to date seems to have no imminent expiry date. It is therefore increasingly likely that we are headed down a path of attempted mutual economic destruction between Russia and the EU.
While there are many factors to consider when contemplating the potential outcome of the current economic war sliding into an all-out effort between Russia and the EU to destroy each other, the fact that we are on a slippery slope in this regard is undeniable. It is driven by an incessant call to fall in line and support a cause that we are increasingly made to believe is the most important cause out there, and that we should be ready to engage in a great deal of individual and collective sacrifice in order to stem evil from winning.
On the other side, they are told this is an existential threat to the very survival of Russian nationhood, with regime change and subsequent capture of the levers of power, NATO outflanking of a besieged Russia, as well as the well-being of their ethnic kin in Ukraine, all on the line. If these economic pressures on Russia are meant to get them to back down, it is unlikely to succeed. The economic destruction of one of the two camps is therefore the likely outcome. While the Russians are likely to incur significant economic damage, the EU is in fact the party that is most likely to be pushed to the point of economic collapse, as this thing keeps escalating.
If or when an actual ban on Russian oil will take place, my intention is to move out of all non-oil or non-gold assets in my portfolio, and I hope to have the foresight to do so before everyone else starts selling. There are also many investments I feel relatively comfortable holding if the EU decides to turbocharge the current global commodities bull market through a Russian oil ban. I currently have Suncor (SU) stock as the biggest holding in my portfolio by far. I also have gold exposure via Barrick (GOLD), GLD (GLD), and physical gold. I bought Peabody (BTU) stock at the beginning of the year and I do believe it would further benefit from any further tightness in the global energy markets. Cameco (CCJ) is also a stock I feel comfortable continuing to hold. Everything else I will be ready to liquidate because it would most likely see a dramatic decline in value.
Regardless of how an EU ban on Russian oil will play out, it will have a dramatic effect on the global economy. In an article I wrote at the end of 2021, entitled; "2022 Will Be The Beginning Of The Era Of Widespread Global Scarcity" I highlighted the growing challenge that the world has in providing the economy with abundant supplies of many crucial raw materials, including oil, which I saw going into a prolonged period of shortage by the second half of this year, even without the disruptive effects of the Ukraine conflict. An EU embargo will remove a few million barrels per day of oil and product supplies from the global market, because of logistics that prevent Russia from immediately pivoting towards Asia for all its sales. Russia will not be willing to give away oil for near-free as some people like to envisage, so it will not continue to flow to the EU. The Politico article I linked to for my article does correctly point out that if Russia will have to shut in production, it will be very challenging to get it started again, therefore it might take years for Russia to get back to its geological potential in terms of crude oil production if a significant shut-in of production were to occur. What this means is that we are risking making a very bad long-term situation, much worse.
While classical economic theory would suggest otherwise, the EU will suffer an outsized impact from the cessation of Russian exports of oil and refined products to the EU. Market mechanisms will not divert enough volumes from other markets, for all the reasons I already mentioned. In other words, OPEC members will find it in their long-term interests to protect their market shares in emerging markets in Asia, where demand is still growing at a robust pace, rather than diverting it to Europe for short-term gains in revenues per barrel. The situation will result in much pain for the Russian economy, but far more pain for the EU economy in my view. Even as Russia will export lower volumes of oil, gas, wheat, palladium, and so on, all of these crucial commodities will gain in their price, to levels that will partly or even completely offset the revenue loss that Russia will experience from lower export volumes. The EU economy however could easily outright implode due to an acute energy shortage.
The concentration of the impact on one single entity creates a risk of a systemic collapse of the global economy. If the market would be able to spread the demand destruction needed to cover the shortfall in global energy stemming from a halt of Russian exports to the EU, then we would be in for yet another global economic downturn, not unlike the 2008 crisis or the more recent COVID crisis in terms of intensity and overall pain for individuals and the markets. If the impact will be concentrated in Europe, the EU economy could shrink by as much as 1/3, which will most likely trigger an all-out institutional collapse that will send financial and economic shockwaves worldwide. The Russians could in fact amplify the damage by withholding other key commodities, calling on allies and friends around the world to do the same, making use of some of its geographical realities to block oil and other exports to the EU, and even making use of some of its assets in places like Africa to hit EU and US interests there. The recent supposed weather-related halt in Kazakh oil exports through Russian territory may be an example of what Russia could do in this regard. Bottom line is that if this confrontation continues to intensify, I for one want to greatly reduce my exposure to most stock assets and I want to do so before the rush through that proverbial narrow exit door will commence.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of CCJ, GOLD, GLD, BTU, SU either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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