The Russian invasion of Ukraine spurred international condemnation, imposition of sanctions and immediate reactions from the equity markets. As the world watches and worries, investors try to figure out what might come next.
As the situation rapidly evolves, Steve Wyett, BOK Financial® chief investment strategist, and Matt Stephani, president of Cavanal Hill Investment Management, Inc., discussed potential short- and long-term impacts.
Did market reaction to news of the invasion surprise you?
Wyett: Geopolitical events are the hardest to forecast and price within capital markets because they’re fairly binary: There is no continuum of outcomes with gradual impacts. So, the speed and scale of the market reaction wasn’t a surprise. Even though Russia and Ukraine are not huge players in the global economy, the market hates uncertainty and is understandably concerned about the potential disruption to the global energy production.
Can you quantify the impact on the energy sector?
Stephani: Russia is the third-largest producer of crude oil in the world and second-largest natural gas producer. Russia is capable of producing about 10 to 11 million barrels of oil per day—or about 10% of global oil production.
Fossil fuels are the biggest driver of the Russian economy. Any disruption in their ability to export would be disastrous to them, but also to Europe as Russia’s largest market. One-third of Europe’s natural gas and 25% of its crude imports come from Russia. Europe needs Russian fossil fuels to run its economy.
So, Germany’s announcement about Nord Stream 2 pipeline is significant?
Stephani: When Germany announced that it would halt certification of the pipeline that would bring more Russian natural gas to Europe, it was very meaningful. When certified, the pipeline could deliver 55 billion cubic meters of gas per year—or more than 50% of Germany’s annual consumption. Non-certification won’t impact current natural gas prices, but it does signal Europe’s desire to move away from reliance on Russia—something that many in the U.S. have expressed concerns about.
How might the invasion impact energy prices?
Stephani: It’s unlikely that we’ll see a complete ban on Russian exports of oil. However, even without an all-out ban, traders may be concerned about disruption, which is one reason we saw prices move up so sharply. Higher oil prices may spur a bad deal to bring Iranian barrels back to the market, which would add significantly more volatility to oil markets.
In terms of natural gas, the timing of the invasion coming at the end of winter—when Europe uses natural gas for heating—might help to mute the near-term price impact. However, it will likely push Europe to look for more stable energy partners, increasing demand for U.S. liquid natural gas (LNG). Greater global demand would probably increase natural gas prices domestically, but it could also encourage and incentivize increased investment in LNG export facilities here at home.
What about the potential for longer-term impacts on energy?
Stephani: To quote Julius Caesar when he crossed the Rubicon in 49 BC, “the die is cast.” Russia’s aggression into Ukraine is awakening Europe to its over-reliance on Russia for its fossil fuel energy sources. In the short run, we’ll likely see higher demand—and potentially prices—for U.S. natural gas as well as an “uncertainty” premium in oil prices. In the longer term, the disruption may strengthen the resolve of Europe to explore and adopt alternative energy.
What are some of the broader economic impacts we could expect?
Wyett: Typically, geopolitical-related market sell-offs are short lived and don’t result in wholesale direction changes. We were already seeing equities come off recent highs; the market’s initial reaction to the invasion is only accelerating or exacerbating the movement already underway.
However, rising energy prices impact most parts of the U.S. economy—from production to distribution to sales. And they are a drag on consumer spending, which can lower the outlook for growth going forward.
Overall, the job for the Federal Reserve just got harder. If oil prices go higher, they may not need to raise interest rates as quickly or as much as previously thought. This could increase inflation in the short run but create a headwind to economic growth over time.
Our sense is the primary factors for the domestic equity and bond markets will be inflation, Federal Reserve monetary policy (interest rates), and the growth of the labor market. We still expect the Fed to finish their bond-buying program and begin raising rates in March.
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