Risk sentiment was tentatively constructive to start the new week, and there was no mystery as to why: The dollar was weaker. By the time you read this, that may no longer be true. It’s noted here for posterity.
Ahead of key US data, the world’s reserve currency was on track for its largest two-day loss in months, a welcome reprieve, assuming it proves durable. And it may not. Prove durable, I mean.
There’s every reason to believe dollar strength is here to stay until the Fed finds an excuse to pause or pivot. That might be the best (and only) argument for a pullback. When there’s every reason to believe something, that in itself can be a compelling reason not to. “Dollar’s peak will prove elusive.” “Dollar rally has further to go as there are no alternatives.” “Dollar strength fading might be like waiting for Godot.” Those were the sorts of blog posts running around on the terminal Monday.
The euro was on track for its best gain in six months (figure below), emboldened by expectations for another jumbo ECB hike, more favorable rate differentials and the Ukraine military’s advance, which appeared to gather more momentum. Of course, rate differentials aren’t actually “favorable,” they’re just less unfavorable. They’re also less relevant. What matters now is the energy crisis, the trade shock and the war.
The ECB is “active” now, though. That’s a good thing for the common currency. It “tweaks the forex narrative from a one-sided view of the Fed setting the pace, to a more nuanced outlook where the ECB will play a more significant role,” Bloomberg’s Mark Cranfield wrote, suggesting that “hasn’t been fully priced in.”
Bets against the euro are lopsided, which sets up a snapback. “The market is sufficiently skewed that a single piece of unexpected news can trigger meaningful short covering,” SocGen’s Kit Juckes remarked, noting that benchmark gas prices are back to levels seen last month (figure below).
I suppose I’d gently reiterate that any sort of victory for Ukraine on the battlefield won’t compel Vladimir Putin to apologize, repent and open the Nord Stream. In fact, the opposite is more likely in the event the Ukraine military is able to sustain gains. I warned on Sunday, in stark terms, about the potential for an escalation from the Kremlin.
“Ukraine just routed Russian forces around Kharkiv, echoing the humiliating retreat from Kyiv. At the least this makes it look like a two-way not a one-way war, and the spectrum of possible outcomes now widens to include far better — and worse,” Rabobank’s Michael Every said Monday. “Less political markets may see Ukraine’s gains as bearish for commodities and bullish for risk [but] if Putin feels his back is against the wall, who knows how far he will ‘escalate to deescalate?'” he added, noting that Russia is “already destroying critical infrastructure in Kharkiv.”
Specifically, Russia targeted power plants in Ukraine’s northeast, causing blackouts, although service was restored to most of the affected areas by Monday, according to reports. Suffice to say Volodymyr Zelenskyy didn’t sound deterred. “Do you still think you can scare us, break us, make us make concessions?” he asked Putin, in a Telegram speech. “Read our lips: Without gas or without you? Without you. Without light or without you? Without you. Without water or without you? Without you.”
That’s inspirational, but from the perspective of markets, I’d caution that a “routed” (as the Western media described Russia’s military in the Kharkiv region) Putin isn’t going to be a happy Putin, and an unhappy Putin won’t be keen to restore gas flows or otherwise help ameliorate Europe’s power crunch.
The fact that market participants felt compelled, early Monday, to suggest Ukraine’s successful counteroffensive might presage lower energy costs stood in stark contrast to images of fires burning at Ukrainian power plants hit by Russian missiles.
“There’s every reason not to get too carried away with optimism that the latest news could shorten the duration of the conflict,” SocGen’s Juckes went on to write, adding that “there are many steps between news of Ukrainian success and signs that Europe’s energy costs can come down enough to improve the economic outlook, and even if that were to happen, we can no more easily go back to ignoring dependency on cheap imported Russian gas, than we can ignore the fact Humpty Dumpty is made out of eggshell.”
I am going to write something that is so obvious that it is inane but it is no less inane than expecting an end of the Russian invasion of Ukraine to solve the energy crisis in Europe. Reliable energy supplies to Europe from Russia will never return as long as Putin remains in power. Even if Europe capitulates, removes sanctions, cuts off Ukraine and gets Putin’s promise to restore gas and oil supplies, the energy from Russia will remain a political tool, not a reliable resource.
Putin’s Kremlin allies are reportedly unhappy with his and the army’s performance after Ukraine’s advance last week. Change will, and maybe must, come from within Russia. Hard to imagine any such change would be worse than Putin.
Starting to look like Putin’s days are numbered. Europe and the U.S. need to stand firm in their support of democratic Ukraine, which has shown the world it is entirely deserving of that support. No guarantee that Putin’s replacement will be more amenable to rapproachment with the West, but it becomes clearer every day that the oligarchs and a majority of Russians do not want to live in a reconstituted pariah Soviet state.
…although elections in Russia over the weekend suggest that Putin and his ruling United Russia Party still enjoy widespread support among rank-and-file Russians.
Putin’s options are becoming more limited as time goes on. Why is he not declaring a full out War against the Ukraine? We know that a full out war would allow him to send additional troops to the front line, but I suspect that this is politically unacceptable and so the Special Operation continues.
If I have my unit conversions right:
Pre-crisis, Europe was paying around $40 per boe for Russian gas.
Post-crisis, I think US LNG will cost Europe around double that. Current Henry Hub $8 = $46 per boe, then around $25 per boe for liquification, shipping, and regasification. Obviously Europe is paying a lot more for LNG now, but this is a guess at a normalized, non-crisis price.
I am assuming, and think, that with LNG export capacity growing so rapidly, US NG prices are not going back to $2 Henry Hub. The days of worthless NG being flared off are over . . . although maybe not in Russia . . .
Given this, the incentive for Europe (in particular Germany) to regain access to Russian gas, to preserve its industry during the transition to other energy sources, is huge.
If Putin were to be defenestrated and his replacement offers to turn Nordstream flows back on without requiring immediate or full sanctions relief, Europe isn’t going to say “no”. My opinion.
Sir
I trust your numbers, but won’t it take a while for us to ramp up gasification capacity? Flared gas has been one of my pet peeves for decades. Lord knows how much of the Earth’s precious energy resources have been wasted this way, and how much this practice has contributed to out greenhouse gas problem. It can be seen from space. Just one more of man’s arrogant, stupid acts.
I can remember a time when the strip mined coal fields of the Midwest looked like moonscapes. Then, despite the objections and dire predictions of the mining companies, the federal government created laws requiring post mining reclamation. Although the visual effects of flaring gas are not quite as disturbing as the gob piles and abandoned waste of the un-reclaimed mines were, they are probably more destructive to our environment. Unfortunately, we live in a time of limited government and captured regulators, so our species can look forward to receiving the final Darwin Award. Drill baby, drill!
@MrLucky, US and global liquification capacity is growing pretty quickly. As of mid 2022, US capacity is about 112 Bcm (billion cubic meters) per year, and global (includes US) is about 651 Bcm. The big global three are Australia, Qatar, US. From the projects underway (data from IEA), I get US adding 58 Bcm and global adding 159 Bcm through 2025 (and more projects can get started).
The problem for Europe is that the global addition in 2022 is only about 12 Bcm and in 2023 about 10 Bcm. The big additions come in 2024 and later. But Europe needs to replace about 100 Bcm of Russia gas now.
To make matters worse, almost all LNG is sold on long term contracts. As liquification trains are planned and built, their capacity is pre-sold. Even though Europe is signing more LT contracts now, it is for capacity still years away. Only about a third of global LNG is truly spot, not counting the Russian LNG now on the spot market due to sanctions. And Asia depends on LNG too.
So Europe previously imported about 100 Bcm of LNG, mostly to Southern Europe, and now needs 100 Bcm more. It is getting some more – I don’t have hard numbers but eyeballing charts suggests in Jan-May 2022 Europe imported very roughly 24 Bcm more LNG than in Jan-May 2021 – if it can keep that up all year, that’s 57 Bcm more, not 100 Bcm.
So far Europe has been able get that much more LNG in early 2022 is that the price Europe was willing to pay is so high that (1) Asia is using more coal instead of spot LNG and (2) China is opportunistically buying Russian LNG at half price and selling its contracted LNG cargos to Europe at full price, while (3) China’s lockdowns have depressed its demand for energy.
Another limitation you’ll read about is Europe’s regasification capacity. I’m unclear how much spare regas capacity Europe has – seems like it is used to capacity in winter, but not nearly so in summer. Anyway, the great majority of regas capacity is in Spain, France, Italy, Turkey. Germany has no regas terminals, and not enough pipeline connection with southern Europe to really use their regas capacity.
Germany is adding 22 Bcm of regas capacity via five floating units, supposed to all come online by end 2022. That is a lot (similar to Spain’s entire capacity) but only half of Germany’s Russian gas imports in 2021.
My sense is Europe’s regas capacity issues can be mostly solved by end 2023, the liquification and contract availability issues cannot be solved until maybe 2024-2025 (?).
Which leaves Europe, and Germany in particular, in very tough shape for this winter and next.
What I’m reading makes me think that Europe will have to (1) cut household gas use by 5-10%, (2) cut industrial gas use by >10%, plus (3) substitute coal and oil, just to meet the physical energy shortfall.
Financially, the cost of protecting households and small businesses from ruin will be huge, some claim as much as 10% of GDP. That price can probably be reduced substantially if Europe changes energy market pricing (decouples non-gas-derived electricity price from gas-derived electricity price) and imposes windfall taxes. Big companies will probably mostly have to cope on their own, by shutting down uneconomic production, adding more costs for the unemployed.
The potential cost of covering hedging margin calls (the $1 TR number in the news) is untenable even for Europe governments, I think, so exchanges might be forced to change rules (accept collateral other than cash).
I’m also reading about risk to the European electricity grid, if generating capacity gets too tight (like Texas).
Basically, I think things look very, very tough this winter for Europe (and maybe even worse for the UK). That is why I think if Russia were to offer an “out”, Europe would take it. If Russia dumped Putin, then for sure Europe would entertain buying Russian gas again. For a couple years, anyway. Even if Putin stayed, I think Europe would do it. After all, it wasn’t Europe who turned off the Nortdstream flows.
Thank you, sir, for your very edifying update. I suspected that the short run situation would be problematic. The only thing Europe can hope for is some kind of sudden need for cash in Russia or a favorable regime change. I’m not holding my breath. One of the problems when an existential system is disrupted is that the cost to make immediate repairs often wastes huge amounts of resources that would not have been wasted had there been sufficient time to make changes in a reasonable manner.
Change happens slowly then all at once.
RIA is spot on.