Macro Outlook: The quest for kosher oil and pareve gas
Despite the ubiquitous and always-on internet it is next to impossible to understand the true situation on the ground in Ukraine: too much censorship, self-censorship, and military propaganda from all sides. Given the vastness of Ukrainian territory, maps of “controlled areas” are meaningless, especially if we are to believe that the Russians are not trying to occupy the country (they say they do not), but rather ruin its military infrastructure. It is quite possible that material destruction of the Ukrainian military infrastructure will be sufficient for them to declare victory and de-escalate.
Not unexpectedly, negotiations between the two sides are in progress. A couple of articles in The Jerusalem Post have outlined Russian proposals (link to TJP) and a more recent article from The Times of Israel (link) confirms that negotiations are on-going. Based on accounts in the Russian press the next round of negotiations will be done by the same two teams over a video link. My best guess is that the conflict will be materially de-escalated by May 9th, when Russia is celebrating the WW2 Victory Day with military parades and fireworks throughout the country.
The impact of the conflict on the labor force of Ukraine is negative. Since peaking at 52 million early 1990s, the country’s population declined by approximately 10 million primarily due to emigration. Most of the people leaving the country today are women and children. They may not want to come back and instead could ask men to join them sometime later. Right now, many men cannot leave Ukraine, because of the military daft (ages 18-60).
Measures undertaken by the Russian Government and the Central Bank of Russia in response to the sanction are temporary, lasting until September 9th. Regulations allowing borrowers to pay their Western creditors are also temporary, lasting for three months, with the possibility for extension for another three months. Clearly, the country would rather avoid a wave of cross-defaults. According to CEO of Norilsk Nickel, the company is hopeful to keep their customers, will be offering them long-term contracts based on adjusted prices, such that purchasers do not suffer from speculative price spikes. My sense is that the Russian business community has no interest in seeing Albanian-style autarky.
In the meantime, the European Commission wasted no time announcing new spending plans under the Repower EU proposal: link to Repower EU pdf. The price tag has not been made public, but I think that the cost of the program will be in hundreds of billions. The ideas behind the proposal are as follows: punish Putin by cutting back on purchases of Russian energy, advance the green agenda quicker, and stimulate the EU economy. The proposal does not mention nuclear, and therefore we may see an increased use of coal: electricity from coal-fired stations will be needed to accommodate more wind and solar in the electrical grid. Another weakness of the proposal is that electricity is a poor replacement of natural gas for space heating and for high-temperature industrial processes.
While I do not question the noble intensions of Frau von der Leyen and the European Commission when it comes to punishing Putin, the impact of the proposal on Russian finances is uncertain. Crude oil and LNG are global tradable commodities. Russian oil and LNG can be sold anywhere, natural gas can be piped to China or converted to other tradable commodities. Even if every single molecule of Russian oil or gas is arrested at the EU border, the EU will still depend on Russian production indirectly. If Putin decides to stop producing energy altogether to punish the EU for not recognizing his warm and brotherly feelings towards Ukrainians, the price of energy will go up on all markets.
It should not go unnoticed that because of this newly proposed policy Ukraine stands to lose the natural gas transit fees of approximately $1 billion per year. This will be painful for a country with the Government budget of $40 billion.
I find it disconcerting that the Anglo-Saxon world was largely at peace with Russia for 165 years (since the Crimean war of 1853-1856), and now it is back to discussing the doctrine of mutually assured destruction…. May be the diplomats of yesteryear knew something about Russia that the current generation does not know. For a quick historical update, I would suggest revisiting The Long Telegram.
A couple for inexpensive French stocks
Spending more money on European infrastructure, as the new plan suggests, will certainly give the EU economy a short-term boost. At this point, I am looking for inexpensive stocks of companies which will benefit from high prices of energy and/or increased spending on infrastructure.
VINCI (DG FP) - €50 Billion market Cap. Vinci operates concessions (toll roads and airports), provides Energy services and runs Engineering and Construction businesses. Concessions are the largest business, where Vinci is contractually allowed to pass on inflation to consumers. Concessions, especially Airports, should enjoy a cyclical pick up post COVID, when travel restrictions are lifted. The rest of the business will benefit from continued investment in low-carbon infrastructure and continued recovery of construction spending. I think that the downside is limited by a relatively high dividend yield/free cash flow yield.
TotalEnergies (TTE FP) - €120 Billion market Cap. Total is one of the most resilient Global integrated oil and gas companies. The company runs four segments: Exploration & Production; Integrated Gas, Renewables & Power; Refining & Chemicals; and Marketing & Services. The company’s LNG portfolio has a strong growth profile. The distribution policy is fair. The stock has underperformed US peers by over 35% and should catch up. Downside risk is tied to energy prices, and the fate of Total’s investments in Russia. Confiscation of Totals’s Russian assets seems unlikely, but not totally impossible.