By Vitaliy Katsenelson
The list of things for investors to worry about is growing. In fact, when you are abuzz with feelings of either success or failure is when you want to tighten your process to make sure emotions don’t mess with your head and decision-making.
High up on this list is inflation, which is seemingly everywhere . Bringing down inflation isn’t easy, and the challenge for central banks is even greater because of six intersecting factors that could be putting the global economy on a path to stagflation.
Let’s review six factors now shaking the U.S. and global economies that set the stage for stagflation:
1. Oil
Even before the coronavirus pandemic, the global supply of oil /zigman2/quotes/209723049/delayed CL00 -1.33% and natural gas /zigman2/quotes/210189548/delayed NG00 -3.83% was constrained by a decline in investment in the sector, caused by low oil and natural gas prices and petrocarbons falling out of favor with ESG supporters. The pandemic caused a further falloff of investment in the sector. Then Russia’s invasion of Ukraine forced the world to excommunicate the third-largest producer of petrochemicals.
The oil market has slightly different dynamics from the natural gas market. Oil is a fungible commodity and is easily transported by tankers, and thus it can be (relatively) easily redirected from one customer to another. For instance, if China used to buy oil from Saudi Arabia and now buys oil from Russia, the oil that China stopped buying from Saudi Arabia can now be bought by Germany. That said, Russia produces heavy crude and the Saudis light crude, so refineries need to be reconfigured, and that takes months.
Sanctions on oil will only have an impact on the Russian economy if everyone stops buying Russian oil. If all countries embrace sanctions, then about 8 million barrels of daily oil exports will be removed from the market. That is a lot of oil, considering that world consumes about 88 million barrels a day.
It is unclear if China and India, the largest- and third-largest importers of oil, respectively, will continue buying significant amounts of oil from Russia, as doing so risks damaging their relationships with the West. Neither country wants to be told what to do by the West. They have their own economic interests to consider, but their trade with U.S. and Europe is significantly greater than it is with Russia.
It seems that both countries have been slowly distancing themselves from Russia. For example, the war in Ukraine is a horrible advertisement for Russian weapons, and there is a good chance India may decide to switch to Western weapons, which would bring it closer to the West.
In the short term, the supply of oil from Russia to the world market will likely shrink. Long-term, the picture looks even worse for Russia. There’s a good reason why Western companies participated in Russian oil projects, while a great love for the West was not the motivator that drove Russia to share oil revenues with BP /zigman2/quotes/207305210/composite BP -0.95% and Exxon Mobil /zigman2/quotes/204455864/composite XOM -0.74% . Western companies brought much-needed technical expertise to very challenging Russian oil and natural gas fields. With the West leaving Russia, long-term production of oil and gas is likely to decline, even if China and India continue buying Russian oil and gas.
2. Natural g as
Let’s turn to the natural gas market. Shipping gasses is much trickier than shipping liquids. Natural gas can be transported two ways: by pipelines (the cheapest and most efficient way, but they take years to build) and by LNG ships. LNG stands for liquified natural gas — the gas is cooled to -260F and turned into a liquid. Western Europe, especially Germany, is heavily reliant on Russian gas, which today is transported to Europe through pipelines.
German politicians, in their fervor to go green, abandoned nuclear power, which produces zero CO2, switched to intermittent “green” wind and solar (and fell back on dirty coal) and tied their future to a shirtless Russian dictator. I discussed this topic before — you can read about it here .
Some smaller European countries are abandoning Russian gas. Germany and Italy, the largest consumers of Russian gas, promise that they can delink themselves from Russia’s gas in less than two years. This trend will continue; it just won’t happen overnight (or in two years). Call me a skeptic, but I think it will take a long time for Europe to completely abandon Russian natural gas, as building LNG terminals takes years, and so does increasing natural gas production.
Oil and natural gas prices will likely stay at elevated levels or even go higher over the next few years, and the U.S. production of natural gas and oil will likely have to go up substantially.
3. Food
Russia and Ukraine together produce about 15% of the world’s wheat /zigman2/quotes/210389638/delayed W00 +0.76% supply. The two countries account for about one-third of global wheat exports (or about 7% of global wheat consumption). Russia has slapped a ban on wheat exports. Ukraine’s planting season likely has been disrupted by the war. The global wheat supply may decline by as much as 7%. This sounds like a large number, but it is not outside the historical volatility caused by droughts and other natural disasters, which have historically driven up wheat prices by a few percent.
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