The closed-door discussion, under Chatham House Rule, took place on day 43 of the Ukraine-Russia War. The projections in the news then were:
- Oil might reach US$150 per 1
- Janet Yellen, US Treasury Secretary, warned of enormous economic repercussions.2
- Inflation was expected to rise by 7% in 2022, according to Fitch 3
- The Fed would plunge the US into a major recession by hiking rates above 5%, Deutsche Bank predicted,4 with Goldman Sachs confirming the chances of a recession to be 30-40%.5
- And the sanctions implemented against Russia are 6
Russia produces 11% of the global oil and possesses 25% of the world’s natural gas reserves.7
- The oil and gas crisis had already begun in Europe before the outbreak of the war, with the continent being 3% – 5% short of its energy requirements.
- Gas storages were significantly underfilled against a five-year average and a forecast of a severe winter caused spikes in gas
- The energy crisis is self-inflicted by the Europeans (exacerbated by war) due to:
- Under building and under filling of gas storage.
- Underinvestment in the petroleum industry driven by an extreme focus on de-investment from the petroleum A policy decision that is linked to energy transition and climate change.
- Collapse in domestic gas
- Increasing demand and decreasing domestic and international supply, exacerbating the reliance on Russian gas to fill the gap (who themselves have depleted their own capacity).
- Tightening of the global LNG supply, due to underinvestment and severe
- Commitment from China to
- Though Russia was fulfilling its contractual obligations to Europe, the gas storages were so significantly underfilled that some have said this was an intentional and strategic move by Russia in view of the impending
1 RHB Research raises oil price forecasts on Russia-Ukraine conflict | The Edge Markets 2 Janet Yellen warns of ‘enormous’ economic repercussions from war in Ukraine – CNN 3 US consumer prices will rise by 7% in 2022, says ratings firm – CNN Video
- The current dependence on Russia for gas is 150bn cubic meters per annum (i.e., 15bn cubic feet per day). Of the total gas imported into Europe, Russia supplies over 40% of Europe’s average need depending on the (Less than 5% in UK and 100% in Slovakia).
- With a lack of strategic vision, it has been extremely difficult to wean off Russia. Europe is trying to achieve this by dramatically increasing its efforts on renewable energy, however, this will not be able fulfil the continent’s requirements in the short to medium The intentional policies that have been put in place by Europe has made it exceedingly difficult to wean off Russian gas supplies, due to the net zero carbon 2050 agenda. Though LNG supplies were available globally, projects were put on hold because Europeans would not commit to the 20 years LNG supply contracts. However, it takes US$5-10bn to build an LNG plant over 3-7 years. The U.S. has pledged to expand LNG exports to Europe, but industry officials say expanding volumes will require new, multibillion-dollar export terminals, which traditionally have required long-term contracts from buyers to line up financing.8
- The alternative pipeline supplies from North Africa have been utilized for the region’s own domestic needs. Other sources flagged from Eastern Mediterranean and North Iraq which could supply 20-25% of need has been too difficult and political to
- On March 16, 2022, Jerome Powell, Chair of the Federal Reserve of the United States, announced that the Central Bank will be hiking interest rates to curb rising inflation which is being exacerbated by the 9
- At the start of 2022, the world had begun to slowly recover from the pandemic, accompanied by The war added a new variable for policy makers, with the security of energy supplies being at severe risk, and enormous disruptions to supply.
- The scale of the economic sanctions is unprecedented, with over 5 billion barrels of oil per day from Russia no longer being accessible. Inflation is rising and the prediction is that it will be around 7% in the US, with an assumption that the war situation will be resolved by the end of the
- The Fed response (with policy errors) has made it much more difficult to press the brakes on the interest rate There has already been a 125 basis-points hike from the Feds, with 50 basis-points coming in under a month’s time, and a run down the balance sheet at an even faster pace. It is worth bearing in mind that financial markets do not really know what happens when the Fed runs down its balance sheet. Note that it does not go down to zero but can go from US$9 trillion in assets to US$6-7 billion.
- Europe is most at risk, being exposed to the conflict in eastern Europe, and Russia has been a big market for EU Domestic inflation will be high. The European central bank has become more serious about the inflation threat, with multidecade highs in the EU zone economy – Germany over 7%, others at 9%.
- In the UAE, the impact of the crisis in Ukraine is experienced through the lens of energy and oil The OPEC decision is to increase production in May to 400K barrels a day, with strong political pressure to do more. The economic position in the GCC is strong, and though there is pressure to increase capacity faster, policy makers are going to stick to their plan. Russia is still part of OPEC Plus, so any increase in production in OPEC countries will come at the expense of Russia’s oil production. This will affect policy thinking in the GCC.
- In the GCC, oil exporters have already been enduring several years of very destructive oil prices and so the long term geo-economic narrative of the region continues to state that it needs oil and gas receipts as a source of revenue to fund the diversification strategy as the pressure from many international organisations continues to
9 Cold War 2.0? The Global Economic Impact of Sanctions against Russia by The Wall Street Journal https://www.wsj.com/video/series/in- depth-features/cold-war-20-the-global-economic-impact-of-sanctions-against-russia/8E58C4A5-D7BE-4773-8B06-C9AB7508C6A2
Geopolitics in Europe
As we evaluate the geopolitical horizon and look at the war unfolding, there is a non-equilibrium, and we are not in a place where the outcome is assured, and investors can be confident of a final fall out.
- Short term possibilities:
- On the positive side, it will be a localised conflict and a retreat of Russian forces, and we are on track for de-
- On the negative side, the conflict will escalate and become more of an existential crisis for all, with an increase in war crimes and major disruption in the energy trade.
- Russian gas cannot be self-secluded entirely anytime soon in Europe, but there can still be an outage, and instead of a substitute there is demand destruction or demand contraction. The consumption must fall, and the economy will slow and
- That outcome will be significant, particularly a stagflation in Europe with a stronger dollar in short term, and weakness in China. This will eventually weigh on the USA equity market and take the wind out of the sails of the monetary tightening Overall, a messy outcome.
- Medium- and long-term issues:
- Could this situation herald the demise of the US dollar as reserve currency, and act as a trigger of a change in the global monetary order. However, this is an overly cautious suggestion. The dollar has been weaponised again, and it is a signal for all the big reserve holders, like China who is critical about the US foreign policy
- In East Asia, the macro-economic model is built on generating, and suppressing domestic demand, using surpluses to acquire assets from developed capital markets. Will China become a hugely different economy that is more driven by domestic demand than it is today?
- If you want to move away from Euro-Dollar reserve system, then one must stop generating surpluses and acquiring those There is no other large liquid financial market where one can store that type of volume of assets and still get an investment return that one is seeking as a large reserve holder.
- From a security perspective, the biggest problem is that of a looming unstable global order, with no clear template that a multi-plurality system works. In fact, it does not seem to work very well, since the evidence shows that it has not generated stability in recent This form of risk premium will be present.
- On the flip side, it could be the end of peace dividend in western political economies, resulting in more defence spending and a different social contract between capital and
- There is a third big push towards de-globalisation. First the trade war, then the pandemic covid, and now the Russia-Ukraine Will this lead to a dramatic reduction in global supply and value chain?
- From a macro-economic viewpoint, this may not be all bad, which is surprising revelation for many to ponder, with a rebalancing affect which can be healthy in the long term. (E.g., extra gains of crude to shareholders at the expense of labour income in developing markets)
- There have been global imbalances driven by having huge export and manufacturing centres far away from consumption There could result more rebalancing between production and consumption which could be a good thing for the world.
What is the Fed going to do about interest rates?
- Recently, the expectancy was that the Fed will hike interest rates by further 2% by the end of They are trying to discover what is the neutral rate of interest right now and are in a rush to get to that level. Beyond that, the policy can become restrictive to growth. During the pandemic, policy makers accepted economic contraction due to public health considerations and now will this happen again due to inflation.
What is the impact on sovereign wealth funds management in the region and the potential benefits due to high oil prices?
- Feels like the 2011-2014 cycle, with the Arab Spring If the current war deescalates, and if oil price settles in the 2-digit realm, this is a strong tail wind for all GCC sovereigns, with surpluses going into SWF coffers.
- These are certain asset classes that are geared towards SWF, who own one-sixth of global private equity market. When we are talking about certain assets, SWFs are target groups, and once the Russians and Chinese are exempted, then there will be a smaller group of potential This is a relatively positive outcome for the GCC, unless there is a bigger geopolitical risk event.
- Politically, the UAE is driving a hard neutrality policy, which is going to favour them, in the long
Fiscal spending in the Gulf – will it lift growth or the diversity push yield benefits?
- Predict surplus across the board for GCC economies, but like past phases when oil prices were raised, the additional capital has not been deployed back in the domestic In fact, the opposite has happened, with fiscal policy become more contractionary. The government is not being the prime mover for the economy and is expecting the private sector to do more of the heavy lifting for growth, and this is going to be with us going forward. There are no big capital projects sponsored by governments or higher wages for government workers, nor is there any reintroduction of subsidies like fuel or food prices. In UAE or big GCC economies, if there is real pressure from inflation and higher day-to-day living costs like food, housing, etc., there will be a ‘cap’ on wholesale price of basic food commodities.
What could the new world economic order look like?
- A little bit of diversification in a global order is not a bad thing, but there are serious limits. For example, if Saudi Arabia gets paid in Yuan instead of US Dollar, they will have to convert it to another currency or they must buy something in It might mean China will reform and open more to foreign investors or drive domestic demand.
- Over the last 20 years, the share of the US$ as reserve currency has declined, but bulk of the diversion has gone to the Canadian and Australian Dollar and other G10
- The world has been moving away from a unipolar to a multipolar order, with a weak and divided West. Transition from US dominated country to eventually to a multipolar
- At the end of WWII, the USA and the West has been exporting their economic model and taking steps towards free market capitalism, good governance, and strong institutions. China does not export its economic model. It tends to stay out of each country’s affairs, while they engage in an economic exchange, extract what they need, give you capital in exchange, but does not interfere in other economic structures. China could do a worse job in being a global power than the
Next six months: worst and best scenarios
Best scenario: Putin realises that he made a major mistake and stops the invasion of Ukraine. However, we won’t be able to go back to pre-invasion state and sanctions will remain in place and renewed geopolitical suspicions about Russia and its intentions. This has broken the mould of Europe.
Energy prices will remain high for longer. The high gas prices driven by Europe’s energy needs will remain for the near future. There will be a huge price volatility in oil supplies, whilst world reorganises with the flow (oil is a more fungible commodity than gas). It will flow eventually to the end consumer but with a lot of dislocation in the short term and price volatility due to this dislocation. Regarding oil, we are not far off from a supply demand balance. The best would be end of war, gas prices remain high and oil prices come down to US$80 a barrel.
Worst scenario: Putin doubles down, crisis escalates, and there are increased sanctions, resulting in the energy prices increase and catastrophic consequences on the European economy, with oil prices spiking over US$200 per barrel.
Best scenario: Putin gets assassinated by a fellow regime insider who decides the war is not worth the economic damage for the country and Russian policy changes in positive direction.
Worst scenario: Oil at US$200 a barrel is a global recession situation, with demand pulls back sharply and severe inflation, like the 1973 oil crisis.
Best scenario: The conflict ends but does not change the geopolitical restructuring. There could be a broader global partnering of networks or alliances, like Russia-China. A more uncomfortable world with both being viewed as more antagonistic towards western interests.
Worst scenario: Escalation of crisis, that also affects Middle East relations and geopolitics, involving Iran.
- Russia is also the world’s largest exporter of wheat, a major exporter of coal, top producers of metals and What will be the consequences of this, especially for the MENA region?
- Will the sanctions backfire?
- Will the conflict hasten global conflict?
- What will the picture look like six months from now?
We will return for part two of this roundtable conversation in Sept-Oct 2022, at Capital Club Dubai.