Well Oiled?

Why Russia’s threats on gas will not damage European growth | The good news: the European economy is beginning to look healthier. In the first full week of April, data suggested that German, Italian and French industrial production rose in February and Greece took its first steps back into bond markets buoyed by an IMF report stating that austerity was paying off, but there was still a long way to go. The bad news: President Putin has warned Europe that its gas supplies could be cut off because of a long-standing dispute with the Ukraine about non-payment of its bills. What impact is this likely to have on Europe and what is the threat to Europe’s fragile recovery?

Since 2009 when Russia halted gas supplies through the Ukraine for similar reasons, Europe’s oil and gas has been less reliant on supplies through the Druzhba pipeline that runs through the Ukraine; its supplies increasingly come from the Nord Stream pipeline directly from Russia. This makes Europe more dependent on Russia, but not as dependent on the Ukraine. In fact, the Ukraine does not feature in the top ten direct oil or gas importers into the European Union because its oil and gas is supplied from Russia (Figure 1a, 1b, 1c – ordered top to bottom).

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Figure 1a/1b/1c | European importers of crude and refined oil and gas, share of total imports 2014

Figure 1 Source | DeltaMetrics 2014

The charts are, of course, slightly under-stating the extent of Russia’s influence in the oil and gas sector. For example, the Netherlands is the largest importer of refined oil into the rest of Europe but its third largest importer of refined oil is Russia, illustrating Russia’s pervasive influence across the region. That said, it is likely to be Germany, as the largest economy and the one that is most reliant on Russian oil and gas, that will be most affected. The drop in imports of oil and gas that we are currently forecasting up to the end of August 2014, is very marked, as shown in Figure 2.

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Figure 2 | German imports of oil and gas from selected countries, June 2001-Dec 2015

Figure 2 Source | DeltaMetrics 2014

The forecasted decline in German oil and gas imports in the second two quarters of 2014 is marked. For example, we expect imports in April 2014 to be around 6% below their value in 2013, in July to be nearly 2% below and in August over 3% below their 2013 year-on-year values. However, this is part of a general downward trend in the second two quarters of this year as we are expecting similarly lower values for imports of oil and gas into Germany from the UK and from Norway.

This points to a more general issue: after a bruising few years, the recovery in Europe is acknowledged to be fragile and nervousness about its vulnerability has affected markets in the early part of April. Yet the Euro remains strong against the dollar and the Delta Economics trade forecast for Europe in 2014 shows a mild improvement since Q4 last year: from a net decline in exports forecast for 2014 of 0.3% to flat-lining growth now. This helps to explain the strength of the Euro: trade is a good proxy for competitiveness and, using Germany as the Penis Enlargement Eurozone’s strongest trading nation for illustrative purposes, as trade improves, the value of the Euro against the US dollar appreciates.

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Figure 3 | German imports of oil and gas from selected countries, June 2001-Dec 2015

Figure 3 Source | DeltaMetrics 2014, Bloomberg

But while no-one has questioned the strength of Germany and its trade competitiveness, the competitiveness of the peripheral regions has been a concern of both investors and policy makers alike since the sovereign debt crisis. Even here there is evidence that Greece and Portugal in particular are beginning to pull through. Austerity measures have been tough but wages are falling and competitiveness measured this way is beginning to be restored even if circumstances remain tough for businesses and people in those countries. Delta Economics is forecasting that Greek merchandise trade will grow by 3% this year and Portugal’s by over 4%. These are above average for the European Union; more than that, there is a similarly strong relationship between the value of the Euro and their trade, illustrated in Figure 4.

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Figure 4 | Greek and Portuguese exports versus USD per Euro, Last Price Monthly, June 2001-March 2014

Figure 4 Source | DeltaMetrics 2014, Bloomberg

What is really intriguing about this chart is that, compared with Germany, the correlation of exports with the USD-Euro exchange rate is almost as high for Portugal and higher for Greece. For Greece, the whole time period correlation is 0.86 while for Germany it is 0.85.

Maybe, then, we should be looking to Greece and its trade routes as a bellwether for the European economy after all. The Greek trade economy is proportionately small but where the Greek economy as a whole appears more stable and on a path to recovery, it certainly calms market nerves and signals that the policies that have been implemented may gradually be having an impact on competitiveness and the risks of further bailouts or contagion reduced. Greece’s largest export product is refined oil accounting for some 26% of its exports, and Delta Economics is forecasting that this trade will grow by 8% in this year and next. In itself, this helps explain the relative buoyancy of Greece’s exports. Iron and steel bars will grow by 6% and steel tubes and piping by nearly 7% and it is the role that Greece is playing as a transit hub for oil, gas and infrastructure products that is really gathering pace, albeit from a low base.

One note of caution: Greece does produce oil itself but it also imports a great deal of oil for export. Its largest import partner is Russia with volumes some ten times higher than the next import partner, India. While India’s imports are growing rapidly (at 11% over the next two years), this will not be sufficient to reduce Greece’s trade dependency on Russian oil. There are risks to Greek trade, and they are linked to the crisis in Russia, but its restored attractiveness as a trade and transit hub across a range of sectors will grow as its competitiveness continues further giving it the opportunity to broaden its exports beyond a dependency on Russian oil. The trends augur well but we should also remember the words from ancient Greece, “A ship should not ride on a single anchor, nor live on a single hope.”