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Capital IdeasTM

Investment insights from Capital Group

Categories
Market Volatility
Biden and Europe walk energy tightrope
Talha Khan
Political Economist
March 3, 2022

Russia’s military aggression against Ukraine, which has become Europe’s largest ground war in generations, has impacted millions of people and triggered a large-scale humanitarian crisis as vulnerable Ukrainians take shelter or flee their homes. The intensification and spread of the conflict is deeply troubling and is having a devastating impact on those people caught in the crisis.


This article focuses on potential market and economic implications of the conflict.


Markets have typically ignored major geopolitical events, or the impact has been more localized. The exception is when conflicts lead to energy supply shocks. A notable situation was the Yom Kippur War of 1973. After that war ended, OPEC, which was very much led by Saudi Arabia, announced a shipping embargo against the U.S. and Israel’s European allies. Oil prices skyrocketed, and the U.S. was particularly vulnerable, especially since it did not have the domestic production capabilities it has today.


Biden is walking a tightrope of trying to punish Russia while protecting American consumers. The energy market is very tight, and with inflationary pressures and mid-term elections in the autumn, I think this could push the Biden administration to renegotiate the Iran nuclear deal. If you have more Iranian oil coming back into the market, it relieves some of the pressure. But this is still not a long-term solution.


It’s a messy policy debate within Europe and the U.S. on what to do about imports of Russian oil and gas. Western politicians are under enormous pressure from high inflation and its effects on real wages and purchasing power. So, while that has played a major role in policymakers providing sanction carve-outs for Russia’s energy supplies, public opinion could very well force a rethink on this. We can no longer rule out either Europe putting an embargo on Russian gas imports or Russia manipulating its gas supply.


That appears to be the logical next step, and one that Western countries have so far avoided in this rising escalation. Ultimately, the events that are unfolding now will hasten Europe’s energy transition agenda and, in the interim, lead to structurally higher energy prices. These factors (or uncertainties) are being closely monitored by the European Central Bank (ECB) and the U.S. Federal Reserve, who will be keeping an eye on whether these feed into medium-term inflation expectations drifting higher. 


Talha Khan covers the euro zone and broader political issues as a political economist. Talha has 14 years of industry experience. He holds a master's in international political economy from the London School of Economics and a bachelor's in economics and political science from Macalester College.

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Market Volatility
Europe
Markets & Economy

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