Risk of disruption to European gas supplies put at 30%

In regards to sending Russian military forces into Ukraine, Vladimir Putin said on Thursday “I very much hope that I am not obliged to use this right,” Amid the intensifying crisis in the region Roubini Economics now puts the risk of a formal Russian military invasion of Ukraine at 50% and the probability of a meaningful gas disruption at 30%.

Its worth noting that Russia didn’t even suspend gas supplies during the depths of the Cold War and with Russia likely to face increased competition from new gas supplies in Europe and North America it is in their interest to keep gas supplies flowing. Using this logic a probability of 30% attached to supplies being completely cut off appears too high. Putin may see things differently though. “We sell gas in European countries which have around 30-35 percent of their gas balance covered by supplies from Russia. Can they stop buying Russian gas? In my opinion it is impossible,” Mr Putin said.

In the scenario that gas supplies to Europe are completely suspended analysis from Energy Aspects suggests that European gas prices could more than double if supplies were cut off for two months and Europe then had to attract LNG supplies to fill the gap. Gas prices rose to almost 62 pence per therm in March after Russia took over the Crimea before falling back to 48 pence per therm. Today gas prices are around 52 pence per therm.

Bear in mind that even if your country doesn’t import much in the way of gas from Russia (Spain and the UK), gas prices will still rise sharply as traders in the continents gas market worry about where supplies will come from. Indeed, competition for LNG will also have a knock-on effect on Asian gas buyers, consultants Nexant estimate that gas prices there could rise by almost 20%.

A more likely scenario is that Russia cuts gas supplies to Ukraine. Mr Putin warned the EU a week ago that Russia would turn off the tap to Ukraine if it didn’t pay its bills. Indeed Putin has now gone further saying that Moscow is ready to wait for one month to Ukraine to pay its gas debt. The deadline falling one week before Ukraine’s May 25 elections. Although this would indirectly cut off around 15% of Europe’s gas imports the impact on gas prices would be significantly less, not least because Europe is moving towards summer.

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Related article: Could unrest in Ukraine have a sting in the tail for commodity prices?

The commodity most affected by El Niño is…Nickel

According to research from Societe Generale the commodity most affected by El Niño isn’t an agricultural commodity but is in fact the metal nickel. Why is this important right now? Well, first Australian meteorologists have just raised their assessment of the likelihood of an El Nino developing during the southern hemisphere winter to greater than 70%. Second, nickel prices have already risen by 25% since the start of the year to around $17,400 per tonne due to a ban on the export of nickel ore from the largest supplier, Indonesia.

Related article: Nickel hits 3-month high after export ban

To recap the El Niño weather event – caused by an increase in water temperatures in the tropical Pacific – recurs every 3-5 years and in the past has triggered wild gyrations in wholesale food prices. In terms of commodity producing regions, El Niño typically results in drier conditions across Australia, other south east Asia, Brazil and West Africa but wetter conditions around the southern US states and coastal areas of South America.

Related article: Higher and more volatile food prices in 2014?

The bank looked at the relative change in prices between when the weather pattern is confirmed and when it ceases, typically 14 months later. Of the 11 commodities most sensitive to El Niños, eight of them are agricultural ones – cocoa, coffee, cotton, soybeans, soymeal, soyoil, sugar and wheat but they were all outperformed by nickel. While the typical El Niño sensitive commodity gains an average of 3.2% during outbreaks of the weather pattern, nickel gains an average of 13.9%.

So why is nickel, a metal so affected by the weather compared with agricultural commodities? It relates to the impact of drier conditions in south east Asia. According to Societe Generale Indonesian droughts “impact nickel production by affecting hydroelectric power generation facilities and lowering the water levels of inland waterways that are vital for ore transportation”.

Although not 100% certain to occur, the prospect of El Niño is one other factor to consider when buying nickel or products related to the metal. Analysts at Macquarie are forecasting that the nickel market will be in deficit by 134,000 tonnes in 2015 if the Indonesian export ban remains in place – elections are due to take place in April and July but there is no indication that the ban will be lifted. They note that the last time the market was anywhere near this tight was in 2006/07. Nickel prices then traded in the $30,000 – $50,000 per tonne range.

5 key charts for commodities from the IMF’s World Economic Outlook

1) Futures markets point to continued falls in commodity prices during 2014 and 2015…

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2) Not that futures markets have been much use over the past decade. Not withstanding that fact that commodity prices are often in backwardation (which could lead to a downward bias to price projections) the volatility seen over the past decade led to some large forecast errors…

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3) Nevertheless expectations for higher interest rates in the US have risen sharply over the past six months although expectations still point to a first rise in rates in twelve months. Higher interest rates and an appreciation in the US Dollar would weigh on commodity prices.

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4) Geopolitical shocks (resulting from North African and Middle East for example) have supported Brent oil prices over the past few years…

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5) Libya, Yemen and Iran need more geopolitical shocks and much higher oil prices if they are to balance their fiscal budgets and current accounts.

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You can find the IMF’s WEO here.