Could the Ukrainian Crisis Send Energy Prices Skyrocketing?

Could a black swan event happen in Ukraine?

Mar 3, 2014 at 4:37PM

Black swan events don't happen often, but when they do occur they change markets drastically.

The sub-prime mortgage crisis and the Great Recession is one example. Very few people expected that lax mortgage lending standards would lead to Lehman Brothers' bankruptcy, which would then lead to massive contagion and credit contraction throughout the financial sector. Despite the fact that few expected it, it happened nonetheless and the global economy nearly fell apart because of it.

In the world today, many seemingly insignificant things, when exposed to the right feedback loops, can become extremely significant very quickly.

Could the current events in Ukraine be a black swan that sends energy prices skyrocketing?

Non-event on the surface
On the surface, the events unfolding in Ukraine don't seem overly threatening to the global economy. The United States has given strong hints that it will not intervene militarily in Ukraine, and Russia itself has not used its forces directly.

In terms of energy production, Ukraine is not very important either; it has to import much of its natural gas and oil needs, which is a big reason why the nation has budget problems.

Danger of natural gas disruption
The big worry is that if the situation continues to escalate, Russia's natural gas supply to Europe will be interrupted. Ukraine is still a major conduit for Russian natural gas to Europe. If fighting were to break out, natural gas pipelines could be damaged and supply interrupted. 

Continental Europe depends on Russia for a quarter of its natural gas , and many European nations have frail economies that couldn't handle a supply shock. If those supplies are cut, despite healthy inventories due to a mild winter, natural gas prices would spike, endangering Europe's economic recovery, which would then have bigger ramifications on the global economy.

The bottom line
In my opinion, despite talk of doing so, the United States is unlikely to impose serious economic sanctions on Russia. Many Western oil companies have significant interests in Russia. ExxonMobil (NYSE:XOM) is working with Rosneft to develop Russia's Arctic, while BP (NYSE:BP) owns 19.75% of Rosneft.  Royal Dutch Shell (NYSE:RDS-B) has a big stake in Russia's Sakhalin-2 as well. 

If the United States were to impose financial penalties on Russian assets internationally, Russia may do the same for Western companies in Russia. In that event, no one would win, and everyone would lose.

Any sort of disruption in Russian oil exports would also have dramatic consequences for the world economy. Russia is the third largest liquid fuel producer in the world. It exported 7.2 million barrels of liquid fuel a day in 2012. A serious supply shock could derail many fragile economic recoveries, including that of the U.S. economy.

I don't believe the current events in Ukraine will be a black swan event. The United States and Western Europe simply have too much to lose if they were to escalate the situation. One thing that is more likely now is that France and Germany may reconsider their fracking bans. If the countries do approve fracking to unlock their shale reserves, this would be a serious penalty for Russia because it would mean reduced long-term demand for Russian natural gas.

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Jay Yao has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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