The Russian fuel giant Gazprom signaled recently that supplies to Ukraine may be disrupted if the country does not pay its debt. NAK Naftogaz Ukrainy, the state gas company responsible for transporting the fuel to Europe by pipelines, owes Russia $1.89 billion and has almost stopped paying for deliveries.
Not everything is economics
As you know, this debt situation comes along with the series of political and military incidents between both countries, which have not found a solution yet. Both companies are state-controlled, so political interests are affecting decisions.
Considering that Gazprom meets 30% percent of gas demand in the European Union, and the fact that the company has the exclusive rights to connect its vast Siberian gas fields with the European Union through pipelines in Ukraine, a disruption would have an impact.
Don't be fooled, Russia has cut gas supplies to Europe twice since 2006. The first one was during freezing temperatures in 2006, and the second one in 2009, due to price disputes between these same two companies, Gazprom and Naftogaz. And it could totally happen again.
What to watch?
So what if a disruption actually happened? One possible effect would be higher liquefied natural gas (LNG) prices, which are already very strong, especially in Asia, the biggest importer. Why? LNG is the readiest direct substitute for Russian gas that the E.U. can buy, and the U.S. and Canada could become good, reliable providers.
This is where companies like Cheniere Energy (NYSEMKT:LNG), which holds a first-mover advantage in the U.S. LNG export business, come in.
Cheniere enjoyed good organic growth opportunities in recent years, when the shale gas and tight oil boom pushed midstream operation firms, and now it has infrastructure capacity to profit from new exports to the E.U.
Looking for cheap energy
A disruption to European energy will certainly impact another market as well. If you look at recent history, whenever gas has been expensive, the E.U. has burned greater quantities of coal to generate power.
Arch Coal (NASDAQOTH:ACIIQ) is the second-largest coal producer nationwide, and it possesses thermal coal operations in its Central Appalachia mine.
The issue with this company is that this thermal coal mine holds high costs and is in secular decline. In fact, Arch Coal is shifting its focus toward metallurgical coal, particularly higher-quality coking coals that hold lower costs compared to other competitors in the region. So, cost-wise, it is debatable whether we would see more coal shipments coming from Arch Coal in the event of higher thermal coal demand.
Peabody Energy (NYSE:BTU) has a similar outlook, but it is better positioned than Arch Coal. Its Powder River mine is located in one of the lowest-cost coal mining regions in the world, and its geology allows easier extraction. Hence, Peabody could arrange coal shipments at competitive prices thanks to this abundant, low-sulfur, and ultra-low-cost mine.
Russia receives about half of its budget revenue from sales of oil and gas, and rationally speaking, this is a moment in which the country might not be in a position to cut off gas supplies to Europe. But never say never: Russia has applied this strategy before, so stay tuned and be prepared.
Regarding gas storage and interconnection, Europe is not in bad shape and is in a better position to handle a gas disruption than before. For example, the region's biggest market, the U.K., has 25% more gas stored than average for this time of the year. Exposure is higher in Germany and especially in Eastern Europe.
In the case of a disruption, the U.S. is a bit behind regarding approvals for LNG export facilities, and this could easily benefit Cheniere, which has approved infrastructure functioning already. On the other side of the Atlantic, there is enough capacity to receive shipments since many European LNG import hubs are under-used.
The case for Arch Coal is less promising, as the company is positioning itself in the metallurgical coal segment. Its thermal coal business will drive higher profits when gas prices become more expensive in the U.S. Some competitors like Peabody Energy are better positioned and could take advantage of the situation in Europe.