A lasting peace between Russia and Ukraine isn’t going to come so easy.
Markets rallied Wednesday based on Tweets and sound bites from Russian President Vladimir Putin and Ukrainian President Petro Poroshenko suggesting that a “permanent” cease-fire had been reached and that both sides were ready to make peace. But backtracking, confusion and a bevy of conflicting reports following the announcements shows that neither side is in complete control of the situation and that peace remains elusive.
Investors jumping on this “peace rally” should tread carefully. Winter is coming, and Putin stands ready to use his nation’s sizable energy resources and its purchasing power to economically force Europe and Ukraine to comply with his wishes. Using those weapons will ultimately hurt everyone, including investors.
It came like a bolt of lightning from the sky: a Tweet from Ukrainian President Petro Poroshenko declaring that he had secured a “permanent” cease-fire between his government and Russia over the months-long conflict in the “Donbass” (eastern Ukraine). On his website, Poroshenko reaffirmed the Tweet and said that the cease-fire came as a result of a telephone conversation he had with Russian President Vladimir Putin.
A stunned market took the message at face value and rallied. Russia’s main stock market index jumped 4% while the ruble gained against the dollar and the euro. Shares in Gazprom, the Russian state-controlled energy giant, rose 6% on hopes that western sanctions, which have put its drilling prospects in the Arctic and elsewhere on hold, would soon be lifted. Several European companies that export heavily to Russia, from German car manufacturer Daimler, to Danish brewer Carlsberg, also saw their shares rally on the seemingly good news.
But as with everything in this crisis, nothing is what it seems. A few hours after the initial announcement, the word “permanent” was removed from Poroshenko’s online statement but the Tweet was kept up, confusing pretty much everyone. The Ukrainians later modified the statement, saying that a cease-fire “regime” had been agreed to and that the two sides would discuss the situation in Minsk on Friday.
Meanwhile, it was widely reported that Putin had outlined a seven-point plan to “stabilize” the situation in eastern Ukraine. Turns out the “plan” was really some chicken scratch that Putin had jotted down on a piece a paper on his flight from Russia to Mongolia earlier that day. In any case, the main points called for Ukraine to withdraw its troops from the east and for the Russian-backed militias to stop their advances. Neither have happened. On Thursday, Poroshenko further “clarified” his statements, saying that he was prepared to call a cease fire for 11 a.m. On Friday if the talks in Minsk “go well.”
It is hard to see how anything will be settled in such a short period of time. On Thursday, Ukrainian officials decided to hedge their bets and met with Nato leaders who were gathered in Wales for their annual meeting. They wanted reassurance from the U.S.-led alliance that it would come to their rescue if Russia (officially) invaded. Russia wasn’t amused, which should put a damper on Friday’s peace talks in Minsk.
It is unlikely that Putin is in any big rush to resolve the conflict now that winter is approaching. That’s because Russia still holds a very big trump card over Ukraine and the European Union: its vast energy supplies; natural gas, in particular.
Natural gas demand in Europe doubles in the winter, as it is used as a heating fuel. Europe receives around a third of its natural gas supplies from Russia, with half of that flowing through Ukraine. Germany counts on Russia to supply half of its natural gas needs, while many countries in eastern Europe, like Hungary, count on Russian gas for nearly all of its needs. As the days get cooler, Russia is hoping that Europe will somehow force Ukraine to acquiesce to its demands.
For Putin to back off, Europe would need to convince Ukraine to grant more self-autonomy to its Donbass provinces. But Kiev probably won’t agree to such a move as it would further dilute its authority in the country while opening the door to possible Russian annexation in the future. It’s worth pointing out that Crimea and Sevastopol were both “semi-autonomous” provinces of Ukraine before they were invaded and annexed by Russia earlier this year. Such a designation isn’t one that the Ukrainians want assigned to any more of its provinces, at least not anytime soon. So, short of handing over those three provinces over to Moscow, there is little chance for a quick peace.
That’s bad news for Europe’s struggling economy, which is in no condition to deal with an energy shock. The last time Russia cut gas supplies off to Ukraine in 2009, natural gas prices jumped by nearly 30% across Europe. That conflict only lasted a couple of weeks—this one could go on all winter.
All this talk of peace shouldn’t deter Europe from getting ready for a winter without Russian gas. The gas currently flowing from Russia to Europe through Ukraine will either be halted or expropriated by the Ukrainian government, so it is likely that Europe will see at least a 16% drop in supplies. Luckily for Europe, last year’s mild winter allowed it to sock away a lot of gas in storage tanks, which can be used to fill a temporary gap in Russian supply. Those tanks, which are around 80% full at the moment, could supply roughly half of Europe’s total natural gas demand this winter; that is, of course, if this year’s winter is “normal.” With some forecasts calling for Europe to have a colder winter than usual this year, those stocks may not last as long.
Europe does have one other escape valve. It can import more liquefied natural gas (LNG). Europe is only using an estimated one-quarter of its LNG import capacity, so it could handle more if things get bad. The U.S. Has a lot of gas but doesn’t have the ability to liquefy it and send it over the ocean (yet), but other major gas producers, like Algeria, Nigeria, and the Persian Gulf states, do. Now, much of the world’s LNG shipments this winter have been spoken for, but there are bound to be a few cargoes that can help Europe fill the gap. They’ll probably be expensive, but given the alternative, it probably won’t be that bad of a deal.
An unexpected spike in energy prices would suck up the disposable income of Europe’s struggling middle class, threatening to throw the continent back into recession. The European Central Bank’s unexpected move Thursday morning to further lower interest rates to spur spending and stimulate growth won’t do much for the economy unless people feel safe to spend. That won’t happen with potential war looming on the eastern front.
Russia is counting on some of these scenarios to play out in its favor in the months ahead so it can bring both Ukraine and Europe down a peg or two. So the prospect of Putin settling anything now, before winter, makes little sense.
