​​How markets will deal with Putin

It is said, and it is true: The world in general and Europe specifically depends on Russian fossil fuels. 

Viewed worldwide, Russia is number two in oil production (the USA is number one) and number one in natural gas extraction. According to Eurostat, in 2020, the European Union imported 43.0 per cent of its natural gas and 25.5 per cent of its petroleum oil from Russia.

So yes, we are dependent on Putin’s fossil fuel power, but things could change faster than the authoritarian leader would like. Thanks to the price mechanism, players in markets often react quickly. What do I mean?

Let’s take an abstract look at the current fossil fuels market. 

After the pandemic subsided, energy demand increased sharply worldwide. 

In the figure above, you can see such a positive demand shock. There are one supply (AS) and two demand curves (AD, AD’). (They are straight lines for simplicity.) AD shows the demand curve during the pandemic, AD’ the current, increased, demand. As you can see, in that new situation, more energy (y2) is sold at a higher price (p2). 

What would happen if large parts of the world abandoned Russia’s gas and oil? To make it more difficult for Putin to finance his army. Or because Putin himself would ban the export of oil and gas.

The figure above shows such a changed energy market. Less is offered, the supply curve shifts to the left (from AS to AS`), prices go up (from p1 to p2), and the quantity sold goes down (y2 to y1).

Even in this static view, an effect of the Russian missing energy supply becomes clear: the reduction of sold oil and gas (distance between y1 to y2) is lower than the reduction in supply (distance between e1 and e2). This is because some customers are willing to pay a higher price than to forego oil and gas. In other words, the renunciation of Russian oil and gas would only partially lead to fewer sales of these fuels. We would just pay more. 

If you leave the static perspective and look at the development dynamically, further effects come into play.

Two effects are essential.

1) If a provider leaves the market, new ones follow. Yes, it’s true, natural gas and oil are finite. But there are deposits whose exploitation is only worthwhile at higher prices. So there are undoubtedly potential providers who are not yet on the market. Therefore, the above supply curve may shift to the right again over time (from AS’ back to AS), then prices will fall and sales will increase. 

2) Supply shocks in one market usually impact other markets. If prices for oil and gas rise, it becomes more attractive to use other energy sources. The war in Ukraine may accelerate the energy transition away from fossil fuels. These effects will also take the pressure off oil and gas prices (in this case AD would move to the left).

How quickly can such a development take place?

Faster than we might think. Satellite data shows that tankers loaded with American liquefied natural gas are increasingly heading for Europe. And the economist Fabian Kurz from the think tank IREF shows (only in German) that efforts to create an EU internal market for gas are now bearing fruit. Gas can now be fed into the grid at almost any point and distributed further. “This promotes competition and, as is now being shown, also energy security,” Kurz wrote. 

Kurz is convinced: “Both in the short and long term, demand for natural gas can be met without Russian imports.” 

So flexible markets could become a nightmare for Putin. His power, based on the country’s wealth of natural resources, will crumble as the world realizes it can do without these resources. We will have to pay a price for this in the form of higher prices. It should be worth it.








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