In the days of WWI and WWII, we thought of warfare and threats through means of guns and soldiers. While much of this remains true to this day, an undeniable increase in the means of conducting warfare has emerged. Crushing circumstances facing Europe and wider regions due to the ongoing energy crisis has opened a new channel for strategic threats.
Biological Weapons
The use of biological weapons is not a recent endeavour, with cases of these types of attacks popping up since the 20th Century. Recent examples include the Salisbury poisonings, where a Novichok nerve agent was said to be behind the deaths of Sergei and Yulia Skripal.
The extent of Russia's invasion into Ukraine in 2022, and the deadlock they face in terms of not being able to overpower the Ukranian army and public with military weapons, has opened up the possibilities of biological tactics being used. The threat of this has exacerbated recently, and is supportive of a sell-off in major sovereign bonds. The market implication of such an advancement in the war would mean further escalation and further panic, especially as a biological threat can extend and affect a much wider range of people. The threats this would pose to Ukraine, and surrounding countries would be extreme, and so we see the market positioning itself for more risk and more volatility.
The higher volatility indeed is also inclusive of several other factors, which you can read more about in ‘Volatility: Predictive Power?’
Coming back to the energy crisis.
The dominance Russia has had of energy and gas supply to Europe and indeed wider reach is frankly frightening. It has been significantly reduced, however the extent to which a country can accumulate alternative supplies at such a short timeframe is small.
Russia has started to use this power to benefit themselves. The dependence has meant negotiations with any hint of threats to reduce supplies have turned in favour of Russia, such as with the return of the Nord Stream 1 turbine from Canada. This was locked in Canada due to sanctions placed on Russia by Europe towards the start of the war, however when Nord Stream 1 supplies were cut to around 30%, this had to be delivered back to Russia to enable supplies to pick up.
However, this has also been seen as a new type of warfare. The mere threat of a reduction in supplies spikes up the price of oil and gas, and rapidly puts pressure on European countries, a dangerous situation for them. Whether the claims that Nord Stream 1 needs maintenance and that is the reason for the reductions in supply to 20% are valid are unknown, however many European countries have claimed Russia is unnecessarily stopping flows to hurt Europe.
The most recent development has been a complete halt of Nord Stream 1 supply: 0%. Again claims of 'essential maintenance' stay, with the validity impossible to say. Many energy companies have stated this is a contract breach, as most utility companies operate with fixed long-term contracts for gas and oil, which are locked in place to avoid such disruptions. The utilities market generally forms natural monopolies, and so these fixed contracts are essential as only a few firms supply the entire gas and energy needs of a country.
Markets did not respond significantly to this however, possibly overshadowed by news of impressive gas storage levels around 80% in Europe. There may be some overconfidence that the crisis is not as bad as it seems, given storage capacities are doing well. We believe this is not the case with a.more medium-term opinion. We think the sell-off in sovereign bonds is likely to continue.
Trade Ideas and Opinions
In the short-term, storages should be enough to get through the winter, even if it is harsh.
in the long-term, utility companies should be able to enter long-term contracts with alternative suppliers, internationally.
In the medium-term however, we believe storages will not be enough to last 2/3 winters, and the alternative supplies will not be in place to cover supplies then. This is because all current suppliers have prior commitments they must fulfil, before entering new contracts.
We believe, in the medium-term, major European sovereign will face difficulties. The sell-off of bonds should support a rise in short-term yields, and so we re-iterate the ‘10s30s steepener’ supported but a long 2s10s30s butterfly belly position.