Pipeline Politics

Story Highlights:

• Wednesday was a tough day for global equities. Volatility somewhat subsided over the past few weeks, but expect these daily spikes—in both directions—to continue.
• Also of note on Wednesday, oil prices dropped over 12%, mostly based on US government reports showing oil inventories rising more than expected and perhaps tied to economic concerns.
• Focusing on US reports to explain oil's moves is likely too US-centric. Oil and commodities in general are a global issues.
• Geopolitics affects commodity prices. The new dispute between Russia and Ukraine over natural gas demonstrates again how pipeline politics affect energy supply.
• It's not uncommon for commodities, like energy, to see these sorts of geopolitical supply disruptions, which together with constrained supply, will keep energy prices volatile.

(Editor's Note: MarketMinder does NOT recommend individual securities; the below is simply an example of a broader theme we wish to highlight.)

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Wednesday was reminiscent of the tough down days global equity markets suffered last fall. Though volatility somewhat subsided over the past few weeks, there's no room for complacency in markets. These daily spikes—in both directions—will probably continue, and unless there are material changes in your longer-term market outlook, there's no need to fret over these jolts.

Wednesday also called to mind another ghost of 2008—big oil price moves. Oil prices fell a little over 12%, mostly based on US government reports showing oil inventories rising more than expected. This is the largest percentage drop in seven years—seemingly huge, except even after the drop, oil is still within a relatively tight price range from about $40 to $50 a barrel.

Perhaps the 12% drop also reflects fears of further economic woes (and thus declines in oil demand), particularly after two negative reports from the US employment sector and Fed. Yet solely focusing on US reports to explain oil's moves is likely too US-centric. Oil and commodities in general are a global issues. Most growth in oil and commodities demand is generated and supplied by emerging countries like the BRICs (Brazil, Russia, India, China).

We previously noted geopolitics' effects on commodity prices, and in particular, energy. The new dispute between Russia and Ukraine over natural gas demonstrates again how pipeline politics affect energy supply. Russia supplies Ukraine with its domestic natural gas, but Russia's state-owned energy company, Gazprom, failed to reach an agreement with Ukraine's state-owned energy company, Naftogaz Ukrainy, on this year's contract over new gas prices. To undercut Ukraine's position in the agreements (and some say Ukraine's pro-Western government), Russia shut down all gas deliveries into Ukraine, including those transporting gas through Ukraine to Europe out of fears Ukraine will tap into the transport pipes for domestic use.

Europe receives a fifth of all its gas through Ukraine, so this problem is more serious than just a neighborly spat. The cold Eastern winds are blowing across Europe, yet there's no reprieve indoors. The supply disruption is leaving Eastern European households without heat and forcing governments to demand gas-intensive factories shut down operations. Though some resolution in this case appears on the horizon, preventing future similar disruptions seems unlikely.

It's not uncommon for commodities, like energy, to see these sorts of geopolitical supply disruptions, which often puts upward pressure on prices. Despite the world's heavy reliance on commodities for existing and new operations, these resources are geographically constrained—not just in terms of supply, but also accessibility. It's not easy (and very costly) to transport crude oil, natural gas, or other commodities. There's a limited number of natural gas pipelines, and the world's most extensive pipelines are controlled by very few hands. In emerging countries, these resources are often state-controlled, and their limited sources and importance to global functioning make them useful political pawns. And because of these politically vested interests, these disruptions will not be easily resolved going forward.

Global economic weakness in the foreseeable future will likely tamp energy demand. But two basic fundamentals—pipeline geopolitics and constrained supply—and the likely push by European countries to invest in alternate energy sources aside from Russia and through Ukraine will surely keep energy prices volatile in the period ahead.