These days, the European stock market is the worst in the Western world. It is underperforming the U.S. by nearly 10 basis points, down 22% year-to-date. Even emerging markets are doing better. It makes sense. Europe’s inflation, in countries like the U.K. and Germany, is worse than it is in Mexico.
Why? Mostly all of this is due to Russian sanctions on energy as punishment for its the war with Ukraine. That’s the most significant headwind. Those sanctions set off a massive commodity price spike that’s hurt the European economy the most.
Some say this is good for Europe because by abandoning Russian oil and gas, the European Union leaders are signaling to its member states and its people,that it is moving into a post-fossil fuels economy. This is something the Europeans, by and large, seem to want. Ursula von der Layen, the EC President, compares going beyond fossil fuels is Europe’s moon mission. (And some activists have glued themselves to paintings over the fight against greenhouse gasses. Others, like Greta Thunberg, have won high accolades as global youth leaders for their activism.)
But these actions and rhetoric won’t turn Europe away from fossil fuels. Nothing could be further from the truth. They had to return to coal to give up Russian gas and are burning more of it to keep the lights on. They are importing Saudi oil as the Saudis import Russian oil for their own use.
Coal is back in climate-wary Europe. Who could have possibly imagined this?
Climate Change: Some Coal Better for the Planet Than Others
The Greens – the second in command in the ruling German Coalition behind the German Social Democratic Party – are happily using more coal. Even though they stopped buying Russian coal, this was not a move to reduce fossil fuels. It may have been sold as such, with political leaders saying this will wean Europe off fossil fuels in general. But this month’s ban on Russian coal just means Germany will get it from elsewhere.
For example, the EU is now buying coal from South Africa.
Coal export groups in the U.S. want in on the action.
U.S. coal exports to Europe rose more than 140% in May compared to a year earlier — and they are continuing at that increased level because Europe desperately needs coal for electricity generation to replace Russian gas. By October, U.S. coal shipments will need to grow much higher than they already are so that enough coal will be available in Europe to keep the heat on by winter, says the U.S. Coal Exports Coalition, part of the National Mining Association.
Like the U.S. government’s undeclared war against Russian natural gas in the European energy market, the coal industry sees the same with the coal Washington doesn’t want. And if Brussels didn’t want Russian coal before the war in Ukraine, they sure could use it now. Russian coal exports alone in energy terms are equivalent to 165 billion cubic meters (bcm) of natural gas – equal to the total pipeline gas exports of Russia to all of Europe (both EU and non-EU members), but they provide a much smaller part of the Russian Government’s tax revenue in comparison with Gazprom’s natural gas.
The U.S. Coal Exports Coalition said Europe faces “the risk of a continent-wide electricity shortage” this winter.
The U.S. is the world’s fourth largest coal producer. This includes coal used for energy generation and coal used for metal works, such as steel making, a market Australia dominates. In 2021, the U.S. produced 539 million tons of coal, slightly less than the No. 2 producer Indonesia and more than Russia’s 397 million, according to the International Energy Agency (IEA).
The coal production growth forecast by the IEA suggests that the world would be able to replace only 80 million tons of Russian coal exports, or around 30% in the next three years, even if the U.S. and Indonesia became huge exporters to the EU market.
Europe doesn’t want Russia’s coal.
But India, China and Turkey are fine with it. Russia is diverting what it usually sells to Europe and shipping it there. However, it is unclear if this makes up for all of what they have lost in the EU market. Only time will tell. More will be known on that by mid-fall. What is known at the moment is that China’s imports of Russian coal have hit a five-year high.
Despite all the talk about climate change and the Paris Accord getting re-signed by the Biden Administration in his first year in office, the world’s biggest polluters are not listening. India said it would delay coal power plant closures last week to maintain low energy costs. Energy has a much higher share in the Indian consumer basket than in Europe.
Bloomberg called it a “blow to climate action,” but they only have to look to Europe to see where the climate action is most in peril. As stalwarts of climate change policy, Europe is looking like a complete failure.
Meanwhile, Russia is not in as bad a shape as people thought. The economy contracted 4% in the second quarter. The market –what’s left of it—assumed double-digit contraction before that. Commodity price hikes have helped, despite massive financial sanctions against the Russian economy.
Thermal coal prices have risen 306% year-over-year as of the second quarter. Natural gas is up 276% over the same period for EU Dutch TFF gas futures.
In 2021, Gas & coal accounted for 74% of primary energy needs ex-oil, according to a proprietary report published by Goldman Sachs.
Russian Coal Not Welcome
Sanctions on Russia have been a disaster for European commodities, and a boon to commodity traders, shipping companies, and oil and gas investors.
No one argues that Russia should not be punished for its invasion of Ukraine. However, these sanctions must be targeted. Instead of sanctioning private companies that export commodities vital to the global economy and have no significant ties to the Russian government or war machine, sanctions should be targeted to top decision-makers, the military and security brass, defense contractors and the financial sector. Instead, the West has primarily shot itself in the foot on energy, done great harm to climate change initiatives, and risks rising food prices due to fertilizer production drops, also thanks to sanctions against Russian suppliers and higher energy prices.
Russia’s Siberian Coal Energy Company, or SUEK, is the world 4th largest coal exporter, is not state-owned but is sanctioned nevertheless. SUEK is responsible for roughly 18% of Russia’s coal exports and is the only coal company sanctioned individually by the U.K. Those sanctions target SUEK founder and Forbes-listed billionaire Andrey Igorevich Melnichenko.
Coal is sanctioned completely from Russia.
SUEK’s exports have declined all year, falling 18% in January versus a year ago, and then really falling when sanctions hit in March by around 27%. The same held in April. There was a slight increase in May due to exports to other emerging markets, but as of June, the Russian coal giant is still down 9% in export volume versus the same time last year.
Other prominent players are also out of the once lucrative European market. Sibanthracite Group is not on any EU-wide sanctions list, but the metallurgic coal it exports is now off limits. In February, before the war broke out, right around the time Presidents Vladimir Putin and Xi Jinping were squaring away a longer-term commitment to each other’s economic and political security, the company said it expected exports to China to rise by more than 30% this year.
Mechel, once publicly traded on the NYSE, said in its recent earnings report that all of its coal sales declined in the second quarter. The company largely blamed the local Russian economy.
Raspadskaya, a coal miner and exporter of thermal coal, tried breaking off a merger agreement with Evraz, a U.K. incorporated steel manufacturer, but due to sanctions, the unwind became financially unfeasible, the company said in its Aug 11 earnings report.
Raspadskya will be laying off workers soon; rumor has it. They are shifting export channels and hoping to gain clients in India. They are also “reorientating European export flows to the markets of the Asia-Pacific region…and shifting focus to domestic suppliers while also looking for alternatives abroad,” the company said, as a sign of the impact of European sanctions on these companies.
But at least Russia has heat, air conditioning, and affordable fuel and energy bills.
The war in Ukraine came at a time when Europe – and much of the West – was coming out of the COVID pandemic and giving up on lockdowns. As businesses ended their pandemic restriction policies lockdowns, energy demand soared as factories began firing on all six cylinders.
With energy bills soaring across the globe, whole industries risk energy rationing, European households are imposing self-rationing, and some governments are kindly requesting they do so. In private assessments made by one company, much of Europe could pay 13% equivalent of GDP for energy in 2022.
It is unclear if any of these bans will come off. For example, foreign investors who have been involved with companies like SUEK are in a tough spot. Is their investment going to be a sanction risk? Can they lend to the company? What will Washington or Brussels do next? What will Russia do to spark a reaction from the West, leading to more sanctions?
Western investments in Russia have suffered mightily.
Europe: Worth the Risk Yet?
For now, macro traders are looking for two signals for Europe and the world economy. These are a ceasefire in Ukraine, or Europe becomes so desperate this winter and supply chains so stretched that it has no choice but to relax some sanctions or convince non-EU partners to relabel and transship Russian commodities to look in compliant with their own rules, but really doing an end-around. The market will figure that out.
Once they do, Europe – as a portfolio investment – will start to look reasonable again. Until then, as one investor recently told me on Twitter, Europe remains “the third world of the western world economies.”
What would make you want to buy the FTSE Europe (
“If I heard Kiev and Moscow were having secret talks and if Germany and China were involved,” says Vladimir Signorelli, head of Bretton Woods Research in Long Valley, NJ. “That would get me really bullish on Europe.”
On Europe being the Third World of Western economies, Signorelli laughs.
“They’re certainly heading that way. And you have the Greens still opposing nuclear in Germany. I just don’t understand them. They are on the fast track to a third world energy program,” he says.
In fact, year-to-date, only China is worse as an investment. China is facing a heated political fight with the U.S., and an internal political fight in the run-up to this fall’s Twentieth Communist Party Congress. Their “zero covid” policy is massively unpopular with investors, but the MSCI China is down only two percentage points lower than the FTSE Europe.
Unless the market sees Europe supplanting Russian energy fully, and at an equal price, Europe’s commodity woes will weigh heavily on investor sentiment for the rest of 2022.