Ukraine and the Energy Picture

 | Mar 27, 2014 | 4:00 PM EDT
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There's little in the energy space that I like right now: The major indices look fairly priced, and energy stocks offer even less to get excited about. U.S. energy-and-production names have had their major run in 2013, and the two values I like -- Anadarko Petroleum (APC) and Noble Energy (NBL) -- have been quiet and need more patience. Refiners are well-priced, considering the curve, except perhaps in the case of Valero (VLO), which seems overextended. Offshore drillers are off-cycle, and I'm not ready to pick a bottom yet. Natural gas, at $4.40 MMBtu, looks steady.

But the continuing story surrounding Ukraine -- which I thought would begin to quiet down by now -- has instead, unbelievably, escalated. As a result, oil prices are at risk for a major spike upward.

The coup d'état in Ukraine was met, in my view, by a very restrained Russian reaction: In annexing the Crimea region, Russia secured its Black Sea port at Sevastopol and reclaimed a majority ethnic Russian population, which stood at some 60% of Crimean residents as of the most recent Ukrainian Census in 2001. My thoughts at the time were that Russia would then proceed to dislodge the minority, Western-leaning government in Kiev by slowly using its strong influence in natural-gas supply through the nation. Russia has used this tactic successfully in Eastern Europe twice in the recent past.

Beyond what was, I suppose, a necessary token reaction of sanctions of half a dozen Kremlinites by President Obama, I expected the rest to be solved internally. I assumed all the fears of further Russian military incursions would fade into the background (because they didn't need it), along with the cries from Kiev for financial help -- cries I expected would go unheeded.

Instead, I've seen a ridiculous barring of Russia from the Group of Eight, increasing sanctions from the U.S. and a European $18 billion aid package put together for the revolutionary and, in my view, illegitimate Kiev leaders. From Russia, I've seen reciprocal sanctions of U.S. senators and a demand for owed Ukraine energy payments to be made immediately and in gold, adding a treasury strain as well as a vindictive monetary twist.

Because of the energy hold that Russia has on Eastern Europe, and even on parts of Western Europe, Russia holds all the cards in this standoff. Besides having all the spigots to European solvency in their back pockets, they have a ready customer in China for almost whatever they choose not to send west -- and reports of increased contracts to the East are already hitting the energy wires.

I've said that only one act could really inflame this situation, and I thought it an impossible option: applying sanctions on U.S. companies doing business in Russia. I'm starting to consider this option less and less impossible.

The geopolitical nature of Ukraine puts Europe and the U.S. on the very short end of this slippery stick, and what has disturbed me is that both the European Union and President Obama, for differing political reasons, seem unwilling to admit it. I think they continue to want to ratchet up pressure on a Russia that holds all the cards, and restrictions on companies like Exxon (XOM) -- working in the Russian Arctic and with liquefied-natural-gas projects -- are the lone remaining way of doing that.

Dangerous and real "new Cold War" ideas are floating around. I think the best energy idea I can give right now is to buy some out-of-the-money crude call options. All the risks seem to be again increasing to the upside.

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