While Americans face sticker shock at the pump, the situation in Europe is on another level.
"As the human tragedy in Ukraine unfolds before our eyes, surging commodity prices are pushing inflation in many countries to the highest levels in over 40 years," Isabel Schnabel, a member of the Executive Board of the European Central Bank, said in March speech. "Our dependence on fossil energy sources is not only considered a peril to our planet, it is also increasingly seen as a threat to national security and our values of liberty, freedom, and democracy."
The reason for this alarmist language? The E.U. sources the majority of its fossil fuels from Russia. European Commission president Ursula von der Leyen recently indicated the bloc seeks to sever itself from that very nation, now continued in it's war on Ukraine.
Per a recent commission report, more than a quarter of the EU's crude oil imports came from Russia, with its ally Kazakhstan also being a significant source. For natural gas and coal, nearly half of all imports come from Russia in each category. For nations like Germany and the nations on the EU's eastern periphery, that number grows. The German coalition government's decision to eschew nuclear energy, a vital potential lifeline, has exacerbated the energy crisis.
This impact has caused the euro area's annual inflation to soar to 7.5% in March 2022, led by energy inflation at a stunning 44.7%, up from an already significant 32% in February. As food supplies and other products stand to be impacted as well, the implications for EU consumers are dire and stand to severely dampen demand for products across verticals while also highly elevating recession risks.
"Germany is the most reliant on Russian oil and gas. Germany represented 16% of Russian nat gas exports in 2020 and 11% of oil and condensate exports," Rob Thummel, portfolio manager at Tortoise Capital Advisors, told Real Money. "Germany is the largest economy in Europe so it will likely see an impact of higher inflation due to higher energy prices."
That is not even to mention the impacts on those nations outside the Eurozone (such as Czechia, my nation of residence) that are dealing with an influx of refugees atop these economic concerns.
European Stocks and Selective Exposure
The main concern as a recession sits upon the table in Europe is, of course, exposure to European stocks.
"The rise in energy prices-both oil and natural gas-is of particular concern for the European economic outlook given it is effectively a tax on consumers," Morgan Stanley wrote in a recent report indicating the broad impact.
As such, Europe's largest companies like Nestle (NSRGY), LVMH (LVMH), Airbus (EADSF) , Diageo (DEO) , and more all stand to suffer. As companies must tighten belts on supply chain constraints, this could also spread to the technology healthcare sectors that dominate the STOX 600 index on the continent as well.
But the issue for Europe is not solely confined to the continent itself. Indeed, many U.S. stocks are highly exposed to the European market that is now likely heading headlong into recession territory.
Travel-focused stocks like Booking Holdings (BKNG) , Marriott (MAR) , and Hilton (HLT) all have significant exposure to the market while leisure plays like Carnival Cruise Lines (CCL) and Royal Caribbean (RCL) also could be impacted adversely.
Further, restaurant chains like McSonald's (MCD) , Restaurant Brands International (QSR) , and Starbucks (SBUX) are likely to be hit as well. For reference, McDonald's operates over 6,000 franchise units operating across Europe, accounting for a significant chunk of international revenues that undergird the chain's success. Amidst Brexit in 2016, for example, the company noted that 35% of its operating profit was generated in Europe. Since that point, the company's growth trajectory has likely reeled in this reliance.
U.S. Imports on the Table?
In contrast to the concerns over slowed spending in Europe, energy may be a silver lining for investors. Indeed, as European officials signal a turning of the spigot to the off position, U.S. energy imports could be a crucial offramp.
"Over time, a significant amount of Russian oil can be displaced with oil production from the U.S. with the help of Canada," Rob Thummel, portfolio manager at Tortoise Capital Advisors said. "Canada can provide the US with additional oil supplies. In turn, the U.S. can export more domestic production."
While he added that this will take time to get online, it could be a significant catalyst on the table by next winter.
"Over the next several years, expect a significant expansion of LNG infrastructure globally in the US and Europe to alleviate reliance on Russian natural gas," Thummel explained. "The best long-term solution for Europe, like the US, is an all-of-the-above approach that includes increased LNG imports from the US as well as continued build-out of renewables like wind and solar and renewable fuels such as biomass."
The all-in approach also includes significant oil exports to Russia in his estimation. Such an approach will have significant benefits to not only LNG leaders like Tellurian (TELL) , Cheniere (LNG) , and Sempra (SRE) , but oil majors like Exxon Mobil (XOM) , BP Inc. (BP) , and Chevron (CVX) . Additionally, firms that dabble in both industries like TotalEnergies (TOT) and Royal Dutch Shell (RDS.A) should benefit two-fold.
Timing is crucial -- and subject to geopolitical changes and significant turmoil. Still, if investors are feeling pain in the same vein as European consumers and businesses, energy might be a seriously important hedge.
