How To Hedge Yourself If Russia Pulls The Plug On European Gas

How To Hedge Yourself If Russia Pulls The Plug On European Gas
Reda Farran, CFA

over 1 year ago3 mins

  • Governments are increasingly worried that Russia’s gas supplies to Europe could dry up, which would hurt consumer spending and industrial output and could trigger a recession.

  • You can hedge against this risk with a long-short trade by buying renewable energy firms and selling midstream companies and energy suppliers on the short side.

  • You can structure the trade by equally weighting the long and short sides, as well as the individual stocks within each.

Governments are increasingly worried that Russia’s gas supplies to Europe could dry up, which would hurt consumer spending and industrial output and could trigger a recession.

You can hedge against this risk with a long-short trade by buying renewable energy firms and selling midstream companies and energy suppliers on the short side.

You can structure the trade by equally weighting the long and short sides, as well as the individual stocks within each.

Mentioned in story

Russia has halted the flow of gas through the Nord Stream pipeline – Europe's main gas import infrastructure – for 10 days of scheduled maintenance. But governments are nervous that the aggrieved country could take the chance to turn off the taps for good, and that it might only be a matter of time before it does the same to the other key pipelines. But while the move would have major consequences for consumers, the economy, and your portfolio, there is a way to protect yourself.

What would happen if Russia halted gas flows?

About 35% of European gas consumption comes from Russian imports, mostly via three pipelines: Yamal (via Belarus and Poland), Brotherhood (via Ukraine), and Nord Stream (under the Baltic Sea).

If Russia permanently halts flows on Nord Stream and follows up with similar moves on the other two pipelines, gas prices would spike from their already elevated levels, in turn pushing up energy bills for households and, ultimately, denting consumer spending. Germany and Italy – which are both very dependent on Russian gas – would be hit particularly hard. Goldman Sachs estimates, for example, that household energy bills in Italy would rise by 65% from today’s levels to almost €500 a month. That represents a nearly 300% increase from just two years ago.

Impact on Italian energy bills should Russian gas flows go to zero. Source: Goldman Sachs
Impact on Italian energy bills should Russian gas flows go to zero. Source: Goldman Sachs

What’s more, Goldman Sachs estimates that German and Italian gas-intensive industries – chemicals, glass, paper, steel, cement, ceramics, and so on – could produce 65% and 80% less due to a lack of affordable gas. That would directly impact industrial activity – a key contributor to the German and Italian economies.

That lethal combination of significantly reduced consumer spending and industrial output is reflective of what would happen across Europe, and it would almost certainly trigger a recession in the region. That’s likely to cause its stock markets to plunge.

How can you protect your portfolio?

You could short European stocks, sure, but the Russian gas situation isn’t the only factor that influences whether that trade proves successful.

So a better approach is to implement a trade that would profit specifically in the event that Russian gas flows are fully halted, which would offset losses in your portfolio caused by the energy crisis. You can do that by implementing a long-short energy trade: buying stocks that would benefit from a full halt in Russian gas flows and betting against those that wouldn’t, and pocketing the difference between the two.

On the long side of the trade, look toward renewable energy firms, which will only become more important in shoring up energy security. Wind and solar farms are going to become more popular with governments too: they have a deflationary effect on electricity prices, since their costs of electricity production are marginal. The big European renewable developers set to benefit include RWE, EDP Renováveis, and Acciona Energia.

As for the short trade, there are two sets of companies most at risk. First, the midstream firms that sell gas to suppliers at fixed rates: they’re contractually obliged to secure any gas shortfall in the spot market at much higher prices, and could face substantial trading losses as a result. The standout firm here is Uniper, which is already contending with this dynamic.

Second are energy suppliers: companies that sell electricity and gas directly to consumers will get hit by a combination of demand destruction and customer defaults as they raise their prices. Firms that’ll have to push through the highest price increases include EON, Engie, and Enel, located in Germany, France, and Italy respectively.

You could structure your long-short trade simply enough with equal weights across the two sides and the individual stocks themselves:

Weights
Finimize

BECOME A SMARTER INVESTOR

All the daily investing news and insights you need in one subscription.

Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

/3 Your free quarterly content is about to expire. Uncover the biggest trends and opportunities. Subscribe now for 50%. Cancel anytime.

Finimize
© Finimize Ltd. 2023. 10328011. 280 Bishopsgate, London, EC2M 4AG