Will the Russian Invasion Hold Back the Fed’s Tightening?

With markets tumbling worldwide this morning as Russia invades Ukraine, it’s unclear how aggressive the Federal Reserve will be with its planned rate-raising regimen.

When the Federal Reserve’s policymaking panel meets March 15-16, the futures market has been giving almost even chances of an interest rate increase of 0.5 percentage points.

In light of the war roiling Ukraine, such a dramatic increase—meant to curb rapid inflation—seems less likely. “The Federal Reserve was very unlikely to do a 50 basis point rate hike for liftoff at its March meeting anyway, but the Russia/Ukraine cements liftoff to, at most, 25 basis points,” said Jamie Cox, managing partner for Harris Financial Group.

As always, the Fed must walk a fine line between tamping down inflation and hindering economic growth.

For more stories like this, sign up for the CIO Alert newsletter. 

The full scale of the war’s impact on the US economy remains to be seen. Like what will happen to oil? If Russia’s exports of crude are curbed, that would limit the amount available globally. And of course, the price would rise enormously, slicing consumers’ spending power, in a time that high inflation already is cutting into it.

Russia, the world’s third-largest oil producer (after the Saudi Arabia and the US), provides 10% of the world’s crude and is the major supplier of it to Europe (ditto for natural gas, according to the US Energy Information Administration).

This morning, oil prices surged toward $100, up $5.80, as the S&P 500 opened with a 1.7% slide.

CIO-022422 OSC-Capital Spending2-Green oil companies_Georgie McAusland-web

Art by Georgie McAusland

Hope seems to be stronger than ever in shareholder activism circles right now. Just last June, a shocking power struggle between a small hedge fund called Engine No. 1 and ExxonMobil led to the replacement of three board members at the oil and gas company with new appointees who have environmental, social, and governance-friendly agendas.

Large pension funds, which often face strong pressure from the public to divest from fossil fuels, were key to this effort. But while dramatic board changes and public net-zero pledges make for great headlines, what is happening behind the scenes? Are the oil giants really taking steps to reduce their emissions?

Jessica Green, an associate professor of political science at the University of Toronto who studies fossil fuel companies, said the results aren’t as promising as one might hope.

“None of these companies has abandoned the idea that they are fossil fuel companies, and that they will continue to be fossil fuel companies well into the future,” Green said.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

Green and her colleagues conducted a study where they looked at oil and gas firm data from 2004 to 2019 and examined both the political behavior and business behavior of the companies.

“We looked at their emissions, their improvements in efficiency, how much upstream exploration they’re doing, and whether or not they’re trying to shift their core competencies away from extraction and combustion,” she said.

What they found was that while most oil and gas companies had made a public shift in how they talked about climate change, their business behavior did not show any significant moves away from fossil fuels and toward decarbonization.

“No single oil and gas firm [in the study] had invested more than 0.1% of revenues into renewable energy,” Green said.

Nevertheless, there were significant political changes. Major oil companies became more supportive of international standards such as the Paris Agreement and carbon capture technologies. They no longer publicly deny the existence of climate change like they once did.

As for the age-old debate of shareholder activism versus divestment, Green had this to say: “Both are helpful. And a lot of that has to do with changes in the culture within companies. But, ultimately, we’re going to need governments to really help us meet the goal of the Paris Agreement.”

However, there is one example of a fossil fuel company that successfully transitioned into becoming a renewable energy company. The Danish energy firm Ørsted, formerly an oil and gas company, now produces 90% of its energy from renewable sources. That’s a dramatic change from just 14 years ago, when 85% of its energy was generated by coal.

In a 2020 interview with McKinsey, Martin Neubert, the CEO of Ørsted’s offshore wind business, said the transition was not without difficulty. Many executives were skeptical of renewables.

“There was internal pressure to keep DONG Energy [now called Ørsted] the same,” he said. “It wasn’t unexpected, because we had spent three decades turning the company into a traditional fossil fuel company.”

He told McKinsey that the company was only able to transition due to a combination of both significant social pressures and financial incentives lining up properly. Around 2012, gas prices began to drop in the United States, leading to a huge surplus of American coal. This coal ultimately ended up in Europe, making things financially difficult for Ørsted. That financial reality made it easier for the company to shift to renewable energy, he said.

Many academics like Green are still skeptical that other fossil fuel giants can make a similar transition to Ørsted. Nevertheless, its transformation provides a glimpse into what’s possible if the incentives are right.