What Is Causing the European Energy Crisis?! And What Stocks Or Assets To Own?
Was owning coal stocks the greatest trade of 2021? Will it continue in 2022? As we continue the decade-long energy transition it is very worth thinking about what, exactly, we will use to power our economies.
We have written about the dirtiest of fossil fuels, coal, twice in the last six months.
On June 13th and September 26th we essentially reproduced the same argument wrapped in different narrative clothing:
Because of surging re-opening economies and foolish and unnecessary energy policies, the US and Europe was facing a self-induced energy crisis with multiple profound implications.
In the most recent of the above analyses we said that while the US would pay far more for energy in the months ahead, it was really in Europe that the crunch would be felt most keenly and might create the biggest headaches.
Our old work can be found here and here in case you missed it.
Now, fast forward roughly two months and there have been two developments:
Winter has arrived (gasp!) and
Europe is on the brink of a true energy crisis.
What do we mean by crisis?
Well, while global oil prices have been coming down on fears about the Omicrom variant of Covid-19, European energy prices have continued to set records. See here:
On Tuesday of this past week, European benchmark natural gas prices (Dutch TTF) climb again above the key symbolic barrier of €100 per MWh (which translates into roughly ~$33 per mBtu or $190 per barrel of oil equivalent).
$190 a barrel of oil. Stunning. And you thought your pain-at-the-pump was real....
Some intraday prices have been even higher. Here is a representative example in Spain:
Furthermore, after a cold snap, Europe is drawing down its (smaller-than-normal) natural gas inventories faster than any time over the last 10 years.
See light blue line here:
This is going to mean A LOT of pain for European households and businesses and eventually, of course, their democratic elected governments.
Higher energy costs will mean higher inflation and lower growth. Some industrial companies are already throttling back production, European consumers will be facing steep energy bills and governments are scrambling to try and find new supplies of power.
They may struggle to find them. As incredible as it sounds, with stocks running low, little spare capacity and few other options parts of Europe may even be looking at rolling brown or even blackouts.
And the cold weather hasn't even really arrived yet.....
This is a shocking state of affairs and will have profound implications for years to come.
There are three winners, however:
Coal miners and coal based power plants
Carbon credit permits
Russia.
Coal:
On the subject of coal, while no fan of burning the commodity, we have tried to suggest that with few other options, profits for both miners and power plants will continue to pile up.
This is great for their valuations (i.e.: their price).
There is no reason to believe that this will change in the short term. Winter is just beginning, coal production can't really ramp up because of years of underinvestment and even if more is produced, then there are the usual logistics hurdles and transportation snags.
If we are forced to ship critical Beanie Babies supplies via air because of a lack of available ships, trains and trucks, then what chance does major amounts of additional coal from Wyoming or West Virginia have?
Once you decommission coal based power plants, shutter mines and restrict banks and pensions from funding more production you can be safely assured that you are artificially limiting supply and profits will continue to be outsized.
This an ideal situation for those who own coal assets or European energy assets more broadly.
Carbon Credits:
Much like their electricity prices, European carbon credit prices have reached record levels day after day as companies and power plants are forced to pay record sums to offset their emissions.
Their price reached over 80 Euros this week. That is up well over 25% in the last month and 145% (!!) this year. See here:
Not bad!
The nice thing about these assets is they are relatively uncorrelated to other risk assets. So, they can do well when others things do not.
The less nice thing is that they are difficult to buy unless you are an accredited investor like a hedge fund or a power utility or a major industrial concern.
That will change with time but for now, it is a difficult situation for retail investors.
The real challenge, moreover, will be that the above rising price does have consequences for the European economies and consumers. Putting a price on carbon means that if the price rises demonstrably then so does the cost of burning carbon!
This tension has been highlighted by many commentators (including us) but now the bill is coming due and we will find out just how tolerant European citizens (and voters!) are about greenflation and paying more real taxes now for a purely theoretical long term benefit in the future.
You know what we think about how such tradeoffs will go down......
Russia:
We saved the nastiest winner for last.
Russia's central and, some might say, pivotal role in global energy markets has been the takeaway from this ongoing crisis.
Russia supplies over 35% of Europe's natural gas (and over 50% of its gas imports) as well as a large percentage of its oil.
This role of critical supplier has combined with Europe's determination to rapidly move away from coal and nuclear and domestic natural gas power sources to increase and entrench Russia's leverage over the continent and its economy.
As a result, Vladimir Putin is riding high. And troop build ups near Ukraine and nuclear-capable bombers flying over Belarus underline how dangerous this state of affairs can be.
Here is a recent US Government slide on the topic of Ukraine:
Russia isn't just using this leverage to carry out more saber rattling and low level harassment. It is also using this opportunity to cement or even extend its influence over global energy markets:
As we touched on in September, Russia is likely holding Europe hostage over the Nord Stream II pipeline by throttling back gas supplies until the pipeline has been formally approved.
The energy kingpin is also deepening its alliance and influence over OPEC by encouraging the cartel to follow its lead when it comes to setting the available supply for global hydrocarbons.
The Kremlin is also diversifying its chief export markets. This will somewhat counterintuitively create more problems for Europe as Russia will have other options.
Russia began exporting gas to China in 2019 via a $55 billion pipeline and is currently building another. It is also presently shipping as much coal as it possibly can, to help alleviate China's own energy crisis.
Finally, Moscow is also stealing a march on the US as the key global oil producer. Its production is expected to rise strongly next year (1M barrels+ a day) while US shale oil continues to grow conservatively.
This multipolar effort, shows that Russia isn't just a brute force energy exporter but also a skilled energy diplomat, deal maker and influence peddler. That is both a new development and a worrying one.
Long term it may still be true that:
Russia's key exports are vulnerable to much less demand as the energy transition progresses.
Furthermore, relying on Chinese demand may also prove to be a long term risk as well. We may cover that in a future week.
And, lastly, it is equally possible that today's high fossil fuel prices will accelerate the shift to renewables and incentivize companies and governments and even consumers to use less energy if at all possible.
But, for the moment, it is abundantly clear that Russia is an energy superpower.
Their energy super status will only add to the thorny difficulty of dealing with a country that is daily and deeply opposed to Western democratic norms, values and institutions.
That spells real, real problems and not just for European electricity prices. The chance of greater conflict in Ukraine is incredibly high. The chance of more brinkmanship around the Baltic states and interference in European elections and policies is nearly just as high.
High energy prices is a great proxy not only for greater Russian wealth but also greater Russian mischief.
Europeans may be shivering and Americans may be angry at their gasoline bills but it is looking like a very cheerful holiday season along the icy Moskva River.
You can buy Russian state owned energy firms like Gazprom if you dare....
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