Inside the Global Energy Price Spike

In the energy crunch heard ’round the world, households and businesses reliant on oil and gas are scrambling, driving financial commentators we follow to warn of impending calamity from the UK to China as oil hits a seven-year high.^[i] Coverage we read warns shortages and price spikes will hurt households, raise businesses’ costs and compound global supply-chain dysfunction as factories slash output. We don’t doubt many will feel a pinch, yet we also think a little perspective is in order. Whilst it may take time to iron out production wrinkles and shortages, in the 3 to 30 month timeframe we think forward-looking markets evaluate, the winter fuel chaos commentators hype doesn’t appear likely to tank global growth—or markets.

What is behind the global energy crunch? Regional factors, based on our analysis. China appears to have banned Australian coal imports over a geopolitical spat, whilst it has also been trying to cut its coal dependence generally.^[ii] Last year, China became the world’s largest liquid natural gas (LNG) importer.^[iii] But switching to gas-fired electrical generation hasn’t been smooth. China’s government caps electricity prices, so utilities couldn’t pass rising costs to consumers.^[iv] Spiking wholesale power prices force them to operate at a loss, so many cut output, sparking blackouts.

In the UK and much of Europe, weak wind power generation has also driven up demand for gas, which smaller utilities struggled to manage, leading to outages.^[v] Adding to the crunch: low reserves, as Russian gas export curbs have depleted inventories to decade-low levels.^[vi] Dutch near-term gas futures, the European benchmark, quintupled to a record-high €100 per megawatt hour last Thursday from €20 in April.^[vii] This appears to be having knock-on effects globally. In the US, natural gas prices more than doubled from $2.43 (£1.79) per million British thermal units in April to $6.31 (£4.65).^[viii] Except for intermittent spikes associated with brief supply disruptions, like a February cold snap that literally froze natural gas production amidst surging demand, prices are at their highest in more than a decade.^[ix]

In response to gas shortages, utilities globally are ramping up oil-fired power plants where they can, driving demand for crude higher.^[x] Brent oil prices jumped from $65 a barrel in August to $83 today, flirting with new highs last seen before crude’s late-2014 collapse.^[xi] There is also the UK’s petrol shortage, which is more accurately a shortage of lorry drivers, but the result—panic buying and long lines at filling stations—is the same, and it triggered a sentiment plunge.^[xii]

With global energy prices spiking, analysts warn of demand destruction and factory closures, whilst some economists suggest stagflation akin to the 1970s’ energy shocks awaits.^[xiii] Many commentators we follow suggest this could cause markets to crash.^[xiv] Take a step back, though, and let us put such dire prognostications in context.

Efforts to alleviate energy shortages: From a high level, economic theory holds that prices can act as a signal for production, consumption and distribution. In this way, we think global markets function as a coordinating mechanism to direct resources where needed, allowing households and businesses to adapt—though it isn’t always immediate, as this year’s port backups and supply-chain issues attest. But in our experience, markets are usually pretty efficient at organising global production—and longer-term growth.

According to our research, producers and consumers are starting to respond to the higher prices. Whilst Russia’s gas flows to Europe have reportedly dwindled along some pipelines—through Poland and Ukraine—alarming many, they seem to be picking up in pipelines through Turkey and Hungary.^[xv] Some think Russia is rerouting supplies to pressure German authorities into opening the just-completed Nord Stream 2 pipeline running from Russia to Germany under the Baltic Sea, which could double gas flows to Europe.^[xvi]

Qatar, a world LNG export leader, is lining up contracts and boosting production accordingly—with longer-term plans to expand capacity greatly.^[xvii] However, like container shipping generally, it is seeing long tanker backups, too.^[xviii] Algeria, a key supplier to Southern Europe, is also ramping up production, although a spat with Morocco is complicating matters presently.^[xix] Last, but not least, American gas exports—second after Russia’s—are hovering near record highs. (Exhibit 1) The US Energy Information Administration (EIA) expects natural gas exports to smash 2020’s record by 27% this year.^[xx]

Exhibit 1: US Natural Gas Exports

Source: EIA, as of 30/9/2021. US natural gas pipeline and LNG exports, January 2014 – July 2021, and EIA forecasts, August 2021 – December 2022.

Meanwhile, China’s government has ordered its coal miners to produce as much as possible, even if it exceeds their annual quotas, and directed its banks to fund the expansion—all to keep power plants operating.^[xxi] The Chinese government is also securing oil contracts to meet its energy needs—which America’s shale producers and the Organisation of Petroleum Exporting Countries and its partners (OPEC+) stand ready to supply.^[xxii] Monday, OPEC+ confirmed its plan to raise its oil output by 400,000 barrels per day in November.^[xxiii] Then, too, in Europe, data from WindEurope suggest stronger wind generation is starting to alleviate pressure.^[xxiv] Hence, Monday’s European wholesale spot power prices fell more than -11% as rising wind supply forecasts swept the Continent.^[xxv] It is a short-term trend thus far, but it could help price pressures abate if it persists. Longer range, Germany has plans to shutter existing coal and nuclear capacity, but it could delay them.^[xxvi] As for the UK, it is hiring drivers, raising pay packages and luring people from other industries (e.g., the army) and countries like Romania, where tax levies there are driving truckers away.^[xxvii]

Still, on top of existing worldwide transportation bottlenecks, the energy situation isn’t great, in our view. To the extent policymakers enact subsidies for households, they could lessen normal demand destruction. But we think there are positive and negative aspects to that. Whilst it may make winter heating more affordable, by itself, it wouldn’t do anything to address shortages—and could exacerbate supply problems. Overall though, whilst production issues will likely take time to work out, in our experience, they usually resolve before too long given the strong incentives to fix them. In short, yes, we think a severe energy crunch would be cause for concern, but we don’t think it rises to an insurmountable crisis as producers and consumers alike respond and adjust to circumstances. Besides, how long it lasts is vital, in our view. If short lived, we think any economic impact would probably be quite small.

We think markets are well aware of the situation. For investors, oil and gas price spikes don’t appear to be sneaking up on markets, which we think are pricing in events and expectations swiftly. The MSCI World Energy sector surged 11.62% in September, whilst all other sectors except Financials fell.^[xxviii] More adjustment may be in store, and volatility can strike for any or no reason. But by the same token, we don’t think it is beneficial generally to react to short-term moves—volatility can end just as swiftly.

Now, energy price spikes have preceded recessions and bear markets (typically a lasting decline exceeding -20% with an identifiable cause) before, so we aren’t dismissing their economic and financial effects out of hand.^[xxix] Although most companies have been able to work—and expand—through supply-chain troubles thus far this year, chronic power outages may be another matter.^[xxx] However, for this to sink markets, in our view, it would have to be longer lasting and more widespread than anyone currently thinks, particularly with developed nations getting more energy-efficient over time, according to our research. Whilst we are keenly on the lookout for this potential, we don’t think it is likely at this point.