🔋In Case Of Emergency

The European energy crisis progresses with price controls, halted gas flows, and massive energy relief packages, but the situation is 'not yet an emergency'...

Sep 07, 2022

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EU seeks to 'balance the pain' from Russia sanctions – EURACTIV.com — EURACTIV

Of the topics I planned on covering when I started this newsletter, a European energy crisis wasn’t even on my radar. While I understand that not directly related to batteries, the broader topic of energy security and independence interests me and could have widespread impacts, thus being article worthy. It will most certainly affect the adoption of renewables/electric vehicles as well as general well-being/economic conditions. I have previously mentioned the sticky situation that Germany has found itself in during an article called Natural Gas Paradox. In short, fossil fuels are a vital resource and natural gas lies at the heart of Europe’s problems. In addition, I have been skeptical of the monetary/fiscal decisions of many European nations (and/or European Central Bank), because they could be divisive and inflationary despite claims to the contrary.

The latest addition to the saga is that despite soaring energy prices, Germany still plans on shutting down its remaining nuclear power plants, but with one caveat; two of them will be on standby in case of emergency. Nuclear is a clean and powerful source of energy, and still produced 11.8% of German electricity in 2021. The question begs, is Germany not already in an emergency?

Philip Oltermann @philipoltermann

Habeck: Germany’s three remaining power plants will be disconnected from the grid at the end of the year as planned but two will be kept on standby as “emergency reserves” until mid-April 2023.

In addition to what I will call a silly decision to shut off healthy functioning nuclear powerplants which have been replaced with coal power generation, the G7 nations have agreed to put a price cap on Russian gas.

Irina Slav_Energy @SlavEnergy

EC: We'll cap the price we pay for your gas. That'll show you. Gazprom: What gas?

euractiv.comLEAK: EU debates price cap on Russian gas as row with Moscow escalates

Russia responded by announcing that they will halt flows of gas. Instead of getting gas at a cheaper price, they will simply get no gas. This would hurt Russia if they did not profit heavily from the high oil/gas prices over the last year and have no other customers to replace Europe. Reality is that other countries not applying sanctions will be more than happy to buy from Russia and will get a discount.

FT Markets @FTMarkets

Russia halts gas supplies to Europe until western sanctions lifted

on.ft.comSubscribe to read | Financial TimesNews, analysis and comment from the Financial Times, the worldʼs leading global business publication

Due to the astronomically high household energy costs, various bailout programs have been instituted. Most recently, the UK will pay billions to subsidize energy costs. This program is so large that it will need to be paid for through new government credit aka money printing. Germany has also instituted relief packages which again only help in the short term while increasing government debt and the money supply concurrently.

Javier Blas @JavierBlas

The size of the UK energy bail-out is off-the charts. According to @alexwickham, on top of the £130 billion to freeze household energy bills, Liz Truss is mulling another £40 billion for small business. The ~£170 billion equals to the annual NHS budget, and it's >5% of GDP

Holger Zschaepitz @Schuldensuehner

Good Morning from Germany where the coalition govt agrees €40bn consumer relief package to mitigate the energy price spike. This is already the 3rd relief package this year. The previous packages had a total volume of ~€30bn.

It is a safe bet that even more stimulus to bailout companies and households will come because energy margin calls have increased substantially. This means companies/utilities with a debt service or obligation and cannot pay it. They either go bankrupt, are penalized heavily, or bailed out by the government.

Christophe Barraud🛢🐳 @C_Barraud

🇪🇺 #ENERGY MARGIN CALLS SEEN TOTALING AT LEAST $1.5 TRILLION - BBG *European energy trading risks grinding to a halt unless governments extend liquidity to cover margin calls of at least $1.5 trillion, according to Norwegian energy company Equinor ASA.

Thoughts

Europe is in a tough spot, and many people are suffering because of it. I do not intend to write at the expense of these people, but instead point out the government decisions that largely got them there and continue to hurt them. For example, price caps tend to lower supply, making further prices increases inevitable. In this case, Russia decided to cut off the gas completely. This is a scenario where we will see who truly holds the cards. Will Russia concede and send gas to Europe at a discount, or will Europe struggle to find the energy it needs while Russia sells to other willing buyers? I tend to think the latter is the case, making Germany’s guidance on nuclear even more puzzling. The irony is not lost in that they don’t believe their situation is an emergency. In addition, OPEC+ announced they will be decreasing the amount of oil/gas production, meaning that the next largest producer won’t be able to save Europe, but quite the contrary.

Secondly, printing money to subsidize energy costs will help households in the short term, but likely not work in the long term. Whenever the government prints money to pay for something, it is a redistributive effect, by debasing the currency and bringing productive value from the future into the present. This is like kicking the can down the road and will likely cause more inflation and debt issues in the future. Honestly, with the high debt in Europe as it is, it is a question of how much longer some of these countries can even kick the can of a sovereign debt default down the road and how many times the European Central Bank (ECB) can bail them out without collapse or destabilization of the EU. These relief packages are huge and no trivial matter. This idea is reflected in the relative value of the currencies. Compared to US which has reserve currency, is raising interest rates more than the ECB, and has a stronger energy position, the Euro has been declining at an accelerated rate since May. While due to multiple factors, the relative debasement of the Euro relative to the dollar plays a role and will continue to into the future. The ECB has instituted bond purchase programs which I discussed before, as well as these new energy bailouts by numerous nations which all will contribute to a further weakening of the Euro. This chart shows price of a Euro compared to the price of a dollar. For the first time since 2002, one Euro is worth less than one dollar. With the decisions and policies right now, it is difficult to see this downtrend reversing in the near future.

Third, high energy prices have caused margin calls to increase. As more companies and funds face solvency issues it is not good for markets or the economy. A recent report showed that 60% of British companies face bankruptcy risk. Any existing or new company is currently struggling to generate income or find funding. Since operation costs eat into or destroy the profit margin, many companies have to turn to funding with debt. With tighter monetary conditions and raising interest rates (ECB raised interest rates for the first time in ~10years, only up to 0%), it is more difficult and more expensive to take on more debt. With no profit margin, it becomes impossible to pay the debt payments on the loans.

Growth & Value @Growth_Value_

60% of 🇬🇧 companies face bankruptcy risks. 60%! Soaring energy bills are threatening to put six in 10 British manufacturers out of business, according to a survey that lays bare the extent of the crisis facing the next prime minister bloomberg.com/news/articles/… via @business

bloomberg.comBloomberg - Are you a robot?

These insolvency risks plague much of Europe and will eventually even plague the US who is in an even stronger position. I think this because the Federal Reserve and ECB do not have a track record of raising interest rates successfully. When they do, they tend to ‘break’ something in the markets and have to supply liquidity via quantitative easing and lower interest rates again. It is only a matter of time before these conditions are met in my opinion. The problem is that Europe is already supplying liquidity, will likely do more, and hasn’t even gotten rates above 0% (and yes that shouldn’t make much sense).

I don’t mean to be all doom and gloom, but the reality is that industry depends on energy prices and macroeconomic conditions. Even profitability/solvency/funding for battery production and raw material extraction will be affected by the conditions we have and the conditions we may face going forward. It is my view that Europe is not in the position of energy security and geopolitical leverage it seems they think they are in by their policy decisions. It is more likely to me that they struggle to find energy they need, businesses go bankrupt/are bailed out, and some nations face solvency risks on the sovereign debt level scale at some point. Until next week,

-Grayson

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