🔋Year Of Pain

2023 will not see the return of cheap energy as we knew it for the last decade unless it is in the form of a recession; neither being a positive for the current energy transition.

Dec 14, 2022

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Jerome Powell speaks at a Fed meeting — **Lowering inflation will ‘bring some pain’ to Americans through lost jobs and smaller raises, Powell says.** Business Insider

Recession 2023™

As we head into the new year, recession seems to be the expectation among a lot of people. No doubt rate hikes and economic activity seems to be slowing, but a contrarian indicator is when most people are saying one thing, something else tends to happen. Recession in the US would involve slowing GDP like we saw in the first half of 2022 combined with an increase in unemployment rate which we have not seen yet. In Crude Awakening pt. 3, I mention that it takes time for the rate hiking cycle to “kick in” and curb demand enough that employers have to start laying off people in earnest which is a reason we have yet to see the unemployment rate rise. Nixon is famous for saying as politicians they can take inflation, but they can’t take unemployment. This gives some insight into the decision making behind politicians, as they can manage inflation to some extent, but it’s a different story once people start losing their jobs. In that article I said,

They (federal reserve) have implied that there will be “pain” and they will do whatever it takes to reign in inflation. Once the interest rate hiking cycle begins, unemployment rate tends to tick up 1-3 years later which is an unfavorable environment politically as well.

Let’s dig deeper and study the last four rate hiking cycles. As seen below, it took on average 30 months (19-39 range) from the beginning of the Fed rate hiking cycle until the unemployment rate started aggressively moving higher. The current rate hiking cycle started in March 2022, putting the unemployment spike somewhere between October 2023 and August 2024. We have seen the start as many tech companies have started layoffs, but it has mostly been in this specific sector. Based on the inflationary 1970s and late 1960s, a similar time frame can be deduced. These three hiking cycles had a time delay of 26 months until unemployment picked up, similar to the above number.

Another famously successful recession indicator is to look at the yield curve which inverted in late October and has since reached the deepest level in history. Below is the S&P500 or stock market. After taking the difference between the 10-year treasury yield and the 3-month treasury yield and placing a black vertical line at the onset of the yield curve inversion we get the figure below. In the past, it has taken an average of 8 months (2-13 month range) before the top in stocks and the bear market begins. It is a similar time frame for that and unemployment increasing as well. 8 months from the inversion would put us around June 2023. It is worth noting that in the past few cycles the market was still going higher. Now we are in what looks like a bear market already. Combine this with inflation and a Fed committed to higher interest rates and we could have a different environment.

Based on these powerful indicators, a recession could be in the cards for roughly the second half of 2023 or the first half of 2024. There is also a case that there is plenty of time between now and then for the market to go up. Plenty could happen that could send the markets in either direction, I don’t pretend to have a definitive answer. I just like to get an idea of timeframes as it’s easy to get caught up in what is being said and think everything will occur tomorrow.

There are nearly infinite things that could cause swings in the market including GDP numbers, corporate earnings, geopolitics, financial market stability, and more. What we can do is have a pretty good idea of the large scale events and when they may occur on long time horizons. What could this mean for energy, batteries, and renewable energy?

Natural Resources

With higher interest rates and quantitative tightening (reducing money supply) in earnest as the dominant policy around the world, investment in just about everything is stifled in this environment. Mining of natural resources is one of those areas. Typically natural resources go through a cyclical investment cycle to begin with, and it’s not given favors when it is hard to find funding for projects.

Right now the world is demanding resources like never before, but we cannot supply it, thus inflation ensues. From energy to consumer goods, this has been the case. Not ruling out a recession which can bring about deflation in the short/medium term, long-term prospects for supply of many key resources look tight. On the battery side, there is lithium, graphite, and copper of just the ones I have covered prior. Renewable energy faces similar challenges. Oil experts suggest that the supply side is tight in that space as well. Even food and agricultural commodities could have supply issues in the coming years.

Cheap credit fueled the shale revolution which got us in the US addicted to the cheap energy on the margin. Now, without the growing shale oil and gas in the US, Russia being cut off from much of the world market, and OPEC unable/unwilling to make up the demanded oil, energy isn’t as cheap as it was for the last decade.

Energy was a dominant factor in lowering the cost of renewables and batteries. People tend to extrapolate the downtrend in prices and hope that 2022 was just an anomaly caused by Russia and supply chain factors. As such, renewables will provide cheap energy into the future in this view. My view is that this is largely not the case. While a demand side recession could lower prices in the short-medium term, the supply side needs to get solved for the real long-term issues to be solved. This means that renewables will not be able to structurally return to the pre-2022 input costs they got used to.

Low interest rates and subsidies fueled the shale boom and renewables, but this is not the environment we are in entering 2023. In an environment without such help, the world is a different place. Most I fear do not understand the importance of scarcity in our world of abundance we’ve grown accustomed. Without cheap energy and without cheap capital to invest, the supply side equations are even less likely to be solved, which is a bad place if you want more renewables or any field that relies on growing amounts of natural resources. Less investment into mining and processing means less wind turbines and solar panels.

Realistically anything could happen in 2023 including stocks go higher and we “avoid” recession at least for a while. Realistically something in the credit markets breaks and causes the Federal Reserve to step in and save the market with quantitative easing or lowering interest rates. Whether this happens second half of 2023 or later and how the employment picture changes I don’t pretend to know for certain, but it is not a conducive environment for inflation or the investment into the necessary resources for the energy transition in the long run. Until next week,

-Grayson

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