Why the Energy Crisis is the Midwife of Stagflation
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The energy crisis is leading to rising prices across the hydrocarbon complex and that is worrying market participants in all asset classes.
In Europe the situation is particularly acute because of the high dependence on gas imports from outside the eurozone.
But energy demand outstripping supply is a global problem right now, with no country or region exempt.
Global problem but worse in Europe and UK
In China the government has stepped in to instruct governmental agencies to do whatever it takes to secure supplies.
The country used to generate 70% of its energy from coal, but cutbacks in carbon emissions, a trade dispute with Australia, which was previously one of its largest suppliers, and the increased demand around the world as industries returns to full production, have all combined to trigger power outages for both domestic and industrial users.
The knock on effect from that means even fiercer competition for energy supplies and Europe is paying the price.
European natural gas prices rose 40% today
Gas prices for the benchmark Dutch contract rose 40% to €162/mwh, which is a record and follows a 20% hike yesterday.
The UK natural gas contract for November rose a similar amount, to 407.8p a therm at one stage, but has since dropped back to 300p.
European equity markets are taking the price shocks badly.
Stocks and gold down, bitcoin up
Euro Stoxx 50 was trading at 3970.17, down -2.34% at the time of writing. The UK’s FTSE 100 has slumped below the 7000 mark and is now at 6945 for a -1.86% drop, while Germany’s DAX index is faring even worse, down by -2.37% at 14834.55, having failed to hang on above 15000, collapsing -359 points.
Gold has been falling because rising yields makes the non-yielding asset less attractive, but has made something of a comeback, now priced at $1,759, off only 0.07% for the day.
However, bitcoin has been shining after Brazil lawmakers indicated that the digital currency will soon be made legal tender. Gary Gensler telling Congress yesterday that the SEC had no intention of banning crypto, investor George Soros saying he was now buying BTC and Bank of America initiating coverage, have all put a rocket under the price. Bitcoin is up 8% $54,223.
The reaction in the bond market is no better.
Bond yields reach near-term highs
After paring recent rises, US 10-year Treasury note bond hit a three-month high of 1.57%, although has since fallen back to 1.53%.
UK government borrowing is also becoming more expensive, with 10-year gilt yields topping 1.13% – that’s a two and half year high.
And in Germany, although yields remain negative on the 10-year bund, it is now at -0.16%, which is a four-month high.
Energy crisis: high energy prices equal higher inflation
Energy is a major contributor to inflation at the best of times but even more so now. With inflation in the US now at 5.2% and 4.1% in Germany and 3.2% in the UK, those numbers look set to only head in one direction, and that is up.
UK market expectations for inflation next year are now nudging 6%.
It is the huge price hikes in the energy sector that are really hurting as they flow through to everything else, depending on the pricing power of particular companies and industries.
Stagflation rears its ugly head when inflation remains elevated against the backdrop of stagnant production.
In the US , where the latest ADP non farm payrolls data came in stronger than expected (568k versus 428k), there are no signs yet of an economic slowdown, although the pandemic is impacting negatively as are supply chain disruptions with unprecedented shipping queues at major ports.
Energy prices are increasing in the US but at the moment the effect is being ameliorated partly by shale gas production, thereby easing its reliance on expensive imports of liquid natural gas and crude oil.
Europe is in an energy bind
However, in Europe it is a different story in terms of the impact of energy prices on production. Here, there is nowhere to hide.
Take the example of ammonia producer SKW Stickstoffwerke Piesteritz GmbH. It is an intensive consumer of energy, using 640 gigawatts of natural gas annually and is now cutting back production by 20%.
“It doesn’t make sense to make ammonia at these price levels,” said Chief Executive Officer Petr Cingr in comments to Bloomberg. “A complete production stop looms if the government doesn’t act.”
France and Spain are urging the European Union to intervene in the market. Spain and Italy rely on 80% imports for their energy. In Germany it is 70%, France 50% and the UK 40%.
Why the UK is so vulnerable on energy security
Even though the UK looks good in that list, it is in a vulnerable position because of its almost complete lack of storage capacity.
Today the British Chamber of Commerce released a survey showing that firms faced an “historic surge” in inflation.
It found that more than 60% of manufacturers and 60% of service sector companies were raising prices in the third quarter.
The BCC’s head of economics, Suren Thiru, said: “Acute supply shortages and rising raw material costs drove an historic surge in inflationary pressures in the third quarter.”
As already seen in the fertiliser business, some companies will have to shut down operations because gas and other energy prices make production uneconomic.
The UK’s problems are further compounded by the fact that a lot of energy is generated from natural gas.
Norway and the UK have just opened an interconnector for electricity. That was good news on the face of it, but much of Norway’s surplus energy came from hydro and most dams are way below the levels they would usually be at and theUK is also competing with continental Europe for the same Norwegian exports.
More and more it is looking like energy prices are the midwife of stagflation, especially where the UK economic recovery is concerned.