Art Berman Newsletter: September 2022 (2022-8)

The world is in energy shock and as a result, it is becoming less energy blind.

Last week, French President Emmanuel Macron stated,

“What we are currently living through is a kind of major tipping point or a great upheaval … we are living the end of what could have seemed an era of abundance…the end of the abundance of products of technologies that seemed always available.”

Even Fox News’ Tucker Carlson commented in an op-ed titled “Back to the Dark Ages” that “Europe is descending into poverty…Why is this happening?…There is an energy shortage in Europe. Cheap energy is essential…but Europe no longer has it and as a result, things are falling apart very quickly.”

None of this is new but public awareness of the crucial role of energy in our civilization is becoming more widespread. Energy price has become so high that everyone is now much more energy-aware.

For example, the price of Brent crude oil increased 108% from 2020 through the end of 2021 (Figure 1). European imported coal increased 421%; German electric power, 518%; European natural gas, 765%; and Asian spot LNG, 957%. That was before the Russian invasion of Ukraine.

Since then, U.K. natural gas futures price has increased +$99.86 (+574%) from $17.41 to $117.27 per mmBtu just since June 8 (Figure 2).

European coal futures price (Rotterdam) has increased +$279 (+270%) since November 21 from $104 to $389 per metric ton (Figure 3).

These figures show that the energy crisis did not begin with Russia’s invasion of Ukraine. Instead, the invasion worsened an already bad situation.

Oil markets are a bellwether and Brent futures prices anticipated the Ukraine invasion three months in advance. Price increased $58 (+84%) from $70 to $128 from early December 2021 to early March 2022. Unlike natural gas and coal prices, however, it has since fallen to $96 per barrel since early June (Figure 4).

Does that mean that the energy crisis is ending? I doubt it. More than anything, it reflects the relatively lower urgency that Europeans feel for oil than they do for coal and natural gas.  Oil price is a major factor that adds to the cost of everything but coal and natural gas are vital for Europe to survive the upcoming winter heating season.

Broader markets also reflect the disruption in the energy sector. Inflation reached a 40-year high in June 2022. Sharply higher energy prices were crucial but government monetary policy was also important.

In response to the Covid pandemic, governments increased money supplies to new extremes. In the U.S., year-over-year M2 money supply growth reached 27% in February 2021—more than twice any previous increase (Figure 5). By June 2022, U.S. inflation rate was 9 percent, the highest rate since November 1981.

The stunning decrease in money supply growth to 5% by July 2022 makes recession likely. Falling oil prices probably reflect demand destruction and fears of economic contraction but other fuel prices remain elevated.

My friend and colleague Nate Hagens recently noted that

“Our culture is becoming less energy-blind by the day. Europe is almost completely energy-aware. Right now, electricity…for next year’s forward prices is between 600 and 750 Euros per megawatt which is in contrast to 40 or 50 Euros per megawatt in the last few years…One in six American households are behind on their utility bills…Unless things change in the next few months, Europe is committing economic suicide.”

It is suicide because governments will have to subsidize the growing cost of energy for the public in order to hold civil society together.  This is happening at a time of economic contraction, high inflation and rising interest rates. That means increased and unproductive debt at a time that states cannot afford its service except with more debt.

Macron’s comments about the end of abundance do not mean that the world is running out of energy. The problem is decreased supply because of policies resulting from the Ukraine War. This is a geopolitical outage on a grand scale and as such, it is temporary. That does not help Europeans with the coming winter or the cascade of consequences from the shortage. Nor will the damage be confined to Europe.

At the same time, it is also about longer-standing policies that sought to accelerate the energy transition away from fossil fuels and nuclear power to renewable energy.

Holman Jenkins wrote this week in The Wall Street Journal that

“Undiluted corruption drove Germany’s choice to rely excessively on natural gas as a power source, dumping its coal and nuclear plants…It only needed to stop, at every step, lending itself to the enhancement of Russia’s energy power. But it was more important at the time to serve up to German voters magical talk of an “energy transition.”

Now, renewable advocates say the problem is that Europe didn’t make the energy transition away from fossil fuels fast enough. Nuclear supporters relentlessly parade the chimera of safer technology that will uniquely save the world from energy shortages.

Both camps ignore the larger problem that both renewable and nuclear energy are mostly sources of electric power. Electric power only accounts for about 18% of the world’s primary energy consumption.

Figure 6 shows IEA’s forecast for energy supply from 2020 through 2050. It includes the spectrum of uses for wind, solar and nuclear energy beyond power generation. Renewable energy is expected to account for 10% of world energy supply in 2050 and nuclear for about 6%. Fossil energy is projected to account for 66% of total supply.

These are only projections but IEA is strongly pro-renewable energy. Double their forecasts for renewable and nuclear and it is still unlikely that these energy sources will solve the world’s energy problems in the next 25 years or so.

Figure 6. IEA expects solar & wind energy expected to account for 10% of world energy supply in 2050 and nuclear expected to account for 6%. Fossil energy projected to account for 66% of total energy supply in 2050. Source: IEA & Labyrinth Consulting Services, Inc.

The New World Order

Saudi Prince Abdulaziz bin Salman (ABS) said last week that OPEC+ may need to cut oil production. This may be necessary, he said, to correct problems in the market because “the paper and physical markets have become increasingly more disconnected.”

This is rhetorical theater. It has no real basis is fact. But that’s not what is really going on. This is about the second Cold War to create a new world order.

It should be obvious by now that Russia’s war in Ukraine is about much more than territorial expansion. Ukraine is the staging ground for a larger conflict between states who are dissatisfied with the present world order versus those that are more-or-less satisfied. We only need to look at the countries that continue to buy Russian oil and cooperate with Russia on oil: China, India, Saudi Arabia and the rest of OPEC including Venezuela, Mexico, Kazakhstan, Azerbaijan, Malaysia, Sudan, South Sudan, Oman, Brunei and Bahrain.

Credit Suisse’s Zoltan Pozsar wrote a fascinating post about this in which he identifies the TRICKs bloc of nations—Turkey, Russia, Iran, China, and North Korea—an alliance of economies sanctioned by the U.S. getting ever closer economically and militarily.

Chinese and Russian naval exercises with Iran earlier this year, talks in July between Russia and Turkey hosted by Iran, and joint military drills yesterday between India, China and Russia seem to support his position that the U.S. hegemon is being challenged more openly than it has since the Cold War ended.

“Today, we are witnessing the implosion of the long-intermediation chains of the globalized world order: masks, baby formula, chips, missiles, and artillery shells, for now. The triggers aren’t a lack of liquidity and capital in the banking and shadow banking systems, but a lack of inventory and protection in the globalized production system, in which we design at home and manage from home, but source, produce, and ship everything from abroad, where commodities, factories, and fleets of ships are dominated by states– Russia and China– that are in conflict with the West.”
–Zoltan Pozsar, Credit Suisse

Today, the world has begun the descending arc of the Oil Age. Europe’s energy crisis, the war in Ukraine, and escalation of U.S. – Chinese tensions over Taiwan are all part of a struggle to dominate remaining fossil resources as well as new energy sources.

The effects of the COVID pandemic are far from over despite expectations to the contrary. The most profound and widespread global economic disruption in nearly a century has not magically disappeared. It has forever changed the way we work and communicate. It has restructured the world’s trade connections and has greatly reduced the on-demand supply of energy. The lingering effects of the virus and its persistent outbreaks have weakened the global workforce and overall productivity, possibly for decades to come.

Putin was mindful of all of this when he chose to invade Ukraine in February.

The world is in energy shock. That seems to be awakening people from the big sleep of energy blindness. A major economic contraction seems inevitable. The world order that has existed since the end of World War II is ending. It’s a lot to take in.

Oil markets are a bellwether for global changes and oil prices are moving sharply downward. Politicians, analysts and economists will beat the drum of a return to normality. Well-intentioned thinkers will offer solutions based on a dying paradigm.

I have no idea what the future state of things will be like but I know that energy will be at its center.