Europe is in the middle of an unprecedented crisis as a consequence of a series of wrong decisions taken in the last years and accelerated by the Russian invasion of Ukraine.
We believe that a major difference between this crisis to the Great Financial Crisis back in 2008 is that Europe is much more damaged than its main peers. The absolute failure of its energy policies and the lack of planning has left the continent without a secure energy supply. The implications are massive, as Europeans advance to a period of loss of purchase power as it has never happened in our lifetime and the status quo of the EU in the world is under threat.
We should remember that throughout history, any civilization has needed energy to thrive. Europe took its energy security for granted and made the catastrophic mistake of outsourcing >80% of its energy needs. Now, it is harvesting the results of giving away its energy independence.
How has Europe arrived at this situation with natural gas?
Europe uses a marginal-cost electricity system. It means that the final energy cost is the one paid for the last incremental unit of energy at that time. It means that if demand cannot be matched with renewable and nuclear energy, we have to burn fossil fuels. The price of the latter (more expensive) settles the total cost of energy used
Europe consumes around 400 Bcm per year (403 in 2021) and produces only 15% of it. Consequently, we are very reliant on imports to meet our energy demand.
The vast majority of these imports arrive by pipelines, from Russia (43%), Norway (21%), Algeria (8%) and Qatar (5%). However, the war in Ukraine has changed these figures. The EU is diminishing the weight of Russia and importing more LNG (mainly from the US). However, it is buying this LNG at a much more elevated cost due to the fact that Europe has to compete for these shipments paying more than Asia and other regions.
Nevertheless, as we pointed out at the beginning, apart from the war in Ukraine and the consequent EU sanction over Russia, there are some other factors that were already poking out way before the conflict: (EU energy policies, ESG management and lack of investment).
- EU energy policies have been focused on powering the adoption of renewable energy. This is necessary to diminish CO2 emissions. The problem is the evident lack of understanding that the policymakers have shown about how the energy network works. They spent billions of € when the technology was not developed enough at the beginning of the century. And in the last years, they have been closing nuclear plants and disincentivising the investment in natural gas. For obvious reasons, and until efficient storage is not developed, renewable energy is so vulnerable that it needs other types of energy connected permanently to the network.
- ESG movement has forced Oil & Gas majors to significantly reduce their traditional hydrocarbon investment in Europe. Moreover, several European countries have banned natural gas extraction, and the vast majority have increased their taxes substantially in the last few years.
What are the consequences of the lack of natural gas in Europe?
The most obvious effect is the rise in electricity prices. As the scale of this rise is unprecedented, it is hurting businesses severely across Europe. Especially, the heavy industries which consume a lot of natural gas. A high number of
Europe will need to import products that it used to produce. This is because
Another predictable consequence is that the ECB will re-start (have they even stopped?) the printing of money to help companies and citizens.
Both the deficit in trade balance and the potential QE entail the Euro to crater, as has been happening in the last months. Our thought is that as we are not even in wintertime, it is probable that this trend continues in the next six months.
However, other countries are also impacted by the European Energy crisis. Emerging countries are getting the worst part of it. Contrary
Another country impacted by the surge in gas prices is the US, which is the one selling the vast majority of the LNG. North America’s natural gas production got a boost in the last decade thanks to fracking. Nevertheless, the best days of fracking are far behind, and the US cannot raise its natural gas production significantly. Consequently, the exports have become a significant part of its production, impacting the Henry Hub price that has trebled from its historic average.
How can Europe go through this?
Europe needs more natural gas supply, but it cannot be achieved from one day to the next.
In the immediate term, there is no alternative to reducing consumption and paying astronomical prices to get LNG (Asia is the typical buyer of LNG, so Europe needs to pay more than Japan, China or South Korea,… to get the LNG)
In the short term and medium term, Europe needs to:
- Levy the laws that several countries have to ban the extraction of natural gas
- Emit new licenses to produce more natural gas in the North Sea
- Sanction new projects in West Africa and develop the infrastructure they needed
- Sign long-term contracts with Qatar (the main exporter of natural gas) which is building a new liquefication capacity and will be ready in 2025
- Review the net zero strategy having into account that it can only be achieved if renewable energy is introduced step by step and with the support of energies such as natural gas and nuclear.
The European natural gas situation from our investment perspective
Our base scenario is a mild winter (natural gas demand is mainly driven by weather) and elevated gas prices for the next 2-3 years (it does not mean the level of prices we have seen so far, and we probably see this winter).
Consequently, as we expressed in this article, the European trade balance and the M2 money supply are going to be impacted in the coming months, making the €uro weak against its peers (mainly against the US dollar -the reserve currency- as other economies are also being impacted).
In case of having a cold winter, the scenario would be exponentially worse. The natural gas capacity in the EU is around 85% filled. However, storage only covers around 15% of European demand and the storage system is designed to receive a continued natural gas flow. Therefore, if we have a cold winter, there is a real possibility of paying anything for an LNG shipment.
We would avoid industrial companies in Europe and minimise the rest of the European exposition as they will suffer the impact on the purchasing power of European citizens.
In summary, we stick to the trade we have been following this year. Long European natural gas & Short Euro. Although it will not be exempted from high volatility. A
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