It’s not a stretch (at all) to suggest Europe is currently facing the most onerous economic outlook in modern history, including the sovereign debt crisis.
Although there was good news this week on progress towards meeting gas storage goals ahead of what could be a harrowing winter, the threat of additional supply curbs (as Gazprom fights the Kremlin’s economic war) is ever present. Three days of maintenance to the Nord Stream, starting Wednesday, is a stark, if superfluous, reminder that flows can cease at any time.
On Tuesday, Gazprom cited contract disputes in telling France’s Engie that gas deliveries will be reduced, starting immediately. “Engie had already secured the volumes necessary to meet its commitments towards its customers and its own requirements, and put in place several measures to significantly reduce any direct financial and physical impacts that could result from an interruption to gas supplies by Gazprom,” the utility said. France’s gas reserves are 90% full. Assuming an average winter, that should suffice.
Nevertheless, the situation remains urgent. Prime Minister Elisabeth Borne on Monday instructed businesses to “stop any energy consumption that isn’t indispensable immediately” or risk “brutal gas outages overnight and serious economic and social consequences” during the winter months. Companies, she warned, “would be the first hit” should rationing be necessary.
Alongside progress on storage targets, news that Europe plans to wade into the market with price caps and a plan to de-link gas and electricity costs prompted large declines across the European energy complex early this week (figure below), a welcome development on the heels of a parabolic ascent. Power prices rose on a 90-degree angle this month.
In a testament to the scope of the crisis, more than a quarter trillion euros is already set aside for aid to businesses and citizens across the EU. Those measures, from tax cuts to subsidies, may help, but they’re palliatives. As Ursula von der Leyen made clear, the entire market needs to be overhauled. “Skyrocketing electricity prices are now exposing the limitations of our current market design,” she said. “It was developed for different circumstances [which is] why we are now working on an emergency intervention and a structural reform.”
Of course, the root problem is dependency on Russian supplies, something von der Leyen readily conceded. “Ending our dependency on Russia fossil fuels is step one,” she remarked. After discussing a proposal for price caps in Prague this week, Olaf Scholz said markets are broken. Prices “aren’t a real reflection of supply and demand,” he told reporters.
In a recent report, Morgan Stanley said demand destruction is key. “If our demand assumptions materialize, inventories are likely to be sufficient this winter and this will probably also be true if Nord Stream flows fall to zero, although an extended outage through all of 2023 would make for a very tight winter 2023/24,” Martijn Rats and Amy Sergeant wrote, cautioning that “we only arrive at this result because our demand assumptions are sufficiently low.” The bank models a 15% reduction commensurate with EU member commitments.
The bank projects industrial gas demand will drop 23%, a tall order. During COVID, it fell just 11%. “Also, whether households can or will indeed reduce consumption as per our current best estimate is an open question,” Rats and Sergeant went on to say. “We will only know the answer probably by mid-October and historically, natural gas demand has fluctuated in narrow ranges and is not so easily destroyed.”
In a new note, Goldman said euro area inflation is likely to top 10% later this year, and could go higher if gas prices don’t come down materially. In a worst-case scenario, there could be “a large consumer drag during the winter months.” The preliminary read on CPI for August is due Wednesday.
“We are encouraged that Germany and Italy have met their gas storage targets earlier than expected and that production cuts so far look limited, likely reflecting significant switching from gas to oil [but] the recent surge in gas prices and subdued flows of Russian gas points to a sizable growth drag ahead,” analysts including Sven Jari Stehn and Steffan Ball wrote. “The sharp reduction in gas demand — with German consumption now down almost a quarter relative to its five-year average — is likely to entail substantial production cuts in coming months despite significant oil-gas substitution.”
For now, Goldman is “comfortable” with a house forecast for a “mild” European recession, but conceded “the downturn could be deeper and longer in case of further gas supply disruptions.”
All of this as the ECB leans almost uniformly hawkish. The notion that rate hikes will be effective at curbing inflation is highly questionable in an environment where the supply distortions are historic and some demand destruction is assured irrespective of monetary policy.
In Jackson Hole last week, Isabel Schnabel delivered a dire message on inflation expectations, even as she seemed to miss the point. Schnabel described “a marked increase in the right-tail of the distribution” — so, a larger share of the surveyed population who expect inflation to settle above the central bank’s target.
“We broadly know why these shifts happen among consumers who are financially less literate,” Schnabel said. “These consumers predominately form their expectations based on inflation experiences.” Silly them. What kind of “illiterate” simpleton would base their expectations for food and energy prices on the price of food and energy?
“What kind of “illiterate” simpleton would base their expectations for food and energy prices on the price of food and energy?” Sometimes I wonder if I would enjoy H’s content without his healthy dose of sarcasm and cynical commentary, content would still be great but I would lie if I don’t acknowledge that lines like the one above make my morning coffee a little bit more enjoyable.
LBBD
Completely agree. First encountered h when his commentaries appeared irregularly on SEEKINALPHA; and beenn anregular subscirbher ever since that was an option. These comments form th
LBBD
Completely agree. First encountered H when his commentaries appeared irregularly on SEEKLINGALPHA; have been a regular subscirbher ever since DayOne when that became an option. His commentaries, along w/ NYT and WaPo, always are the first stage in our morning ritual attempting to remain among the survivors in this foundering geopoliticized state.
+1
The key really is folding all of this stuff together in a coherent way that’s long enough to be comprehensive but short enough to be a semblance of concise, and sarcastic enough to be funny / cynical without being so sarcastic that people roll their eyes or cringe. On the first point, if you look at Bloomberg (just to use the obvious example), they’ll take the same one-day rise / fall in European energy prices and write five different articles on it. Then they’ll take the proximate cause (e.g., new Nord Stream maintenance or a plan to cap prices) and do another five articles on that. So that’s 10 articles on (basically) the same story in a single day. It’s not reasonable to expect people to digest all of that. Nobody has that much spare time, and if they do, they’re not going to spend it reading 10 articles on the same subject — they’re more likely to go over to the Times or FT and read a longer, better-written article about something totally different. So I try to pull all of this stuff together in a way that people can readily absorb. On the second point, I think some of the other “alternative” financial portals (and this shows up on finance-focused social media too) have gone so far down the sarcasm road that it’s just clearly derision for the sake of derision or, more to the point, sarcasm for the sake of web traffic. That’s “fine” for those portals, but I think it creates barriers for some (if not most) readers. So, for example, if you’re a staid pension fund manager or someone who just wants good information delivered in an engaging way while sitting at your desk, you don’t want to be opening articles where you feel like, you know, “Oh my gosh, should this even be on my screen at work?” So, I try to avoid that and strike a balance. My sarcasm is biting, but it’s 100% workplace compatible, which I think is important.
It’s all about tact. Even when the world is upside down.
H for Prez
The energy price shock is a big problem for Europe of course. But they will be able to get through this winter. Fortunately natural gas has morphed from a local commodity to an international one so they can import from other sources eventually. By next year additional LNG terminals will be built for imports away from Russian pipelines. And there will be substitution in the next 3-12 months using oil, coal, and renewables. The conservation numbers they are shooting for sound aggressive. The variable in this is temperature- a cold winter would be very unfortunate. Putin has this year to wreck havoc. After this, his hand will be much weaker.
Although work arounds are in process, it doesn’t seem any of them will be as inexpensive/efficient as the deal they had going with Russia. So energy/electricity will be structurally more expensive for Western Europe, going forward?
Seems like they were just keeping their heads above water (economically) with cheap gas. How are they going to compete/thrive with not-cheap energy?
H-Man, I remember a post you did regarding the musings of Harley Bassman on excluding food and energy from the CPI calculation. Harley’s comment was something to the effect that if you exclude enough items from CPI you can get it down to zero.