Blain’s Morning Porridge Feb 2^nd  2024: The Energy crisis in the rear mirror is bigger than you think!

“What you mean you can’t swim? The fall’ll probably kill you!”

Markets are bracing for a wave of commercial property impairments – but these are a known and largely quantified known. It’s usually the no-see-um hiding in plain sight that does the most damage. I reckon it could be Energy costs. (Crashing minor chords offstage…)

Apologies for lack of commentary y’day, but was rushing round London. Some very interesting client discussions.

As January goes the way of all things, we have three major market issues to ponder:

• The Fed confirming they are in no rush to ease – but there is an increasing realisation this year the Fed will be acutely “politicised” – how that may affect markets may be a topic next week.
• Meta produced excellent results, but even the mighty Apple’s numbers remind us nothing is perfect. How sustainable is the current priced-to-perfection tech market bubble when everything across tech is less than perfect?

And,

• Commercial real estate: The collapse of Austrian smoke and mirrors property company Signa has dragged down Julius Baer’s CEO, and a host of German (always German), Austrian and French financial institutions have lent it billions – secured now by the square root of zero. In the US a new round of secondary bank wobbles driven by rising commercial real estate impairments are worrying markets.

One thing I know for certain about markets is that’s it’s never the train on the tracks coming directly towards you that does the damage… it’s the swift moving shadow in the mirror that sends you skiting into the wall… We’re all focused on commercial property – so what else is about to pop…?

Who knows, but we can make some educated guesses…

Ultimately… everything that makes the modern economy tick is the price of its Energy. To produce, consume, to thrive – all depends on energy. Energy rich nations do well. Energy deficient ones become their provinces. In the past energy was a local thing: the power to fill a cargo ship’s sails, the river driving a mill, then how much coal was needed to produce iron, till industrialisation confirmed a nations ability to build Dreadnaughts was based on coal supply, and later oil to drive tanks, fly planes, and power fleets.

The equation evolved into the 20^th Century – you may argue World War 2 was about control of Energy resources as small nations Germany and Japan tried to seize control of regional oil reserves. In my lifetime globalisation, growth and the population explosion has meant economies became increasingly vulnerable to energy scarcity is the form of oil-shocks. Today we’re at a stage when the demand for energy has never been so great, nor the supply so constrained.

Back in market La-la-Land, many market participants believe inflation is beaten. Most acknowledge the inflation event was triggered by an energy shock – gas prices after the Russian invasion of Ukraine. An increasing number believe energy costs have stabilised, and are fully “priced-in” and known. They see little to fear from another shock, so clearly central banks should slash rates and propel markets higher.

Err.. no.. but..! 

One of the best thinkers in the Capital Markets is Rob West, CEO of the remarkable research firm Thunder Said Energy.

He makes no secret of being a nerd, peeling back layer after layer of the frustratingly complex onion that hides the fine details of energy costs and transition. He has little time for simplistic nonsense, like “nuclear will sort it all”, or “let’s electrify everything”. He’s worked out new technologies boil oft down to new supply/tech bottlenecks. It’s the companies that solve these that offer the “bottom-up” opportunities in energy transition. His in-depth analysis of the companies at the “coal-face” (hah!) of transition tech are well worth the subscription cost.

He also looks at the macro-factors. His big theme for 2024 is a New Age of Volatility in Energy Markets.

Rob’s arguments are much the same as mine: the world is changing, and that has consequences. Far from energy prices stabilising, they are far more likely to become increasingly volatile. Sticky, stubborn inflation could become endemic, triggering multiple consequences as the unpredictability of energy costs ripple out across the economy.

Key points on volatility include (mostly Rob’s points, but some of my own):

• China and India are ramping the production and use of coal, prioritising energy security over decarbonisation plans.
• Cheap Russian energy is a gift to nations prepared to take it.
• Energy infrastructure across the West is tired and creaking, and investment in replacement is unfocused and unfunded.
• 25 emerging market nations have populations over 100 mm, require growth to feed, clothe and employ them, and, critically, the energy to do so. This becomes a key driver of their political choices.
• Nations will tend to focus on their energy security at costs they can afford, including changing strategic alignments to secure their energy. Better to use Russian oil than no oil at all!
• Wind and solar are scaling up dramatically – perhaps 30% of total power by 2050m but these are notoriously variable and weather dependent. Throw in a couple of extreme weather events and the +/3-5% variance in predicted wind that Rob has calculated becomes a serious and difficult to predict issue.
• Even Hydro power is vulnerable to the weather – with a 12% availability range between dry and wet years.
• Rob’s research (based on US windfarms) confirms what I’ve long suspected – O&M is a problem: turbines reach peak generation after 2 years, but then roll off becoming progressively less efficient, declining by 3-4% per annum once they are a decade old.
• (Which reminds me – I must ask Rob about Tidal power. The only renewable resource on the planet that is 100% predictable and utterly reliable – yet I still haven’t seen it innovated at scale.)
• The volatility in gas is highlighted by President Biden’s actions in the USA last week – leaving Germany dependant on spot pricing for over half its energy.

Perversely, Oil, the root of all previous energy shocks and the factor most market watchers pay most attention to, is perhaps a less volatile source of energy – partly by OPEC being balanced by shale growth in the US. The potential of instability on global tensions could yet turn that around. Talking to clients about this y’day, a number suggest $140 oil is not out of bounds in a shock.

There are mitigants, says Rob. Capacitance solutions in battery or physical format (for instance a new Electric mountain hydro scheme is under construction in Scotland) can smooth volatility. However, the limits of battery storage “hinge on physics and chemistry,” he reminds us – you can’t change these rules, not matter what market shills would wish for. Energy is also limited by cost constraints.

The point is energy volatility could seriously destabilise the current soft inflation/recession thinking across markets. As we have seen these past 2 years, rising inflation and pressure to dismiss the environment and ESG concerns are correlated. In a world where costs are spiralling, wage demands and labour unrest is rising, when inflation becomes established the longer it takes to eradicate – further pressuring efforts to decarbonise. The UK government’s embarrassing the King over the climb-down on targets is one example.

Having watched markets for many years, there are flows and current within the stream of markets. Simple things like the promise of new riches from the innovation on new tech form repeating eddies and whirl-pools in the flow. Some move forward – like the EV revolution, while others spiral around before popping into oblivion – like the Metaverse, NFTs and We-Work. But there are longer lasting currents – like growth, inflation, rates, and the price of commodities – which boils down to three things; food, resources to make things from, and energy to convert resources.

Watch these flows for signs of trouble. The surface waters may appear calm, but beneath there are sharp pointy rocks disturbing the depths. Energy is scarce and increasingly volatile – What should that tell you? The likely outcome is higher prices.

On that happy note, I am going to intro a new feature to the Friday Porridge next week:

The Top Market Quote.

Please send me noteworthy quotes, snippets or insights from the market press, commentators or analysts worthy of sharing. (Short and quotable sentences only please..)

This week I offer the following from the FT on Musk’s pronouncement the company will leave Delaware to reincorporate in Texas:

“Their ways of working just don’t apply to Tesla, which is less a company and more the publicly traded division of self-contained hysteria factory”

Out of time, have a great weekend.

Bill Blain

Strategist – The Morning Porridge.