Energy supply crunch triggers a global power crisis

Posted on October 13, 2021October 15, 2021 by Vrasidas Neofytou

A combination of strong energy demand, weather-related production disruptions, and tight supplies from Russia, have depleted the global energy inventories to record lows, leading to the current power crisis.

Severe shortages in natural gas and thermal coal supplies have started impacting power generation in many countries around the world, at the same time, demand has begun surging as economies re-emerge from the pandemic lockdown.

Major industrial countries such as India and China are teetering on the edge of a power crisis, after some of their states have been suffering from electricity cuts since the start of October and will face further outages as their energy inventories fall to critical levels.

Both countries are struggling to keep their power grids running, after many coal-fired power plants, which convert heat from coal to electricity, have been forced to shut down production due to coal shortages, whilst governments are warning of power blackouts.

Lebanon, which is suffering one of the worst economic recessions in global modern history, had also experienced a total power blackout during the weekend after fuel supplies run out.

On top of that, other sources of electricity generation such as hydropower, wind, and nuclear have also declined, triggering an unexpected rally in electricity prices in Europe and Asia ahead of the winter heating season.

Investors also worry that the power crisis will have an immediate impact on industrial and agricultural activity in Europe and Asia, while a colder-than-normal winter in the Northern Hemisphere could threaten the global economic recovery post pandemic.

Equity markets: Climbing the wall of recovery worry

Posted on October 11, 2021October 12, 2021 by George Kessarios

Inflation: The greatest enigma going forward

The biggest enigma over the next several quarters and, and perhaps years, will be inflation. In fact, weather we are talking about short term or long-term inflation, it’s the issue market participants will be required to wrestle with most.

Listening to analysts and pundits there is no agreement as to the inflation endgame. The debate on both sides is fierce, and both parties have convincing arguments. Central Bankers insist it is transitory, and so far, the bond market seems to agree (mostly).

However please note that dealing with inflation is something new to most market participants, especially fund managers. It has been several decades since fund managers had to deal with inflation, and very few of those that did, still manage money.

Central Bank policy still in focus

Monetary tightening sems to be on everyone’s mind. And while this tightening is still very vague, everyone agrees it will happen in some form. Initially at least, some form of tapering will happen (or so they say) and further on, we will get rate hikes.

Even assuming all the above happen, what is very different this time around is that negative real rates will still be with us (nominal rates adjusted for inflation). As such, this is not a typical economic rebound that we are used to. As such, investors need to adjust to a new reality, and that is one where yields will not rise by much in the face of an economic snapback.

Irrespective of what inflation does, there isn’t much Central Banks can do about it

If you recall, several years ago the Fed tried to raise rates in the name of inflation expectations. It did so to the tune of 2.5% and the U.S. economy and markets collapsed. So, if the economy was not able to withstand interest rates of 2.5% back then, how are today’s economies going to withstand the increase in interest rates needed to combat today’s inflation? The answer is they will not be able to. The US, Europe, and Japan cannot operate in a high interest rate environment. The main reason is that a significant rise will cause havoc for government budgets, debt to GDP metrics, and in most cases higher rates will trigger a recession.

In other words, even if we assume raising interest rates is the solution to fight inflation (a view that I do not subscribe to), it is impossible to raise interest rates to levels needed to fight today’s inflation headline numbers.

So, while Central Banks talk about tapering and higher rates (AKA normalization of policy), I am personally talking the rate hike talk with a huge amount of salt. This because economies will crash and burn with much higher rates, and that is not a Central Bank mandate in any country.

A long list of things to worry about

1. Economies are more leveraged today than they were just several years ago.
2. Individuals, companies, and governments have much more debt that needs to be serviced.
3. Markets have a much higher multiple than almost any time in the past.
4. Real estate prices are elevated all over the world.
5. Economies are snaping back, but there has been a lot of pull forward demand
6. Concerns about growth in China
7. A higher Dollar is bad for global growth

The big risk to economies and markets are higher rates. If we do see much higher rates, all my above worries will be triggered, and the outcome will be brutal. Central Bankers know this, which is why they are being vague about normalizing monetary policy, and refrain from saying when rates will “takeoff”.

Please note that while inflation is a concern, a collapsing economy and a bear market in equities is the lesser of two evils. As such, Central Banks will probably do more talking than acting when it comes to rates. Central Banks know all too well higher rates will do a lot of harm to economies and markets. And personally, I just don’t think this is what they have in mind.

So Central Banks will continue to assure markets they are committed to fighting inflation, but it will not act upon these commitments. But even if we assume Central Banks raise interest rates substantially to alleviate inflation concerns, they will probably lose.

So, what should investors do?

Overall, economies are still growing fast with fiscal and monetary policies still supportive for risk assets. However, investors must not be complacent. There are far too many things that could derail the current global economic recovery. There are still many potholes on the equity yellow-brick road.

My two biggest concerns are elevated equity valuations (especially the US), and the strengthening dollar. Especially insofar as the later, a stronger dollar means that there is either a dollar deficit in the world, or investors are buying dollars as a safe-haven trade. In both cases this is not good for equities.

However, to the extent that Central Banks don’t make a major policy mistake – like tightening too fast, or more than needed – equity markets should continue to offer better returns than bonds. It’s also important to remember that diversification is very important in this environment. Investors need to diversify across asset classes, geography, and sectors.

Surging energy costs threaten global economic growth

Posted on October 6, 2021October 11, 2021 by Vrasidas Neofytou

Global equities lost 1,5% on Wednesday as investors worry over surging energy costs and high inflation which would derail economic recovery after pandemic, while the International Monetary Fund cut its global economic growth forecast for 2021 to slightly below its July forecast of 6%.

Brent oil tops $83/b and Natural gas hits fresh records:

The energy sector continues outperforming the market as the prices of crude oil, natural gas, and coal have hit fresh multi-year highs this week amid tighter supplies, lower-than-average inventories, and strong demand ahead of the winter heating season in North Hemisphere.

The international benchmark Brent crude rose to a three-year high of $83/b on Wednesday while U.S. benchmark WTI crude climbed to near $80/b, hitting its highest since 2014.

The rally in oil prices was driven by the decision of the OPEC- Organization of the Petroleum Exporting Countries, and its allies led by Russia, known as OPEC+ alliance, to stick to their planned output increase of 400,000 barrels per month rather than pumping even more crude.

Meanwhile, the price of the cleanest burning fossil fuel, Natural gas, climbed to $6,40/MMBtu in the U.S-based Henry hub, amid robust global “green” demand and record low inventories levels in Asia and Europe ahead of winter heading season.

The lower-than-expected gas supplies from Russia, the colder winter, the hotter summer, and the competition for LNG supplies have caused a delay in the injection gas season during the summer.

As a result, the European and Asian gas inventories have fallen to around 70% level compared to the 5-year average of nearly 90%, forcing local governments to order huge quantities of gas supplies at any cost ahead of winter, skyrocketing the prices of natural gas and Liquified Natural Gas (LNG).

Global economic growth under threat:

Investors are afraid that the rising energy costs and supply chain disruptions would feed inflationary pressure in global economies, generating financial problems in households, global trading, and industries.

The elevating inflation rates could potentially threaten the global economic recovery after the pandemic, just as global trade and consumption growth is picking up as economies reopen on the back of successful vaccination campaigns.

The first negative signs in consumption activity have started coming up in the industrial-focused Eurozone, with the German factory orders, a normally reliable leading indicator of trends in Europe’s largest economy, falling 7.7% in August, a sharp slowdown from the 4.9% gain in July.

Meanwhile, the Eurozone’s August retail sales increased only +0,3% vs +0,8% market expectation amid rising costs in food, drinks, and tobacco.

On top of that, IMF-International Monetary Fund on Tuesday cut its global economic growth forecast for 2021 to slightly below its July forecast of 6%, citing risks associated with debt, inflation, and divergent economic trends in the wake of the Covid-19 pandemic.

Q4 Energy Outlook: Higher crude oil prices are expected on tight supplies

Posted on October 1, 2021October 11, 2021 by Vrasidas Neofytou

We maintain our positive outlook on crude oil prices into Q4, 2021, based on the bullish energy market dynamics, the strong economic rebound after the pandemic, the unexpected energy crisis, and the reflation bets from institutional investors.

We expect the current global supply/demand imbalance to deteriorate further since the energy-demanding regions of Asia, Europe, and North America (Northern Hemisphere) are entering the winter season (when heating demand picks up) with crude oil, natural gas, and coal inventories below the 5-year average.

Brent breaks above $80/b reaching our bullish scenario price target for Q3 2021:

For the third quarter in a row, the soaring Brent and WTI crude prices hit our bullish scenario price projection of $80/b in Q3, 2021, anticipated back in June when oil prices traded around $70/b, approx. 10-15% lower than today’s prices.

Brent crude, the international benchmark, topped $83/b in early October, hitting three-year highs, while WTI crude, its U.S. counterpart, retested the psychological $80/b mark, surging to the highest level since 2014.

Both oil contracts had risen by more than 25% in Q3 and almost 60% since the start of the year to date, fully recovering the pandemic-led losses of 2020, when oil prices collapsed to near zero after the “demand shock”, when consumption for gasoline and jet fuels was limited following the Covid-led lockdowns.

Bullish crude oil outlook for Q4, 2021:

Considering the rapidly tightening oil supplies, the weather-linked supply outages, the lower-than-normal oil inventories, and the fast-improving global petroleum consumption (energy agencies project a potential oil demand boost up to 1,5 mmbpd in the next quarters), we revise upward our crude oil forecasts until the end of the year.

Base-case scenario: Averaging between $75-85/b

Our base-case scenario sees both Brent crude and WTI crude oil contracts averaging higher between $75-85/b. (vs. $65-75/b in Q3) during Q4 2021, as the current tight supplies and surging fuel demand are bullish factors for crude oil prices.

Bullish scenario: Crude oil prices at $100/b?

We anticipate that crude oil prices may break above $90/b or even revisit the $100/b psychological resistance level driven by a combination of multiple factors that could affect the supply/demand equation of the market.

Among the possible reasons for a spike in crude oil prices towards $100/b are; a strong oil demand growth following a faster-than-expected economic recovery after the pandemic; tighter energy supplies after some sharp cold spells during the winter heating season; and unplanned weather-led supplies disruptions (similar to the hurricane-led oil and gas outages in the Gulf of Mexico).

OPEC+ output policy supports higher oil prices:

Heading into the final quarter of the year, the supply conditions are bullish for the black gold market, especially after OPEC (Organization of the Petroleum Exporting Countries) and non-OPEC allies led by Russia, known as OPEC+, maintained their output policy agreement.

The OPEC+ alliance decided not to flood the market with more supply and stick to their previously agreed decision in July to raise output by 400,000 bpd a month until at least April 2022, to phase out 5.8 million bpd of existing output cuts.

OPEC+ took this decision despite the political pressure from big oil-consuming nations such as India and U.S. to increase production to tackle surging gasoline and electricity prices and ease inflationary pressure.

Energy crunch will benefit oil prices:

Crude oil would also be an indirect beneficiary if the situation with the global energy and electricity crisis continues to worsen around the world during the coming winter heating season.

Natural gas and coal prices have skyrocketed this year amid strong heating demand, following a long and cold winter, a solid cooling demand after a warmer-than-normal summer that drained global energy stockpiles, coupled with the tighter-than-expected gas supplies from Russia.

Considering the above factors, we believe that surging gas and coal prices, together with the larger-than-expected energy shortages in Europe and East Asia, will force many utilities in those regions to switch to cheaper fossil fuels as an alternative for power generation such as crude oil, further stressing the already tight oil supply situation.

Bullish oil demand growth:

We believe that the global crude oil demand will continue growing into the year-end, as the positive vaccination programs around the world (with 40% of the global population at least partially protected), in our opinion, allow economies to recover faster-than-expected from the pandemic-led financial recession.

The Covid-19 pandemic, and especially the “Delta” variant has started subsiding in some major energy-thirsty economies such as China, India, Japan, U.S., and the Eurozone, allowing the resumption of global trade and travelling, which would improve the demand outlook for petroleum products such as gasoline, diesel, jet fuel, and petrochemicals.