Energy Politics & Money - 25 July 2022
Curated news from the worlds of energy, geopolitics, and money just for you!
Welcome to the Energy, Politics & Money news feed of Monday, 25 July 2022, with your daily dose of cutting-edge insight into everything of importance in the connected worlds of energy, geopolitics and the economy.
In this roundup, we look at:
Developments in China and the impact of depopulation on economic growth and stability,
Examine the nascent but ever worsening European and UK energy crisis from multiple perspectives,
How the aerospace industry faces pressure from its customers in addressing its huge carbon footprint,
The consequences of not closely monitoring your organization’s ESG efforts, and,
Examine recent developments in the global EV market where substantial investments in India are growing, Apple’s multiple EV patents demonstrate its seriousness, and VW’s decision to dump the architect of its post-diesel gate move into EVs.
General Energy News
Bloomberg reports oil continued its downward trajectory today, as market concerns about an economic slowdown overshadow signs of a tight physical crude market.
As to refined fuels, Bloomberg reports Asian margins on products like gasoline have dropped back to levels seen before Russia’s invasion of Ukraine as tightness eased. Diesel-cracking margins in Asia have also been under pressure. They’ve fallen 40% from their recent peak in late June but remain more than double the level reached before the pandemic in July 2019. This could translate into lower refining utilization in Asia over coming months, Bloomberg says, which would of course translate into lower crude demand.
Energy Transition & Technology News
The Farnborough Airshow took place this week in the UK, and according to Reuters it was an occasion during which pressure on global aviation to shrink airplane emissions was clearly increased, as were calls for turning a raft of potential solutions -- many of which are yet to be proven -- into reality. Apparently, pressure is coming from governments and customers, especially corporate travelers, whose companies are looking to reduce aggregate carbon footprints. Sustainable Aviation Fuels margins are likely to be exceptional for a number of years, as it really is the only way for airlines to deliver a short-term improvement in their emissions.
The Financial Times George Bridges, in an opinion piece on the topic of Energy Transition, asks, “what is the plan to deliver affordable and reliable energy as we transition to net zero?” The answer, he argues, “there isn’t one”.
We intend to include the topic of societal pressure facing the plastics industry under Energy Transition, as both are resulting from the global sustainability trend. The Guardian has an interesting piece on how Covid brought the plastics industry some (temporary) relief from this pressure. The key question is, will this hold, or will the plastics waste problem soon become center stage again?
The Macro Environment (economics & geopolitics)
John Kemp of Reuters reports “Recent moves in crude oil and interest rate futures anticipate a downturn in the business cycle that will cause oil consumption to dip before the end of the end of the year and into the first three months of 2023.”
We’ve been writing on China’s current economic challenges, because whatever happens in China will have global ramifications. Key challenges this year have been its Net Zero Covid policy that severely hindered economic growth (and recovery of the global supply chains) and the instability in its real estate sector that drove Chinese demand and thus the global commodity boom during the 21st century. Reuters now reports the country will focus on economic recovery in the third quarter, putting a priority on stabilizing employment and prices. This clearly indicates the two challenges we have covered have indeed severely upset the overall macro environment in the country. According to Nikkei Asia, among the “solutions” China will be utilizing is further inflation of its real estate bubble.
Over in Europe, the ECB’s cautious approach to rate-hiking can be explained by an experience from 2011. Bloomberg asserts that back then, ECB’s interest-rate-hiking cycle started with a rate increase in April, followed by another increase in July, and were designed to fight off inflation. But, instead, their moves caused the sovereign debt crisis beginning with Greece and soon engulfed other economically weaker members of the region. It threatened to fracture the Euro until, then ECB chair, Mario Draghi famously declared he would do “whatever it takes” to protect the currency. Today, it appears that the ECB is walking the exact tightrope.
Because of this tightrope the ECB introduced the the Transmission Protection Instrument - a new “solution” to mitigate sovereign-debt problems in the Southern countries of the EU zone. We explained it last week and Bloomberg published a Quicktake on the subject. For an even more detailed analysis, head over to project Syndicate where Willem Buiter reviews the ‘solution’ thoroughly.
On the subject of monetary policy, we usually recommend the analyses by Mohammed El Arian. Here’s his latest for Bloomberg: “Global economy watchers and market participants will be paying a lot of attention next week to how the Federal Reserve describes the US economic outlook, to the magnitude of its interest rate increase and whether it changes the pace of its balance-sheet contraction. Yet for the well-being of the US and global economy, the answer to these questions is less important than whether the Fed shows seriousness about fixing four failures that continue to fuel one of the worse policy mistakes in decades: Failures of analysis, forecasts, response and communication.”
Lastly, geopolitics.
As to the trend toward regionalization of the global economy, it is worth taking note of the fact that China’s Semiconductor Manufacturing International Corp. has likely advanced its production technology by two generations, defying US sanctions intended to halt the rise of China’s largest chipmaker. The Shanghai-based manufacturer is shipping semiconductors built using 7-nanometer technology, industry watcher TechInsights wrote in a blog post on Tuesday, according to Bloomberg. This is still behind “cutting edge”, which is at 3-nanometer, but China previously was at 14-nanometer, so it clearly is closing the gap, despite the US’ best efforts to prevent this.
The Financial Times reports that some of China’s largest banks are offering a lower interest rate on long-term deposits compared with short-term as a dearth of quality lending opportunities points to a sustained slowdown in the engine of global economic growth.
As to the stress the country’s real estate sector is experiencing, extensively covered by us over recent weeks, Reuters reports China will set up a real estate fund to help developers resolve a crippling debt crisis, aiming for a war-chest of up to 300 billion yuan ($44.4 billion), according to a state bank official with direct knowledge of the matter.
Optimists will conclude China’s government is taking the issue serious and Pessimists will conclude the issue is serious. We are in the middle: yes the issue is serious and yes the Chinese government is taking it seriously, so we do not expect a Lehman-style implosion of the banking system anytime soon. The reason we believe the Chinese government will not let this get out of hand is reported by Bloomberg: around 70% of Chinese middle-class wealth is tied up in real estate, which means an implosion of the sector would be absolutely devastating for the sector as whole. A more likely outcome, therefore, is more government support for the sector. Indeed, worsening the underlying problem, but postponing the unavoidable day of reckoning.
The Financial Times opinion piece by Mohammed El Arian included an outlook for developing economies. Clearly, he shares our pessimism, arguing “this is a tricky operating environment for emerging economies, particularly commodity importers. Heightened food and energy insecurity is compounded by slowing global demand, dollar appreciation, a tightening in capital markets’ financial conditions and a tougher landscape for official bilateral aid.”
As we mentioned before, one of the macro-trends that we believe will be driving the global economy over the medium- to longer-term is significant population decline in mature economies. According to Reuters, China's population is expected to start to shrink ahead of 2025, the state backed Global Times reported, citing a senior health officials. The post-Covid worker shortages experienced by various sectors of the economy reflects the depopulation trend. Another symptom of depopulation will the effect on aggregate demand – contact us in case you would like to know more about how we think this will be playing out.
The Electrification of Transport
Normally, we would not spend much time on personnel changes of the companies in the industries we follow. We are making an exception for Volkswagen, who ousted its CEO Herbert Diess on Friday. The reason for the exception is that Diess was instrumental in Volkswagen’s shift from from ICEVs to EVs – something that was not easy to do even after the Diesel-gate scandal. In its reporting on the subject, Bloomberg named him “the architect of the auto industry’s biggest electrification effort”. We wonder, therefore, whether this change will lead to Volkswagen stepping back from its electrification focus? Diess’ successor will be Porsche CEO Oliver Blume.
A joint investigation by Nikkei Asia and Tokyo analytics company Intellectual Property Landscape found Apple’s much talked about push into automobile-related technologies is sincere, as shown by the company's recent patent applications. Apple has filed patents in self-driving and other vehicle software as well as in hardware related to riding comfort, such as seats and suspension. The U.S. tech and services company is also targeting vehicle-to-everything (V2X) technology, which allows cars to communicate with each other and connect to the “Internet of Things”.
India want EVs to make up 70% of sales of commercial cars and trucks, 30% of private cars, 40% of buses, and 80% of two- and three-wheelers by 2030. Nikkei Asia reports that, naturally, both local and foreign companies will be fighting for a slice of the resulting opportunities, and that local players are preparing to win in this competition. The electric car subsidiary of Indian auto giant Mahindra & Mahindra this month raised $250 million from British International Investment, pushing the unit's valuation above $9 billion, about half the market capitalization of its parent. That follows India's largest electric car maker, Tata Motors, sealing $1 billion of finance in October to back its EV ambitions.
ESG
In case you ever wondered why carefully managing ESG performance is important, we note Reuters’ report regarding a subsidiary of Hyundai. According to local police, the family of three underage workers, and eight former and current employees of the factory accuse the subsidiary of using child labor at a plant supplying parts for the Korean carmaker’s assembly line in nearby Montgomery, Alabama. Imagine the consequences this accusation will have for the company globally. Cue the spin Doctors.
The Global Energy Crisis
Although gas is flowing again through Nord Stream 1, Politico highlights this may be short lived. A gas turbine has been sitting in Cologne for days, stuck in sanctions limbo. It should have been ferried to Finland and into Russia by now, to begin pushing vital gas supplies through the Nord Stream pipeline into the EU. If it doesn't arrive before Monday to replace a worn-out twin, Russian President Vladimir Putin has warned that flows through the undersea gas link will plummet once again.
Russia’s threat to (again) cut flows through Nord Stream 1 if the (in)famous turbine (see above), that was in Canada for maintenance and then got caught up in sanctions, was not returned to it today. Bloomberg reports the handover is delayed but progressing. Traders rightly conclude from Russia’s message, however, that gas politics are not over yet – which of course they won’t be until sanctions politics are over – and are therefore sending gas prices higher.
Energy company Uniper got squeezed by the gas crisis in Europe, resulting in accumulate losses of 6.2 billion euros ($6.3 billion) due to reduced deliveries of Russian gas that forced the company to buy gas at much higher prices elsewhere. In response, the German government stepped in on Friday to rescue the company through a 15 billion euro ($15.3 billion) bailout. This is an early signal of the cost the European sanctions on Russia will have. The German government has said German gas consumers will not be left to shoulder higher energy costs alone, but any measures it is taking are short-term, to get households and companies through winter.
And, the French Government took similar action to Germany’s bailout of Uniper. The French government proposes a similar move for EDF, offering to pay 9.7 billion euros ($9.85 billion) to take full control of the company.
Eventually, and one way or another, the cost of higher energy will be passed on to consumers, households and industry, either in the form of higher prices, higher taxes, and likely a combination of both. Remember, it is still early days in Europe’s energy crisis and things will certainly “heat up” as we approach winter and energy demand in Europe starts to increase for heating.
According to an opinion piece in Project Syndicate, Mohammed El Arian feels sanctions on Russian should be tightened further. While an end to sanctions would be the easier solution for many of the economic (and resulting social and political) problems the world is currently experiencing, or shorty to experience, he calls upon the world to “bite the bullet and eliminate the carve-outs for energy”. “Doing so would undoubtedly have a severe short-term economic impact on European economies and the rest of the world”, he says, while “Muddling through risks bringing about the worst of all possible worlds. It is insufficient to dissuade Russia from continuing its illegal war; it is fueling deeper fragmentation of the international monetary system; and it is not even protecting Europe from a winter gas disruption.”
While we agree the current policies are “little bits of nothing” put together, from our (economic) perspective clearly the sensible thing for Europe to do would be to end its sanctions on the Russian economy, rather than further tightening them, to allow for Russian gas to flow freely again. But we agree (and understand) that our reasoning is unaffected by moral arguments, i.e. hardcore “realpolitik”.
However, moral arguments against such a move continue to have significant support among the European public and it would, at present, be “political suicide” for most European politicians to venture into this direction. But this may change, especially if the consequences of the current course of action starts to affect millions of households and thousands of companies in Europe more directly. While we predict this will happen, it will not happen all over Europe at the same time.
Hence, we may see individual countries making moves in this direction while the bloc as a whole continues to hold on to its current policy position. This explains why, as Bloomberg reports, Hungary’s Foreign Minister Peter Szijjarto visited Moscow on Thursday to request an additional 700 million cubic meters of natural gas.
Asia Times agrees with our perspective that the EU’s position regarding Russian sanctions could possibly change. It writes, “As the need for Russian oil and gas will grow in Europe with the change in weather at the end of the summer, the Europeans may not be able to keep solidarity with the US on Ukraine’s future. Should the US continue to back Ukraine and support Zelensky’s government’s opposition to negotiations, at least some of the Europeans may split from the US and lift sanctions on Russia.”
We reported on both the EU commission’s proposal for a 15% gas usage cut across the block, as well as the push-back this resulted in from a number of countries.
Reuters reports that immediate resistance to the EU plan to cut gas usage by 15% until March 2023 has forced member states to renegotiate. Spain, Portugal and Greece are among the most openly hostile, while diplomats say Denmark, France, Ireland, Italy, Malta, the Netherlands and Poland also have reservations about giving the Commission the power to order cuts. On the subject, Politico highlights that at least these conversations force EU countries to take serious the risk of gas rationing as Russia cuts supplies.
Today, details emerged as to what the push-back countries want. A draft proposal seen by the Financial Times suggests that while a voluntary target could be standardized across the bloc, compulsory targets should take into account each state’s dependency on Russian gas as well as the amount they have managed to funnel into storage. To us this hints at the lack of solidarity across EU countries, which we also discussed previously as one of the major challenges for the EU in its energy crisis going forward.
The importance of the EU coming up with a commonly agreed plan is highlighted by the futures market for gas in Europe. The Financial Times reports, it indicates traders expect European gas prices to remain elevated for years to come. The price of gas set to be delivered to Europe at this time of year in 2023 and 2024 is near its highest level on record at €134 and €82 per megawatt hour respectively, according to trading in yearly forward contracts used by consumers of the fuel to lock in long-term prices. Before last summer, European gas prices traded consistently below €40 per MWh for more than a decade. The EU plan should therefore include a shorter-term element, about how to achieve supplies of the necessary energy over the coming winter; and a medium- to longer-term element, about how to keep the cost of these supplies at a level that is affordable for households and keeps European industry internationally competitive.
The EU’s recent deal with Azerbaijan will not be enough to save the continent in case of further cuts, argues Responsible Statecraft.
Other
The Conversation has a deep dive on President Biden’s announcements on climate action this week.