Energy prices remain sky high in Europe. And collectively, governments are attempting to ration energy consumption so they have enough power to make it through the winter. But how bad will it be? Will anyone be forced to shut off power? And how long will the crisis last? On this episode of the podcast, we speak with Bloomberg Opinion columnist Javier Blas and fund manager Alex Turnbull for some perspective on what to watch with energy this winter. The transcript has been lightly edited for clarity.
Points of interest in the pod:
How bad is it in Europe right now? (4:10)
How Europe is lessening its pain (6:52)
How are things looking for Europe (9:22)
The worst case scenario (14:56)
The impact in Europe and Asia (20:08)
What leaders in Europe need to do (29:30)
What’s the state of Chinese demand (39:02)?
What's happening to ESG now? (41:38)
Tracy Alloway: (00:10)
Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway
Joe Weisenthal: (00:14)
And I'm Joe Weisenthal.
Tracy: (00:16)
Joe things look rough in Europe.
Joe: (00:19)
Yeah. We've talked about this. We haven't done a Europe specific episode in a while, but something we've been talking about lately is the macro forces — shortage of energy, high inflation, but also sort of mediocre underlying growth. Tough position right now.
Tracy: (00:36)
Yeah. You know, my mother is actually visiting the States at the moment. She lives in Austria, so I'm getting a firsthand picture of a lot of the stuff that's going on there in terms of attempts to save energy, in the middle of a heat wave, I might add. And she even had to trade in her car, she says, for something more efficient and reasonable in the current climate. So she gave up this very, like, gas guzzling convertible in order to get some efficient, like, sedan.
Joe: (01:06)
Well, that's the goal, right? Everything becomes a little bit more efficient conservation to ease the pain. Will she come on the podcast?
Tracy: (01:14)
I don't think so. But, you know, there's a lot going on in Europe with energy at the moment, and it's pretty clear now, you know, we touched on this a little bit earlier in the year, the potential for an energy crisis in Europe, and it now looks like Europe is firmly in one. So for instance, if you look up the benchmark gas features in Europe — Dutch TTF contracts — I think there's still hovering around like 200 euros, which is pretty close to a record high.
We know that before Russia invaded Ukraine, it was responsible for something like 40% of Europe's energy imports. That has obviously dropped quite a bit as Russia sort of cuts off gas supplies. But the big question is what can Europe do to offset this and exactly how bad could things get this winter?
Joe: (02:08)
Yes, this is the key question. How bad will there be a big shortage? You know, in the summer, you can not run the air conditioning as hard, or maybe, you know, a lot of places don't even have air conditioning, et cetera.
Tracy: (02:19)
Open windows is what my mother keeps telling me.
Joe: (02:22)
It's worth noting, by the way, that Dutch natural gas futures contract that you quoted around 200 euros. In 2019 it was 11. So I just think it's really, for some context, just an absolutely insane jump on the gas shortage or the gas crisis part of it, but also a lot of attention paid lately to the state of the French nuclear industry, disrepair, lots of shutdown reactors not operating. So there is a confluence of factors really putting the squeeze on Europe right now.
Tracy: (02:54)
Yeah. And again, like, it is just crazy to think how far we've come, both in terms of prices, which you pointed out, but just in terms of the actions to try to contain this crisis, because I remember when Pierre Andurand came on the show, you know, in the spring and he was talking about Europe might have to ration energy. And that seemed so extreme at the time. And, you know, fast forward a few months, and that is exactly what is happening.
There's a scramble not only to save energy, but also a scramble to store as much gas as possible. So I am very, very pleased to say that we are going to be speaking with two people on this topic today. We're gonna have a real discussion around the issue, get some varying viewpoints. We're gonna be speaking with Javier Blas. He is, of course, a columnist over at Bloomberg Opinion and an expert on all things energy. And we are also going to be speaking with Alex Turnbull, who we've had on the podcast before. He's a fund manager based in Singapore and also a researcher in global energy. So thank you both for coming on the show.
Javier Blas: (03:59)
Thank you for having me.
Joe: (04:00)
Thank you very much.
Tracy: (04:02)
So Javier why don't we start with you. Let's just do the basic question: How bad do you think things are gonna get in Europe this winter?
Javier: (04:10)
Well, it's gonna get bad and allow me to give you a personal example and also show you how bad I am at investments. I just recently closed the purchase of a house in London, in West London. I resisted for many years. I was very happy with my flat, but I wanted a garden as every middle-class British person likes.
And you know, I did it probably at the very peak of the market. So that's how bad I am. So I'm just doing my moving and I was thinking how bad it will be if I could not carry my gas and electricity contract that I have. And it's for a number of months still ahead. And I have to start from a scratch, just to get a new electricity and gas contract on the new property.
I'm currently paying about 135 pounds per month for electricity and gas in my current flat. If I have to get a new contract because prices have gone so much up and because every utility in the UK is already factoring the big price increase that we are gonna get from October, my bill will go monthly from 135 pounds to 475 pounds per month. That is how bad it's gonna get. Now, just in mind, working class families, getting electricity and gas bills, unless the government makes an intervention of anything north of 400, 450 pounds, which is more than $500 per month, just for electricity and gas, put aside gasoline prices. That's how bad it’s gonna get in terms of the impact of the cost of living crisis. And that is across Europe. What is happening in the UK is very similar in Germany where utilities are already warning consumers that the utility’s monthly charges are gonna double at the very least starting on the first of October.
Joe: (06:14)
So Alex, I wanna bring you in, you know, as Javier mentioned, his energy bill is gonna soar. And of course, we're going to see that across Europe, if people haven't already had that rerating kick in already. But it's one thing for prices to surge. It's another thing for, say, people to not have power, maybe people do not have heat, or probably more likely, industry in some countries has to shut down because it's uneconomical. What do you see as this sort of, uh, you know, is there risk of something beyond it's just more expensive and something more sort of fundamental hit and shortages, uh, this coming winter?
Alex Turnbull: (06:52)
I think in the short term, it's very hard to do a lot of substitution, which is why we saw not a lot of change in industrial gas demand in Europe around last winter. There was a sense in which everyone was kind of frozen in place. But you are already starting to see quite substantial substitution for industrial demand.
The problem is that as a consumer, it's as Javier’s points out, there's not a lot you can really do in the short term. But, you know, here's where my story of buying a house comes in. I bought a house briefly before COVID in Australia and I was planning on putting solar panels on it, but then I kind of got locked outta the country for two years cuz of Australia's COVID controls and my tenant was not happy with the change in power prices where basically said like, do you wanna put solar on it?
And I said, yeah, actually I'd love to do that. And so that's already nuked about 70% of their power demand and their power bill. So in places like Australia, where you are similarly impacted by issues of gas. and the coal price has been the marginal pricing source of demand certainly in New South Wales, you can take remedial action. And I think you're gonna see a lot more of that over time, but that does take time and that’s demand destruction, not in a bad way, and a sense that people have worked out ways to consume less while preserving their lifestyles. That is a multi-year process. And so in the short run, people can't really cut their consumption much. But over time that does tend to happen.
Joe: (08:25)
You know, I think the real lesson is to be like Tracy. And when you buy a house, discover that you actually have a mountain of coal in your basement, which is something Tracy revealed to us under a recent episode. That's like the ultimate hedge is to buy a house that comes with coal.
Tracy: (08:42)
Don't worry, guys. I too bought at the top of the market. So yes, I have some commodity exposure to offset that purchase. But yeah, Alex, I mean, I mentioned the benchmark gas contract in Europe earlier hovering around like 200 euros. And Joe pointed out that that's up from 19, you know, just a little while ago, but it has come down a little bit. Like, there does seem to be some moderation recently that's driving that. Is that a sign that maybe we're turning around the corner as some of these energy savings kick in or as Europe starts to reach its 80% gas storage target?
Alex: (09:22)
I’m loathe to make any definitive comments here. On the one hand, I'll point out that if you talk to your friendly prime broker about wanting to trade something, which realizes about 400% volatility on a good day, you may find that actual risk taking capacity in these markets is heavily constrained.
And the information in prices is not quite what it once was. The other thing I would point out is that that can be both to the upside or to the downside. So we saw similar dynamics in coking coal for much of this year when people were concerned about Russian supply getting taken out of the market. But then China opened the border to Mongolia. So you took 17 million tons out from Russia, but then actually China just bought it all more or less. And then you also had Mongolia enter the market for a 36 million ton run rate currently. So as a result, coking coal went from say $250 to 600 briefly and is now back to $200. So I don't think we're gonna get a kind of supply deus ex machina in gas or high calorific value coal to fix Europe's problem that quickly though.
Joe: (10:50)
Javier, can you sort of give us the broader picture of how you weight the different factors driving up European prices right now? Cuz obviously everyone is quite aware of the stress and the tensions between Europe and Russia over the war and the declining exports. But then, of course, you know, there's also, and this has gotten more attention in the last couple of weeks, the French nuclear industry is operating at diminished capacity. France is currently an electricity importer as opposed to an exporter. So there's multiple factors and how would you, uh, attribute them?
Javier: (11:26)
So Joe you right, there are multiple factors that they're driving here that the market on gas, the most important one certainly is Russia restricting supplies to Europe. You take Germany as an example. Supplies are down 80% for where they were normally. And that is a completely political decision by Vladimir Putin to put pressure on Europe and drop the support on Ukraine. Then in electricity, the situation in France is certainly the main driver. About 50% of the nuclear reactors in France are not working at the moment. Most of them are on maintenance, revised, just checking for cracks on some welding. And that has really forced France to import large quantities of electricity from every neighboring country, which is putting pressure on gas because that means that we are consuming more gas for, power generation looking forward.
What a lot of the situation in Europe is gonna depend is I think on three factors. Number one is what Vladimir Putin does in the next few weeks and months, whether he shuts down completely supplies or not. Number two is the weather, how cold is gonna be the winter in Europe or how warm. If we get a mild winter like last year, Europe may be able to weather the problem without much of a additional problem.
If it's really cold in Europe, then there is trouble in Europe. If it is cold in Japan, there is also trouble in Europe because it means that Europe is gonna have to compete with Japan for LNG supplies. And the other big question, and Alex was talking about this earlier, is how much consumers from myself to the big companies are gonna be able to save this winter. We are beginning to see signs that demand in the industry is coming down.
That's in part due to high gas prices. We are beginning to see some substitution on companies trying to run on fuel oil or diesel, some of their operations. And I think that consumers are gonna save quite a lot of gas in part, because to be frank, I don't want to be hit by a 475 pounds a month bill for my electricity and gas. So yeah, I'm gonna put my thermostat a bit lower and how those factors are gonna interact over the next three months is gonna be the key.
But the big problem for policy makers and for traders is that you cannot really model properly. Two of those factors, I mean, you could make assumptions on savings, how much demand substitution is gonna be. You could really try to attempt to answer that question, but you cannot really answer the question of what Vladimir Putin is gonna do and how cold is gonna be the weather four months from now. And that is why it is so difficult and so volatile the market right now. And Alex said, add to that, that there is very little liquidity. So the information on the price is rather imperfect at the moment.
Tracy: (14:22)
That's really interesting. So I take the point that it's difficult to predict what Putin is gonna do, and it's probably difficult to predict exactly what the weather is gonna be this winter. But could you make an assumption about how, or could you try to model how well prepared Europe is for the possibility, for instance, that Russia just cuts off all the gas. Cause I think at the moment, like the flows through Nord Stream, something like one to 20% of normal capacity, what if they just go away? How prepared would Europe be for that scenario?
Javier: (14:56)
If the flows of Nord Stream were to stop, let's say tomorrow, you know, we are not nearly there. We will not have enough gas in storage to make it through the whole winter without having to save a significant amount of gas. That means demand destruction in the industry. If we can build inventories to the 80% target or 90% target that Germany has put itself, which is a target, higher target, by October, November, and then putting shut down completely gas supplies, we will make it through the winter barely, but we will make it through the winter. But that's gonna still require very high prices because you need to make sure that some industries are not consuming gas.
If you have a combination of Putin cuts supplies, say September, October, and we have a cold winter while that really requires some significant savings on energy and that will require the German government effectively taking control of the energy sector and saying, you can consume, you cannot consume cuz we need to, we need to make sure that every home has enough gas for hitting the priority will be the homes and everything else will be secondary to that.
But all of those scenarios also create a problem, even if we make it through the winter without massive troubles, just with an economic recession is a given. But you know, without additional pain, beyond that, we are in a very precarious situation for the following summer and the following winter. So this becomes a bit of a multi-year problem. So even if you make it through the winter in 2022/2023, then you emerge in March of 2023 in a very low situation of inventories and probably with not enough time to rebuild inventories for 2023/2024 in any meaningful way.
So then you have another year of problems. Another year of high prices. Look, it is not how to put it. I mean, it is not really good. It looks very challenging. Best case scenario is we make it through the winter without significant trouble, having to reduce demand in the industry and paying very high prices. Similar to now that I think is best case scenario, worst case scenario is we have to ration gas significantly and pay even higher prices than today.
Joe: (17:26)
Alex, what is your assessment of the inventory situation right now? And then, you know, if this is like, you know, we're not just talking winter 2022 and 2023, like is there more capacity to import gas besides Nord Stream like through terminals or is that just completely maxed out basically?
Alex: (17:48)
I guess on inventories currently, depending on how you configure your model, we're in the 70s now in terms of storage. There's still two months of pretty aggressive storage builds ahead of us. So we will be, by my estimates, you know, in the mid eighties, by the time it peaks, which is generally a very good place to be in terms of storage levels.
And if you look at, you break down, the modal consumption of the way they've present the data in Europe and industrial demand’s already down 20% in a lot of places. And some of that's, we easier saving some of that's BASF moving more of ammonia production to the states, but industry's already very much doing its bit. If you assume households do very modest levels of demand constraint. I don't think the winter's gonna be that stressful.
However, every marginal gigajoule that comes into Europe or gigawatt hour or however you wanna measure gas, that gas has to come outta the LNG market. And that is very tight. And the reason that's tight is, is cuz it had to grow to accommodate Europe very quickly. When it's normally had quite a moderate sort of mid- to high- single digit growth at best, it's had to grow almost 20% this year and that's not easy to do. And the reason that's tied is that you cannot get a lot of incremental gas into the market without more LNG landing capacity in Europe, which is coming in, but also more export capacity from the US.
So over time I agree it's a multi-year process, but that's spread between US gas prices, Henry Hub, and what that translates to into TTF will converge towards Henry Hub, plus a spread, over time, as US gas becomes essentially linked to global L&G prices. Historically it was linked, but it, but it, it sort of broke because we suddenly hit a constraint in terms of export capacity and demand in Europe.
Joe: (19:50)
Just real quickly. To what degree, Alex this aggressive demand for LNG in Europe, how is it spilling over to other LNG importers? And I'm thinking, you know, the natural gas dependent Asian countries, like what is this sort of like global knock on effect?
Alex: (20:08)
It was quite funny as an Australian because it very quickly blew up Asian LNG prices where cargos had to be rerouted, or China, due to lockdowns consume less gas. So resold cargos in spot markets rotated them to Europe. But then in Australia, people thought they were sort of immune. And then by April-May Australian power prices started moving very aggressively up because the European grid will first burn gas if it can. Or consume it, if it can't get that it has to burn coal. And the coal it burns is 6,000 kilo coke coal, which is exactly what is produced in the Hunter Valley of Australia, where most of Australia's Eastern grid's power plants are. So everyone has got swept up in this to one shape or form or another.
Tracy: (21:00)
I wanna bring Javier in on the same topic really. I mean, it has been a pretty rapid adjustment the way the LNG market has done this. And, you know, it used to be a fairly fragmented market. And now it's increasingly globalized because of all these pressures and some other factors. How do you see that shaking out? And how does it sort of change the dynamics of the energy industry as a whole?
Javier: (21:24)
Well, clearly the ability of Europe to tap the LNG market has really saved the day for Europe. If this had happened only 10, 15 years ago where the global LNG market was not nearly as developed as it is today. And the ability to reroute cargos was much lower, particularly on the spot market, Europe would have had a big problem. And the dependency on Russia was much, much higher.
So the LNG market is offering a relief to Europe in so many ways. One of the things that we are seeing, that to me is very interesting, is Europe at the moment is outbidding everyone else on the market, taking the LNG. That's one of the reasons we have these very high prices in the market. I mean, on fundamentals as Alex was pointing out, we should not probably have 200 euros per megahour of gas because the inventories are building in the right direction and we should have enough gas if Putin was to keep the flows. But obviously we need to continue outbidding the whole market for LNG supplies.
And for that, we need to sustain very high prices in Europe for that to happen. What's happening there is that a number of countries that were starting to rely on the global LNG market for supplies, middle income and poor countries thinking the likes of Pakistan or Bangladesh, or even India… they're seen now that European nations and European utilities can pay much higher prices.
So they're not getting the cargos that they were expecting. Some of the cargos that would be going into Asia at the moment are rerouted into Europe. And we are seeing power supply problems in Bangladesh or Pakistan, which is affecting the textile industry. So in a way it may be a case where Europe avoids the blackouts that many of us have been talking, but only because the blackouts move somewhere else, where they cannot really pay the price that Europe is paying for the LNG. And then the blackouts are happening in Pakistan or Bangladesh. And that global LNG market is allowing that arbitrage to happen. Without it, well, it will not be happening. And the blackouts would be happening in Europe because we will not be able to get enough gas.
Joe: (23:45)
Real quickly. Is there any prospect in the sort of near future for there to be a single natural gas price? I mean, there's not a single oil price, but it's close, you know, Brent and WTI and the other benchmarks, they tend to not be that far off. Whereas with natural gas, you know, the gap between Henry Hub and the Dutch number are sort of wildly different and it's different all around the world because the transmission infrastructure is so fragmented. But if this market keeps getting built out and export and import terminals and so on, will, is there a point in the future where there's more or less a global natural gas price?
Javier: (24:18)
No. I think that we are still far away from that. I think that we are getting a lot more integration and you see now that something happens in the US and that's moving the rest of the markets or vice versa. Something happens in Europe and moves the global gas market, but we are gonna still have a lot of spreads and you're not gonna have Henry Hub trading at TTF level. I think that’s far away from today,
Tracy: (24:41)
Alex, I wanna go back to something that you said earlier, which is that the informational value embedded in commodities prices might be less than it was because of the volatility in the market and the uncertainty over the outlook. Can you give us a little bit more color on this aspect of it and what it's actually like trading energy at the moment?
Alex: (25:07)
Well I think it's with any value at risk model, the more volatile a thing is in general and the more thinly traded. So the less volume going through the exchange, or however you measure that liquidity, the more you will be charged to trade that both by exchange margin and whoever you are trading through in my case, or if you're a bank, you trade direct to the exchange, but your internal cost of capital for that stuff goes up pretty quickly.
So yeah, if something realizes more volatility, then extremely marginal crypto tokens, then you cannot get leverage on it, which means your ability to bet on spread trades between maybe I think the price is a bit crazy today, but it's the backend prices are, you know, good value that just becomes very expensive to put on. And when you model out the returns, the amount of capital you get tied up in those transactions gets to be wholly unappealing as a result. People just pull back from the market. And so if you are a physical trader, it generally means that the spot market becomes very wide and disorderly, which is amazing if you're a Glencore or Trafigura or the like, but for people trying to lock in, like industrials, big energy users trying to lock in longer term prices, it becomes more or less unworkable.
Joe: (26:26)
Both of you, you know, can come in on this question. If the price of energy or the price of a given contract, as you say, loses some of its informational value or it's less liquid or harder to arbitrage, what are the consequences of that? Is it that it makes planning harder? Is it that, you know, thinking about what you need to do for the winter? Like what are the negative effects of prices losing their informational value?
Alex: (26:52)
Yeah, I think it's very hard for people to plan. I think it's also modeling people will assume a price on a screen has inherent meaning. And whereas you've often gotta start to take a view as to how, for example, growth in energy export capacity from the US and demand destruction in Europe and landing capacity in Germany will lead to some sort of convergence to some arbitrage condition or close to that arbitrage condition. Because right now it's pretty wild. So I think that, yeah, you really have to have a good view on value to be able to take risk. The other thing you're seeing of course is that if you want to build a solar farm in Europe and get a PPA at what used to be an obscene price, people will just about take your hand off because it's a firm source of power and it's gonna be a lot cheaper than spot. So those guys are doing okay right now.
Javier: (27:51)
Yeah, I think that, I mean, to Alex’s points, I think that just planning, it's becoming very complicated for companies. And also the liquidity, particularly in the forward market, is so thin that anyone that wants to hedge any risk is facing a very difficult time with additional problem that you are hedging any risk. And particularly if you are a power producer and that you want to sell forward. I mean, this is the moment where you will think, well, you know, prices are at record high. You are a power producer: sell forward, lock in revenue, a gray market. But obviously if the market moves against you and goes even higher then you are gonna be facing huge margin calls and those margin calls could just potentially blow a company completely out of the water and run out of credit.
Not because it made the wrong call actually was hiding at risk selling, selling for the, the electricity looking fantastic prices, but then margin calls hit you. You don't have the credit to pay them and, and you could go belly up just because of that. So it is a very difficult market. And I think that for the market right now, in terms of offering a product for laying off risk, it's just not having the value that they used to have.
Tracy: (29:11)
So we have seen a number of efforts to obviously mitigate some of the impact of higher energy prices. What do you think is most helpful or most effective at the moment, Javier, and actually, why don't I ask you also, what do you think is, is the least effective? Just cuz I wanna hear Javier rant about things.
Javier: (29:30)
I think that the most effective thing that you are gonna need to do right now is, I mean, we really are gonna have to support the poorest families through the winter. It's just gonna be catastrophic. I cannot really think what is gonna be for, you know, poor working class families in Europe, when they start facing a bill that is 400, 500 euros or dollars.
And that is most likely all the discretionary spending monthly, just going to pay electricity and gas and they may have kids. They may have elderly people that they need you to keep warm at home. I mean, you know, you don't need the lights to go off to face a problem where people cannot really heat themselves and access electricity. If it's just too expensive, then you could have the same problem. So assisting that class of people, it's gonna be an absolutely priority.
And I don't see nearly enough in Europe done about that. Providing blanket support to everyone, no matter what the wealth is, no matter what the salary is, it's the wrong answer to it. It's just supporting demand in a moment that you need to be restraining demand. So I think that targeted support is critical. Providing blanket support as many governments, particularly the UK, has been providing where everyone is basically getting a rebate and a money from the government is wrong to do.
We are gonna need in Europe to get a lot more serious about trying to be clear to people of what's coming. I mean the Bank of England press conference when they increase interest rates, it was hard to listen to because the governor said we are gonna have a even higher inflation and we're gonna have a one-year long recession, but at least you could criticize whether he was too slow raising interest rates. But it is the first time that I see a policymaker, a central bank governor, a finance minister, just telling the public what is coming and warning in very clear terms what's coming. I think that it's time that prime ministers and finance ministers start to be clear to the population about what's coming and then offer some solutions. But at the moment in Europe, there is not even an acknowledgement of what's coming and how bad it's coming.
Joe: (32:05)
So I'm thinking still about this tail of two homes. There’s Tracy's house, with the big pile of coal underneath, and then Alex's house where there's solar panels on the roof. And it feels like this is the fork of the road, the two different directions...
Tracy: (32:23)
I've gone the non-ESG route.
Joe: (32:27)
Yeah, exactly. So it's like, is this a moment where the world sort of backtracks on some of these ESG goals and starts maybe reopening, or opening new coal mines, which maybe a few years ago seemed unthinkable or is this really catalyzing an acceleration of different renewable energy sources? And it seems like maybe it's both or one or the other, but Alex, I'm curious, like really both of you though, like what do you see as the sort of like first and second order effects of this in terms of where energy investment goes from here?
Alex: (33:00)
Well, personally, if you look at what's in the IRA bill, there's a lot of clues there and particularly things that Joe Manchin was very keen on. The US is gonna export a lot more LNG; there'll be more pipeline takeaway capacity to places like West Virginia. That is absolutely not an accident, at least from Joe's point of view. But I think similarly, you are starting to see in places in Europe where Italy basically allows you to write down the entire cost of getting a heat pump, that sort of demand destruction and pretty muscular approaches to that are gonna be more common. Europe's quite perverse. And particularly the Netherlands until recently, whereby you get sort of protected by the government on gas prices, but you have full pass through of power prices, which are effectively gas prices.
So you're discouraging people from switching their heating to electrification through the structure of your electricity and gas tariffs. And I think there's a lot of cleanup to be done there. But in coal, for example, I don't think that's gonna happen. The only grade of coal that is going bananas right now is the one that you can burn in European coal plants, which have been reopened or the other grades like, you know, Indonesian lower calorific grades… that's already started selling off pretty heavily because China's just importing less coal and producing more of its own. So I think the China impact is going one direction and the Europe gas shortage, and then substitution dynamics going another, I think realistically talking to people in the coal industry, they expect to have a really good time for two years and then be back to maybe not very good times opening new mines would seem to be a poor financial decision, but no doubt someone will try it.
Javier: (34:55)
Yeah I kind of agree with Alex. I think that we are not gonna as the international coal mining, just having a boom, but we are gonna see more coal mining in China and in India. And, you know, the expectation is for this year global coal demand to heat, too much, the 2013 peak and in 2023 on an annual basis, we will set probably a new all time high.
I think that the biggest consequence of the current crisis is gonna be a sharper focus on energy security. That was, I wanna say abandoned, but they, energy security took a backseat to climate change over the last five years or so. I think that you are gonna have now energy security at the same level as climate changes in terms of concerns by policy makers. And that most likely is gonna mean a slowdown in some of the climate changes initiatives you are gonna have, you are gonna keep a lot more of coal fire generation on standby at least. You're not gonna shut down the plant and dismantle them for good.
You will keep them on standby. I think that it's gonna be a reconsideration of nuclear in many, many countries. I mean, we are beginning to see when the Germans, despite everything, they are beginning to warm up to the idea that maybe keeping the plants a bit longer is not such a bad idea.
But I do think that we are gonna see also many individuals where possible to try to install solar panels on their houses. So I think that we are gonna see on the next few years, a boom in solar installation on individual houses that is gonna depend a bit on prices. I mean, the price of solar panels is starting to go up, uh, I'm speaking from, from own experience about this house, because, uh, that will be my first investment on the house.
Just put the solar panels. I do have solar panels for the hot water. So I think that the shower is guaranteed over the winter. It may not be very warm, but it's gonna be at least there, but I would not be surprised if in many European countries, we see many houses that don't have a solar panel today, that they will have a solar panel by 2025. Because I think that people have learned a lesson and say, well, if I can generate myself a bit of electricity, that is gonna be very important. The other thing that I, for the first time, am beginning to see a lot of attention is modeling electricity demand for the next few years.
Electricity demand in many OECD countries has been relatively flat despite economic growth over the last few years, but we are gonna put quite a lot of more electricity consumption into the grid coming from electric vehicles, coming from heat pumps. And that means that previous assumptions, that electricity demand was not gonna increase, need to be revised. And I see a lot of people now beginning to spend quite a lot of time of modeling electricity consumption in Europe and in the us for the next five or 10 years. And the message is coming is that the demand is gonna go up and, and going up in some cases, quite meaningfully.
Tracy: (38:22)
Alex, talk to us a little bit more about what China is doing here. I mean, both in terms of energy transition such as it is in China, but also in terms of securing additional gas supplies. Because one of the interesting things we've seen this summer is that while it seems like the rest of the world is really scrambling to get as much LNG as possible before the winter, China has mostly stayed out of that market. And doesn't really seem to be ramping up imports or not trying to secure additional supply what's going on there. And if they come back into the market, you know, at the last minute, is that gonna drive up prices?
Alex: (39:02)
It may well do. If they do that, though, if you look at the data for China's pipeline imports from Kazakhstan, Turkmenistan, and Russia, they are more or less running those pipelines flat out at this point in time. So they have massively increased their purchases from Russia and Kazakhstan. The data is getting a little bit, well…. accuracy is more contested than it was a couple of months ago.
But they appear to be buying a lot more and that's, that's relatively uncontested. There's also longer term. And this is a big question for the LNG market and is that they're talking about doing a very large pipeline power of Siberia too, which would then lead to a question of how much more LNG is China really going to import cuz a lot of the, power that China or a lot of the LNG that China is imported historically is very seasonal.
It's often geared towards heating in Northern China in the winter and recent promulgation from, you know, the relevant organs have indicated they want to go very hard on heat pumps also for, for actual load balancing in their power grid. They now want to do, I think it's 250 gigawatts of pumped hydro so that they can better utilize their coal resources. So China's making a push much like everywhere else for essentially friend ensuring their energy supply to people in the greater URA land mass as well as also just trying to reduce their reliance on gas, full stop, because they are price sensitive like everyone else. And if they have a lot of high quality coal, they can burn instead and LNG costs 40 bucks or more, um, per gig oil equivalent, then they absolutely don't have time for that.
Joe: (40:47)
Javier, I just wanna go back to something you were talking about before and this idea of energy security, maybe becoming on the same level as a priority of climate, but you know, just in general or sort of Europe specifically, and then more broadly, like what do people think about ESG these days?
Do you see some of the resolve weakening on some of these efforts that were very popular in the 2010s to, you know, reduce emissions? Do you see a sort of like actual backlash coming to this and maybe like people questioning is like, was going, you know, was trying to discourage investment really, uh, a useful exercise given where we are with, uh, you know, cold demand today? Like what do you see as the sort of near term future of ESG either at a sort of like corporate level or just a sort of a policy level?
Javier: (41:38)
Well, to me, it was very interesting when earlier this month in August, we had the Glencore first-half results and they have the conference call and obviously Glencore is the world’s largest commodity trader and is a big miner of coal. It's the largest exporter of thermal coal in the seaborne market.
And typically, you will expect some investors or sell-side analysts just giving the company a bit of a hard time, “Why you are still investing in coal? Why you are not spinning off the business? Why you're not selling it? Sell it to the Chinese.” It was a typical question and in this conference call actually a sell-side analyst from a big major American bank, ask the CEO of Glencore, he said something like, you know, the world is short of energy. What is gonna take you to start investing in coal mines to help the world in the short term with, with supply?
And to me that was the kind of “aha moment.” I mean like when, you know, when a sell-side analyst is kind of saying, “No, actually the question here to us is why these guys are not investing more on call?”
That's how I think ESG is taking right now. I mean BlackRock put it quite well earlier this year when it was just describing views about some of their shareholder resolutions on climate change, and they said that those resolutions, they needed to take into account the current geopolitical context, the energy market pressures and the implication of both into inflation. I think for the time being ESG has gone, at least on energy and commodities, has come from really the hottest selling item. I asked recently a big European institutional investor about ESG. And, and he was saying to me, “That is very yesterday. It’s not really what I'm focusing right now.” Is it gonna go away? No, I don't think it's gonna go away. This is a cyclical business. High prices give way to low prices. And I think that at that point, ESG is gonna be back. But for the time being, I think that you are gonna have a lot of investors just paying lip service to ESG and climate change. And at the same time as Glencore, are you gonna put more money into the coal business or not?
Alex: (44:06)
Can I just say something on the ESG thing? I think there's a real problem with the interactions between both investors and the companies in that people do not make big, good equilibrium models of what demand should be for these fuels over time. And so when the war happened, obviously there was some quantum of gas and coal taken out of the market. And then there was sort of a record scratch and ESG investors could not change their tune or answer, well, how does this change things? You know, how do we get the fuel supply? Should we think about the geopolitical risk weighting of our fuel supply? There was absolutely no response to that, but unfortunately, and this has been no credit to people on in the energy sector, is they have not developed a coherent response aside from “let's drill some holes now.”
And so I suspect we're gonna probably get over-investment and then the energy sector will probably look silly again in course, especially the most marginal fuels, namely thermal coal. And so I think there needs to be a lot more of an effort to model the world well so that we can pick up things, you know, like we did in our paper that China was probably just gonna step away from coking coal maybe forever. And that's that stuff's important, but it's, it's hard modeling and it is not done enough today.
Tracy: (45:38)
Alex and Javier, we wanna give you guys the opportunity to ask each other a question. So maybe we start with Alex. Is there anything that you wanna ask Javier
Alex: (45:48)
Javier, I mean, when you talk to all the trading houses, I mean, what is the general sentiment of the guys who are in physical trading that you talk to? I mean I talk to a lot of the folks in Singapore, but it clearly seems like complete disorder in European power right now.
Javier: (46:07)
I think that everyone's trying to balance the risk of supply and the recession that is coming in in Europe. I still see most traders, quite bullish thermal coal and LNG supplies and gas in Europe. With oil, they have a bit of a less clear outcome because there are so many moving pieces and each of those moving pieces is a million to 2 million barrel a day, a piece. I mean, is it gonna be a deal with Iran? Are the sanctions in US, the European sanctions on Russia are they really gonna hit hard or not? Is China gonna rebound from COVID or is gonna remain with the zero COVID policy?
So they're a bit confused, but one thing that a lot of people seem to think is that we are not yet over on oil with is diesel in particular. And I hear a lot of concerns about the diesel situation coming later this year in Europe. That is one that perhaps we are not on the season. So it's kind of dropped a bit out of the radar for a lot of people, but there are a lot of concerns on physical trading houses where Europe is gonna have enough diesel this winter
Joe: (47:23)
Just real quickly. What is the issue there? Why diesel specifically and why the seasonal element of it?
Javier: (47:28)
Well, obviously we need more diesel because diesel is also heating oil for winter. And we still use it particularly in Germany for a lot of heating oil for the winter. And also because we are beginning to get a sense that if there is a problem of gas supply or companies see these high gas prices remaining, a lot of the incentive is to try to run on diesel or heating oil through the winter because economically that makes sense. And, you know we have seen even huge multinationals, like a BASF, the big German chemical company, talking about using fuel oil or diesel as an alternative to gas and sorry a lot previously, a lot of the diesel was coming from from Russia. So from February in theory, Europe is not gonna be importing any diesel from Russia.
And that's when, you know, we have been talking about all the announcements on sanctions were for tomorrow, but that tomorrow is getting closer and closer by the day. By December, Europe cannot buy Russian crude anymore. We are still buying it. And by February we cannot buy refined products. And when you take that amount of supply from the market it gets complicated.
So Alex, my question to you. You are based in Singapore, very good view about Asia, how you see the response, which I'm very, very curious, because we, we sometimes forget about Japan, you know, particularly from the point of view of Europe. But you know, it is still the, for largest oil consumer is a huge, I import of LNG and has a huge nuclear industry. I mean, to me it is one of the most important energy countries. Even if the demand there is no longer growing, but it's still a huge consumer. What do you think the Japanese government in particular and, and that kind of intersection between the Japanese government and the minister of METI and the Japanese trading companies. What are they thinking, how are they responding to this crisis that has put the wall of energy upside down?
Alex: (49:36)
When I speak to people there, and some people at METI, they are engaging in as broad, and I would say a deeper, rethink of some of these issues, both for both, for the energy shock reasons, but also for security reasons, due to recent developments, as much as anything since the 1970s.
I'd say there is all sorts of things that were considered quite futuristic, for example, like using ammonia made from renewables in Australia, you can blend about 20% of it into the fuel of a coalfire power plant without substantial retrofits. That's all been pulled forward, I would say five years. So they are considering that sort of stuff. They're also considering, and they have been doing a lot more in renewables as well, both in terms of looking at agrivoltaics.
So due to heat stress from, from the recent, really a brutal weather they've had, people looking at basically putting solar in the middle of fields to reduce heat stress on plants, because you don't actually lose much of anything in yield. So there's a lot of stuff which is a little bit, maybe not science fiction, but further down the critical path that has now been pulled forward, as well as of course trying to get nuclear plants restarted. But I think there's also recognition that we are unlikely to, unless Saudi Arabia were to, um, evaporate or Australia, you know, levitated off into the outer galaxy or something like that. You're unlikely to generate as big shock for them in terms of energy, uh, ever again.
Joe: (51:16)
Real quickly, and we're just about to wrap it up, but Alex, since you mentioned heat stress, this seems to be a thing that bubbles up everywhere. And, you know part of this story with the French nuclear is that they had to pare back production because the rivers were so hot that they couldn't dump additional hot water. We know that there are concerns with river levels in, uh, Germany. It's also in the American Southwest, very big concerns about, uh, water levels, like to what degree is climate itself contributing to, uh, strains on the production of energy around the world?
Alex: (51:51)
Can, can I give you a specific example
Joe: (51:52)
Please!
Alex: (51:53)
So there are a couple of nuclear plants in Switzerland. One of which was just in the middle of sort of a little ladder fish island and a river, and does not have a cooling tower. So the design was the river's always cold. It's Switzerland. We can just use the river to cool the plant, no problems, right? Unfortunately now you get to a point where they can't run the plant as hard because the water level, the temperature in the river, gets too high. And it's not that the river's about to boil off or anything like that, but you will kill all the fish who don't really handle temperatures above 25 degrees centigrade. So that there's all these kinds of subtle constraints in these systems that you just kind of glide over as an assumption, but as the climate changes and systems change, these become real issues in terms of how you can run a fleet of power assets,
Tracy: (52:45)
Right? And then it becomes almost self-reflexive because as the energy crisis worsens climate change, some of those like second order effects make it harder to transport commodities or produce commodities. And then you have to go back to dirtier energy, like coal. I'm thinking specifically about the water levels of the Rhine issue. The fact that it's more difficult to get commodities up the river, given that the water levels are so low. All right, Alex, and Javier, that was a fascinating discussion. I feel like we covered quite a lot of ground on what is a complicated topic. So thank you so much both of you for coming on. All thoughts.
Alex: (53:21)
Thank you. Thank you very much.
Joe: (53:23)
That was great. Thank you so much for coming up.
Tracy: (53:40)
So, Joe, that really was an informative and thought provoking conversation, I thought. So one thing I hadn't realized, but both Javier and Alex kind of brought it into sharp relief was just the idea of maybe the price of commodities aren't telling you as much as they used to in the current environment.
It seems like traders are having difficulty with volatility, you know, Javier mentioned margin. And the fact that it's difficult to trade, if you think that your position is going to blow up, you know, in the next week or two. And then the other thing that really struck me is the follow-on uncertainty from all of that on actual companies and manufacturers and producers, because I think Javier was the one who made this point. It does seem like a huge impediment to investment and just normal business if you think you aren't going to be able to hedge your energy needs.
Joe: (54:35)
Totally so many interesting things. That's like a really big one. And of course, you know, some of our conversations earlier this year with Zoltan Pozsar were kind of about that and how these energy trading shops were the new banks. And if there's a decrease in liquidity at the new banks then you know, that creates all kinds of new issues.
The other thing I was thinking about is this idea of Europe being far and away the top bidder for LNG. You know, one of the stories that gets told throughout history is EMs are particularly hit hard in a Fed hiking cycle. Interest rates go up and the liquidity drains. And we are seeing some of that, but there's also now this other cycle layered on top of it, where many of those same countries, in addition to seeing higher interest rates, are also seeing the energy that they might have bought get bid away. And so as Javier puts it, you know, it's like basically shifting blackouts this winter from Europe to poorer countries.
Tracy: (55:37)
Yeah. And this to me is a very, very big takeaway from the conversation. There are a number of them, but the globalization of the LNG market that we've seen in recent years, and there's been so much focus on what's happening in Europe because of Europe's proximity to Ukraine. Because it's the, the most directly hit by Russia's invasion, but the knock on effects are arguably bigger in a country like Pakistan, which, I mean, my mother used to live in Pakistan too. S I know that there are many, many blackouts in Pakistan and it's sort of a constant issue there, but it seems like they might actually suffer a lot more than Europe, even though the focus is on Europe at the moment.
Joe: (56:24)
Yeah, absolutely. Yeah. So many interesting things have that conversation. It's such a treat to like talk to people who are just like, so in the weeds and can get so technical and detailed and also can explain things. So clearly, you know, I think that last point that Alex made probably deserves its own episode — heat stress on the energy system itself, because, you know, he mentioned that situation. It's like you put up a nuclear plant in Switzerland. Oh, we're always gonna have access to plenty of cold water. It's literally Switzerland and then suddenly that gets called into question.
And then I think there's water levels elsewhere are an issue. We saw it in Texas on the flip side when we had those freezes and some of those natural gas power plants that hadn't been properly winterized went down at the exact moment that everybody was cranking up their heat, like all kinds of interesting interplay between climate change or extreme weather events and the production and transmission of energy itself. That feels like a whole episode at some point in the future.
Tracy: (57:28)
It's another Odd Lots episode that has led to another Odd Lots episode in the future. Those are the best ones, those.
Joe: (57:35)
Those are the best. Those were two great guests for for talking about them.
Tracy: (57:40)
For sure. OK. Shall we leave it there?
Joe: (57:42)
Let's leave it there.