European gas and electricity prices break records almost daily. The effect of energy on an economy is often underestimated. Almost all economic activity consists of energy, but in a different form.
Labour is energy. The production of capital goods requires a great deal of energy, and even more energy (labour) can be saved. Conversation is energy and doing something requires energy. Products, services, in fact everything consists of energy. Money is a form of stored energy. It can be converted into any form of energy: into food, a house or a car. Money is only energy when it is spent. Debt is negative energy, no problem as long as it is used to make investments that, in the long run, create more energy.
The first economic form of energy was human muscle power, followed by the control of fire and the use of animals as draught animals and pack animals. With the sail, one could make use of the wind. Mechanical energy generation started with wind and water mills. Peat formed the basis of prosperity in many northern European countries during the Golden Age. The industrial revolution was made possible by fossil fuels, first coal and coke and then oil and gas. In the last 150 years, strong economic growth has been made possible by exploiting fossil fuels as efficiently as possible, so that we now burn around 100 million barrels of oil a day.
Whoever has access to cheap energy has a competitive advantage. China had such a competitive advantage between 2000 and 2011. The country burned plenty of Chinese-produced coal, to the detriment of the environment and the lungs of the Chinese, but nowhere was the electricity it produced as cheap as in China. It is therefore not surprising that the Chinese economy, and with it the stock market, performed excellently in that period.
The baton to the US
After China, the baton was taken over by the United States. Thanks to technological innovations such as the extraction of oil and gas in shale rock (fracking) and horizontal drilling for oil, American oil and gas production has risen sharply. This shale revolution provided an additional competitive advantage to the US economy.
Partly as a result, the recovery from the Great Financial Crisis was remarkably fast and US equities began a long winning streak against equities outside the United States. However, the shale revolution is now over and, with recent developments, it is certainly not Europe that can take over from the United States.
When energy has become unaffordable, an economy cannot help but shrink. This is particularly true in Europe at the moment. Dependence on Russian energy is pushing up prices, especially in Europe. That immediately puts us at a competitive disadvantage compared to other regions in the world. Yet Europe is not an island.
In the past, natural gas prices were determined by regional conditions. Thanks to the use of liquefied natural gas, this form of energy can be transported all over the world. With these high gas prices, Europe has become the main marginal buyer of natural gas. Therefore, all the gas that does not have to be delivered against fixed contracts is now going to Europe.
This inevitably means that gas prices will rise elsewhere. This will mainly affect the poorest countries, because they will no longer be able to pay for energy, thereby widening the gap between rich and poor. Meanwhile, producers and consumers are switching to alternative forms of energy. Clean, but also less clean. German industry has started to switch to fuel oil, for example, because the oil price has lagged far behind European gas and electricity prices.
Coal and coke are popular again, it is just a pity that they are difficult to transport at the current low level of the Rhine. Consumers are switching to other forms of energy: wood, petroleum or via solar cells. Even electric cars have become more expensive with the high electricity prices, the advantage of the hybrid is that only driving on petrol or diesel is then quickly cheaper. As so often, people adapt. Something that is often underestimated in economic models.
Most predicted recession
So high gas prices in Europe mean more demand for oil in the form of heating oil for industry and petroleum for home heating. The oil price has also risen in recent months, but only in the somewhat longer term. In fact, in recent months, financial markets have been in the throes of the most predicted recession ever. That in itself is something special, because a recession usually comes unexpectedly. When speculation about a recession is rife, it is quickly discounted in the prices.
The prices of commodities, including oil, have fallen in response to this recession news. At the moment, the spot price of oil is still falling, but from about two years down the futures curve, oil prices are rising. The cyclical pressure of a recession is in fact countered by the fact that there is structurally insufficient investment in new production. The scarcity remains.
The big advantage of switching from gas to oil is that it makes Europe less dependent on Russian energy. At the same time, Russia does have somewhere to go with that energy. At present, Russia is being boycotted by about 1.5 billion people. In a total world population of more than 7 billion people, there are therefore enough consumers left.
Russia may stop supplying NATO members with energy, but supplies to China, India and other parts of Asia are being increased. Often these countries can buy energy at much lower prices than Europe. If this situation continues for a long time, energy-intensive companies in Europe will lose out to their Asian competitors.
In recent decades, much business has moved to Asia because of low wages there; now lower energy prices will be an argument for companies to move their production to Asia. In addition, less developed countries cannot afford the energy transition. They see it as an expensive hobby that is only reserved for rich Western countries. For these countries, energy security is much more important than energy transition. Then the cheaper energy from Russia comes as a present. The price differences therefore also frustrate the energy transition.
Whereas Europe has to contend with relatively high wages and relatively high energy prices, this development enables Asia to compete more effectively with European and also American companies. And cheap peat made may well result in a Golden Age for Asia. Europe will once again draw the short straw.
Han Dieperink is chief investment strategist at Auréus Asset Management. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. His analysis appears in Dutch every Tuesday and Thursday and in English usually on Thursdays.