Jupiter Merlin Weekly: Warm weather confounds Putin’s plans
Jupiter Merlin Weekly: Warm weather confounds Putin’s plans
The Jupiter Merlin team discuss energy markets, as warm weather in Europe takes pressure off demand, but consumers and business alike continue to feel the pinch.
Investment Manager, Jupiter Independent Funds/Merlin
Investment Manager & ESG Investment Director, Independent Funds/Merlin
Upside down weather frustrates Putin’s plans
Welcome to 2023. It’s already the end of the first week in January. There is more snow for skiing in the Scottish Cairngorms than in large areas of the Alps. In central Poland the thermometer this week has been as high as 19 degrees centigrade; usually at this time of year the average daytime temperature is -3 degrees. Thanks to the El Nina cycle, with the Jet Stream well to the south of its seasonal norm and drawing warm, humid air up from the Atlantic and Africa, rather than being to the north and pulling dry cold air from the Arctic, continental Europe is basking in unseasonably warm weather. Even when the UK had a two-week cold snap in December, most of the Continent missed it.
If Vladimir Putin was gambling that closing the gas taps to Europe ahead of the winter would subsequently create a state of twenty-first century dystopian misery (although he has certainly achieved that in large parts of Ukraine) and precipitate a major political crisis in the EU, so far that strategy has failed. The weather decided not to cooperate with his big plan. He has surely been a malign catalyst behind runaway inflation and incipient recession but the lights remain on, factories are still humming and the inhabitants of those member states previously reliant on Russian gas are still able to heat their homes and to cook.
If Vladimir Putin was gambling that closing the gas taps to Europe ahead of the winter would subsequently create a state of twenty-first century dystopian misery (although he has certainly achieved that in large parts of Ukraine) and precipitate a major political crisis in the EU, so far that strategy has failed. The weather decided not to cooperate with his big plan. He has surely been a malign catalyst behind runaway inflation and incipient recession but the lights remain on, factories are still humming and the inhabitants of those member states previously reliant on Russian gas are still able to heat their homes and to cook.
Europe breathes a sigh of relief, dodges the gas bullet
The gas storage tanks, topped up with imported LNG from the United States, Qatar and Libya in the late autumn, are still at more than 80% of their capacity (the Trading Economics website cites 83.5% full as of 2nd January, versus 70% as the seasonal norm). As time marches inexorably on towards the spring, the longer it stays mild with little if any excess usage, the greater the likelihood of the EU emerging relatively unscathed and avoiding energy rationing. Having already closed off supplies and with the Nord Stream 1 and 2 pipelines significantly damaged, specifically concerning gas Putin seemingly has no more cards to play holding western Europe to ransom (the same does not apply in oil). It does not mean that Europe’s strategic energy crisis is over, far from it. Many countries including the UK are still adopting the classic ostrich position: bottom-in-the-air-head-in-the-sand, hoping that come 2030 and the self-imposed deadline for the prohibition on the sale of new combustion engine vehicles, and in the absence of a viable alternative fuel for mass transportation, somehow in the ensuing years there will be enough electricity to go round to meet all our demands. In the UK, our government’s deluded idea (and let it be said the Opposition parties, largely in awe of Greta Thunberg, Extinction Rebellion, Just Stop Oil and others, are just as clueless on this subject) that in the new carbon net-zero world sufficient electricity can be generated to power the world’s sixth largest economy principally using unreliable wind and sunshine, is for the birds.
“What’s all the fuss about?”
But back to business. Literally. Since the energy hiatus which did for the 44-day Truss administration last autumn (politically it might have been the £2bn unfunded reduction in the 45p top tax rate that was her undoing, but it was the ludicrous £175bn targeted at capping the price of electricity and gas where the fiscal maths spectacularly fell apart), European wholesale gas prices have tumbled. In fact, the benchmark Dutch TTF gas price peaked on August 26th at €339/MWh, fell to €97 on November 11th, rallied 54% to €159 by December 7th and today stands at €68/MWh. In the UK, ‘Business’ is worried: the six-month energy cap for the industrial sector expires at the end of March. Business leaders are pleading for financial aid on current terms to be continued.
Having noted that prices have not only fallen 80% since August but are back to where they were before Putin launched his invasion of Ukraine last February when Dutch TTF was €67/MWh, as Nick Robinson on the Today Programme was moved to ask of a business leader this week, “so what’s all the fuss about?” The hapless interviewee failed to make his point, blethering on about how difficult it all is.
The nub of the issue is what was not discussed: that even at €68/MWh and having more than halved in a month, the price of gas is still significantly higher than industry was used to paying before Putin started weaponising it, using it as a geopolitical lever, in August 2021. For the fact is that until June 2021, the wholesale gas price in Europe had never been higher than €30 in more than 10 years since the economic recession in the aftermath of the Global Financial Crisis; for virtually all of 2019 and 2020 it was less than half that, below €15/MWh (for a couple of months early in the pandemic, it was even below €5/MWh).
Essentially, industry was conditioned to thinking that energy in the form of gas was available literally on tap, unconditionally, and that it was cheap and its price nominally relatively stable. It was an important input, especially in heavy-use industries such as glass manufacture, chemicals, fertiliser production (a by-product of which is CO2 used in the carbonated drinks industry, food production and packing), and of course, electricity generation, but one whose price could be largely removed from the business margin equation. Putin exploded that myth.
Having noted that prices have not only fallen 80% since August but are back to where they were before Putin launched his invasion of Ukraine last February when Dutch TTF was €67/MWh, as Nick Robinson on the Today Programme was moved to ask of a business leader this week, “so what’s all the fuss about?” The hapless interviewee failed to make his point, blethering on about how difficult it all is.
The nub of the issue is what was not discussed: that even at €68/MWh and having more than halved in a month, the price of gas is still significantly higher than industry was used to paying before Putin started weaponising it, using it as a geopolitical lever, in August 2021. For the fact is that until June 2021, the wholesale gas price in Europe had never been higher than €30 in more than 10 years since the economic recession in the aftermath of the Global Financial Crisis; for virtually all of 2019 and 2020 it was less than half that, below €15/MWh (for a couple of months early in the pandemic, it was even below €5/MWh).
Essentially, industry was conditioned to thinking that energy in the form of gas was available literally on tap, unconditionally, and that it was cheap and its price nominally relatively stable. It was an important input, especially in heavy-use industries such as glass manufacture, chemicals, fertiliser production (a by-product of which is CO2 used in the carbonated drinks industry, food production and packing), and of course, electricity generation, but one whose price could be largely removed from the business margin equation. Putin exploded that myth.
“Not our fault, guv”
Consumers, both industrial and domestic, can fairly claim that the predicament is none of their own making. The reactions of governments to two global exogenous shocks, one a pandemic, the other a major war in Europe, are the problem. In the case of the pandemic, the extraordinary and huge distortion simultaneously to the supply and demand sides of the economy when populations were first confined to barracks in 2020 and then released when the vaccination programmes began in 2021. As for Ukraine, the western sanctions regime and Putin’s malign influence have significantly skewed world commodity markets. In addition, in the UK, the corporate sector faces the combined headwinds not only of rising wage rates (which tend not to go down, unlike volatile commodity prices), but also a big rise in business taxes imposed by the current Chancellor and proposed by his predecessor, Rishi Sunak.
Hunt: dancing on the head of a pin
Chancellor Jeremy Hunt significantly diluted Truss’s original energy price cap proposal for both the business and domestic sectors. As the deadline rapidly approaches for the industrial aid package effectively to end and faced with truculent industry leaders and having to keep on the right side of the markets when it comes to managing government debt, in proposing scaling back the aid he is prepared to avoid a cliff-edge for business but not to write an open-ended blank cheque. His argument is simple: it’s a global problem, he’s helped UK industry through the worst; it has cost £18bn; continuing at the same rate is unsustainable, business now has to look after itself. He is probably also watching the rapidly changing dynamics of international energy markets (as of 2022, the US is now the biggest global exporter of LNG) and taking a punt that medium-term wholesale gas prices still have further to fall.
State aid, an unlevel playing field
Both sides have a point.
Inevitably, looking behind the scenes the picture is far less simple beyond a superficial view. Other western governments have also been active in developing their own state aid packages to help with the cost-of-living crisis and to mitigate against inflation. Each is tailored to its own unique domestic economic and political circumstances however much global energy costs are a common problem. The result is far from a level playing field. Take Germany as a good example: its energy relief package for industry only began only on 1st January but lasts until April 2024, a year after ours has been pared back; further, in the German programme there is the facility for companies to re-sell their surplus specified allocations of subsidised gas back to the market (one Belgian think-tank estimated that a big gas-user such as chemicals giant BASF could potentially net a windfall gain of over €2bn through such a mechanism). From a UK business perspective, in a highly competitive environment it is easy to see why British companies feel bruised that they are being placed at a significant disadvantage.
Inevitably, looking behind the scenes the picture is far less simple beyond a superficial view. Other western governments have also been active in developing their own state aid packages to help with the cost-of-living crisis and to mitigate against inflation. Each is tailored to its own unique domestic economic and political circumstances however much global energy costs are a common problem. The result is far from a level playing field. Take Germany as a good example: its energy relief package for industry only began only on 1st January but lasts until April 2024, a year after ours has been pared back; further, in the German programme there is the facility for companies to re-sell their surplus specified allocations of subsidised gas back to the market (one Belgian think-tank estimated that a big gas-user such as chemicals giant BASF could potentially net a windfall gain of over €2bn through such a mechanism). From a UK business perspective, in a highly competitive environment it is easy to see why British companies feel bruised that they are being placed at a significant disadvantage.
Meddlesome governments?
In an earlier column, back in 2019 before the pandemic and Putin’s war, we discussed the extent to which the Tories (Theresa May was the culprit) had pinched Ed Miliband’s Labour populist idea for a regulated price for domestic electricity. In the way that it was structured, we argued that from an investor perspective the dice was loaded against providers of private capital to electricity generators and distributors in an innately asymmetric system (input costs highly variable and subject to global forces, output prices fixed by decree). The environment now is significantly more complex and, like it or not, national governments’ interference on a grand scale, however understandable, has only exacerbated the tensions.
Among commodities, energy is unique. It is the only one traded internationally which all of us uses directly, daily and in quantity in its raw or refined state; further, in the case of oil, a third of global production is controlled by OPEC+, a cartel which fixes production quotas, something which is illegal in any other environment. In some countries, energy is nationalised, in others it is fully privatised while a third model such as ours is euphemistically what might be termed a ‘regulated hybrid’ or more prosaically a ‘bit of a mess’.
But what the completely unconnected events (war and pestilence) of the past three years have reminded us of is that energy can never be taken for granted. Over four decades since the 1980s global developments have lulled us into a false sense of security that energy had a diminishing ability to cause significant economic damage, notably its effect on inflation. The landscape has changed. And all of this before we really get under way with the biggest of industrial revolutions when in less than three decades governments attempt virtually to replace the source of fuel which has powered the development of global society for the past three hundred years.
For investors, opportunities abound. However, the path remains liberally strewn with cowpats for the unwary, particularly as the western democracies on their short-term electoral cycles remain acutely sensitive to the variable and fickle winds of public opinion, are susceptible to lobbyists of all varieties and who have an infinite propensity to meddle without always understanding the consequences.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
Among commodities, energy is unique. It is the only one traded internationally which all of us uses directly, daily and in quantity in its raw or refined state; further, in the case of oil, a third of global production is controlled by OPEC+, a cartel which fixes production quotas, something which is illegal in any other environment. In some countries, energy is nationalised, in others it is fully privatised while a third model such as ours is euphemistically what might be termed a ‘regulated hybrid’ or more prosaically a ‘bit of a mess’.
But what the completely unconnected events (war and pestilence) of the past three years have reminded us of is that energy can never be taken for granted. Over four decades since the 1980s global developments have lulled us into a false sense of security that energy had a diminishing ability to cause significant economic damage, notably its effect on inflation. The landscape has changed. And all of this before we really get under way with the biggest of industrial revolutions when in less than three decades governments attempt virtually to replace the source of fuel which has powered the development of global society for the past three hundred years.
For investors, opportunities abound. However, the path remains liberally strewn with cowpats for the unwary, particularly as the western democracies on their short-term electoral cycles remain acutely sensitive to the variable and fickle winds of public opinion, are susceptible to lobbyists of all varieties and who have an infinite propensity to meddle without always understanding the consequences.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
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