The week of August 1, 2022: Europe’s energy woes, regulation, inflation, climate, and much, much more.
The week of August 1, 2022: Europe's energy woes, regulation, inflation, climate, and much, much more.
J ust under a year ago, I gave a Capital Letter the headline “Winter is Coming.” Not very original, but there we are. The topic? Rising energy costs in Europe. Matters have not — shall we say — gotten better since then.
Currently, TTF natural-gas futures (a good reference price in Europe) for September 2022 are trading at a level nearly five times the price of the equivalent future a year ago, which at that time was itself nearly twice as expensive as its counterpart in August 2020. The panic-inducing price levels of eleven months ago now look like a happy memory. Today’s price is still far lower than the spike that followed Russia’s invasion of Ukraine, but it is again moving upwards thanks to Russia’s decision to cut flows to Germany through Nord Stream 1 to some 20 percent of normal levels for “technical reasons,” mainly revolving around a confected drama involving a turbine.
As I noted in the most recent Capital Letter, toying with Europe suits Putin’s purposes well. It’s a constant reminder of the damage he can do. The high gas price has more than made up for the lower volumes delivered, at least up to now, and there’s plenty of cash in the Kremlin’s till (Russia’s current-account surplus may roughly double this year, to some $200–250 billion). If the war drags on (best guess, it will), and high energy prices pummel Europeans, the chances that Europe’s leaders will be willing or able to maintain some sort of united front in support of Ukraine will dwindle, creating just the sort of dissension that Putin enjoys exploiting. At some moment (just before the winter, in the view of Bloomberg’s Javier Blas, which seems right), Russia will switch off the gas altogether.
That’s why the Europeans have been scrambling to fill up their gas reserves (no easy task given the sharp reduction in flows from Russia).
Nations are lining up alternative supplies and infrastructure to import more liquefied natural gas, and storage sites are now about 70% full, in line with the five-year average. The storage injection rate remains “the bright spot” for the market, said analysts at Alfa Energy Ltd.
Falling demand is also helping:
In July, industrial gas use dropped by 19% year-on-year in the region and 24% in Germany, according to analysts at Morgan Stanley.
Of course, what that says about German industry is none too reassuring. According to a survey published in late July by the Association of German Chambers of Industry and Commerce, nearly one in six industrial firms are cutting back (or even abandoning) production because of higher energy costs, which they simply cannot pass on.
It’s a sign of the times that German chancellor Olaf Scholz has said that it could make sense to keep open the country’s remaining three nuclear power stations. Whether anything will come of that remains to be seen. That Scholz will even consider it, given how politically tricky it could be, is a measure of how worried he is. As he knows, things could be trickier still if Germany runs into a major energy crunch this winter.
Last week, the EU agreed to a voluntary scheme to reduce gas consumption by 15 percent this winter despite earlier grumbling (noted in the last Capital Letter) from a number of EU member-states, including some badly scarred by the euro zone crisis. After all the lectures from Berlin a decade or so ago, they found a certain irony in the fact that they were now being asked to help Germany emerge from the wreckage created by Angela Merkel’s reckless Energiewende. The only hold-out from the voluntary arrangement was, predictably enough, Hungary, a regular outlier. A 15 percent reduction should be enough to see the EU through the winter.
One of the questions that came up when a voluntary agreement was being discussed was whether, under certain circumstances, there should be mandatory cutbacks, something that the EU Commission (the EU’s bureaucracy) had reportedly already suggested that it had the right to do under Article 122 of the EU Treaty. This would have been a stretch, but someone in Brussels evidently thought it was worth a try (never let a crisis go to waste). Wiser heads prevailed and the EU Council, which is made up of the prime ministers of the different member states together with its president and the EU’s top bureaucrat, agreed (Hungary, again, dissenting) that those cuts will become mandatory for most countries (there are some exceptions) in the event of “a complete halt of Russian gas supplies by the end of [2022]” and subject to certain other conditions. Expect some interesting discussions if the EU reaches that point.
Restrictions on gas usage are already coming in. Hanover (Germany) has cut off hot water in public buildings, swimming pools, sports halls, and gyms, and other German cities have followed suit. Nuremberg has closed three of its four public indoor swimming pools. Households in Munich are being offered €100 if they cut their energy use by 20 percent, and, the Spectator’s James Forsyth reports that the city’s authorities are mulling establishing “heating havens” for those who cannot afford to heat their homes. Vonovia, Germany’s largest private residential landlord, (which owns around 500,000 apartments), is cutting heating at night to 17 degrees Celsius (which, translated into a proper measuring system, is around 63 degrees Fahrenheit).
Meanwhile, the Spanish prime minister has advised workers not to wear ties, but shocking though that is, Spain’s measures don’t stop there.
Under a decree that comes into effect in seven days’ time and applies to public buildings, shopping centres, cinemas, theatres, rail stations and airports, heating should not be set above 19C and air conditioning should not be set below 27C. Doors will need to be closed so as not to waste energy, and lights in shop windows must be switched off after 10pm.
Nineteen degrees Celsius is roughly 66 degrees Fahrenheit. Twenty-seven Celsius is equivalent to about 80 Fahrenheit. Both limits are well within my personal guidelines for my home, guidelines repeatedly and expensively ignored by my wife, who, like many from the southern U.S., believes that an apartment should double up as a refrigerator in the summer and an oven in the winter.
The mayor of Madrid is having none of it:
The new measures were swiftly rejected by Isabel Díaz Ayuso, the populist, rightwing president of the Madrid region. Ayuso, who frequently railed against the central government’s Covid restrictions, said the rules would not be applied in her region.
“Madrid isn’t going to switch off,” she said. “That generates insecurity and scares off tourism and consumption. It brings darkness, poverty and sadness, even as the government covers up the question of what savings it will apply to itself.”
Ayuso’s stance was questioned by some who pointed out that 4,500 people who live in two sectors of the enormous Cañada Real shantytown on the outskirts of Madrid have been without electricity for almost two years.
The regional government of Madrid blames the continuing lack of power on illegal marijuana plantations in the Cañada, which it says place the electricity network under such huge strain that it shuts itself down for safety reasons.
An early skirmish in what may well become far bigger political battles across the continent.
Meanwhile, in France (via Ambrose Evans-Pritchard, writing in the Daily Telegraph earlier this week):
Half of the [somewhat elderly] French nuclear fleet is out of action. The day-ahead spot market for electricity in France on Wednesday morning was €488 MWh, ten times the decade-long average. Futures contracts are pricing in yet higher levels over the winter.
The German economy, powered in the last decade by cheap Russian gas and, notably, exports to China — what could go wrong? — is showing signs of weakness, most recently seen in a year-on-year decline in retail sales (for June) of 8.8 percent in real terms, the steepest fall since this data started being collected (1994). In a pattern also being seen in the U.S., consumers are being squeezed by inflation. In Germany this now stands at 8.5 percent (the IMF’s full-year forecast is for inflation of 7.7 percent, which, if reached, will be the highest in 70 years (strict monetary targeting meant that the country avoided much of the inflation seen elsewhere in the 1970s).
One in four Germans is living in fuel poverty, a number that is likely to get worse. This may also pose difficulties for smaller residential landlords, who pay energy bills in advance for their tenants, one example of the way that this crisis may send dominoes tumbling. The IMF has also cut GDP growth forecasts for Germany to 1.2 percent in 2022 and 0.8 percent in 2023, numbers that could look like boom times if things go badly wrong this winter.
Across the wider euro zone, inflation sped up to hit 8.9 percent in July (a record for the currency union, and above expectations). The peak is still anticipated to be some way off, with core inflation (found by stripping out food and energy) accelerating too. Worst affected have been the three Baltic states, all of which have seen inflation pass 20 percent in the last month or so. Meanwhile euro zone growth for 2022 is now forecast (by the EU) at 2.6 percent in 2022, declining to 1.4 percent next year, the latter, in particular, a forecast that may look optimistic.
Adding to the mess, the euro zone seems to be stumbling towards yet another structural crisis, centered on Italy, which (unlike Greece) has a significant economy — the third-largest in the currency union. Italy has a massive debt burden (debt to GDP of around 150 percent), a currency unsuited to the realities of its economy and, following the collapse of a broad-based coalition headed by a technocrat with impeccable connections to the Brussels establishment, is facing an election in late September. On current polling, the new government will be right-wing, Euroskeptic (although this should not be overstated), and closer to Russia than it should be, and its prime minister will be the leader of the post-fascist (a description that can mean a lot of things in Italy) Brothers of Italy — not a combination designed to reassure markets or entice Italy’s euro zone partners to help out.
That said, fear of what the alternative might be (together with the principle that the EU project must never be allowed to go into reverse) will mean that some sort of support for Italy will undoubtedly be arranged, the need for which will become even more pressing if an energy crunch drives the economy into recession, something that will take government debt still higher. On the brighter side, Italy is doing well filling its gas-storage capacity, and the outgoing government thought that the country could get through the winter with “only” a seven percent drop in consumption.
The proximate cause of Italy’s euro zone problem is that, with the ending of the ECB’s QE program, there may not be enough buyers for Italian government debt. The spread between the yields on Italian and German government debt has widened, and, although it is below recent peaks (for now the European Central Bank is applying a very large Band-Aid), that gap is a warning of what may lie ahead.
Evans-Pritchard:
[T]he eurozone is . . . in trouble. The underlying contraction of the real money supply is flashing a red alert . . . The long-standing pathologies of a half-baked monetary union are again coming to the fore.
Is there a lender of last resort for eurozone sovereign states in trouble under the legal constraints of the Maastricht Treaty, or is there not? We do not know.
The ECB has tried to fudge this confusion with a new “anti-fragmentation” tool but is so paralysed by political differences within the governing council, and so afraid of the German constitutional court, that nobody is sure whether it can be used, short of a systemic crisis. Therefore a systemic crisis is what markets will inflict.
Evans-Pritchard is not always the calmest of writers and, as I argued above, Italy will not be allowed to fail, although there could be some alarming moments along the way, especially if a massive energy crunch and the recession that will come with it come into the mix.
And, the U.K. will not be immune.
Up to 40% of households could be drawn into fuel poverty by soaring energy prices this winter, the boss of one of the UK’s largest energy providers has told Sky News . . .
The Bank of England has warned that households will suffer the biggest income squeeze on record as soaring energy prices plunge the UK economy into a year-long recession. Governor Andrew Bailey said families faced a “very big” shock to their finances as interest rates were raised to 1.75pc, the highest since 2008.
Its bleakest set of forecasts since the pandemic showed the Bank now expects inflation to hit a four-decade high of 13.3pc this year. It is also predicting the largest hit to real household incomes since records began in 1963, with a fall of 3.7pc across 2022 and 2023.
This is a bigger drop in living standards than during the financial crisis, the slump of the early 1990s or the stagflationary turmoil of the 1970s, even taking into account government help with energy bills.
What’s more, as the Spectator’s Nelson points out:
National Grid is suggesting that the UK will avoid blackouts. But it is not hard to see how they could end up taking place. As Covid showed, in times of crisis contracts across borders are not always honoured, a problem for the UK given that we tend to import energy from the continent in the colder months.
If, as I expect, Liz Truss, the current foreign secretary, becomes leader of the Tory party, and thus replaces Boris Johnson as prime minister, she is going to have a mountain to climb.
But the way things are going, hers will not be the only European government to have to confront very tough times, politically as well as economically, this winter.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 78th episode David is joined by John Tamny, an editor at RealClearMarkets.com and a highly regarded economic writer and speaker. The two of them tackle some of their economic vocabulary challenges which interfere with a cogent understanding of “inflation,” and seek to put the focus on the lowest hanging fruit for facilitating economic activity. You will find it provocative, informative, contrarian, and maybe even a little enlightening.
The Capital Matters week that was . . .
Regulation
Back in February, the Wall Street Journal reported growing anxiety and pushback from the business community, concerned about the negative impact that a rush to regulate will have on the fragile economy. The White House responded that nothing is being rushed, and that “standard rule-making” processes are being followed. Perhaps that is the problem.
The Regulatory Studies Center at George Washington University tracks the number of “significant” rules and regulations that take effect each year — the ones that create contradictions with other rules, have major budget effects, or alter Americans’ rights or responsibilities under the law. These are not your homeowner-association’s rules about mailbox color — these are significant regulations that have a substantial impact on the way Americans live and conduct business. Aside from the early years of the Trump administration, new significant regulations amount to hundreds every year going back to the early 1990s.’’’
The SEC argues that “materiality” matters in its proposed carbon-emissions disclosures for publicly traded companies. Materiality limits disclosures “to those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security registered.” This limitation requires the disclosures of public companies to be directed at informing potential investors of the firm-specific financial risk they would be taking on when investing in them.
Such a materiality requirement is impossible to reconcile with the SEC’s proposed emissions disclosures.
Climate
Over the weekend, I noted how, undaunted by the uproar in the Netherlands over the impact on farmers of rules limiting nitrogen emissions, Canada’s government was now looking to go down a similar route.
Well, I should have mentioned Ireland, too . . .
The ostensible inevitability of decarbonization, however, has always been more bluster than substance, allowing the climate-change alarmists to survive levels of unpopularity and dysfunction that would have ended any other activist campaign years ago. Yet its proponents’ ability to hide its failures and costs enabled the activism to thrive, along with its intimidating reputation. Recent events around the world, however, are conspiring to stop the movement in its tracks.
It is economic and energy-security concerns — not climate change — that have driven countries such as China, India, and Japan to ramp up their clean-energy investments in recent years.
None of this means renewables are some sort of panacea. As McGillis rightly points out in his article, solar and wind are still unreliable sources of energy, only generating electricity when the sun is shining or the wind is blowing: “Any policies that move our grid away from the natural-gas and coal plants that supply more than 60 percent of our utility-scale power,” he writes, “must account for the pitfalls they would invite.”
Here, McGillis and I agree. In the absence of greater storage capacity, renewables should not represent more than about 40 percent of our electricity generation. The conventional view is that the rest should be generated by nuclear and natural gas.
Crypto
Regular folks may turn lemons into lemonade, but crypto bros — male and female alike — attempt to spin straw into gold. Incapable of being chastened or called to account, the industry has fashioned a counter-narrative in which its manifest failures are merely growing pains — necessary ones — rather than signs that the product itself is a pointless, redundant gewgaw beloved by, well, let’s just say people who are not, perhaps, the financial world’s most respectable players. Indeed, the bros claim that 2022’s failures have ushered in a “crypto winter” from which only the best cryptocurrencies will emerge, presumably stronger than ever . . .
The Inflation Reduction Act
[T]here is a solitary good idea in this mess of an agreement: environmental-permitting reform. James Broughel argues for these provisions today in Forbes . . .
Spending
Should the government be paying for child care? Senator Mitt Romney (R., Utah) sure thinks so. He has recently introduced a child-care plan that would see the federal government sending most parents checks of up to $350 per month per child.
Romney’s plan is just the most recent episode in a burgeoning and bipartisan effort to expand the role of the federal government in American family affairs. The Biden administration’s American Families Plan includes federally mandated paid leave, a massive expansion in child-care subsidies, and expanded tax credits, much of which was not paid for with corresponding revenue . . .
The Economy
The Conference Board’s Consumer Confidence Survey didn’t reveal much in the way of good cheer last week, falling for the third consecutive month . . .
Confirming the fears of economic observers across America, the Bureau of Economic Analysis estimates that real gross domestic product (GDP), the main measure of output in the economy, decreased by 0.9 percent at an annual rate in the second quarter of 2022. Real GDP has now fallen for two consecutive quarters, assuming data for either quarter is not revised upward into positive territory. Although most economists don’t technically define a recession as two consecutive quarters of negative real GDP growth, that is a popular rule of thumb for non-economists.
As such, commentators have been debating whether this announcement means the United States is in a recession . . .
Sovereign Debt
Just how big a player is China? Peter Hartcher of the Sydney Morning Herald writes that “China has more money on loan to the world’s poor countries than the combined lending of the 22 rich nations that make up the Paris Club of creditor countries.” He notes that “most of the world’s poor countries — 60 per cent of them — are now in debt distress or at high risk, according to the World Bank.”
If many of those countries go bust at the same time, the consequences for China would be significant. The Belt and Road Initiative (BRI), considered by some to be a genius geopolitical strategy, is a big part of the reason for China’s exposure to risky sovereign debt.
Woke Capital
A woke philosophy inevitably requires a business to prioritize something ahead of turning a profit. It also often requires alienating some portion, perhaps a large portion, of its potential customer base. A company has to hire all of those special executives to coordinate “diversity and inclusion” and to make donations to all of the appropriate progressive groups and causes. A woke CEO needs a financial cushion to enact all of those changes.
And America’s business leaders see rougher times ahead . . .
Free Markets
Opening the American Economic Forum on July 29, Intercollegiate Studies Institute president Johnny Burtka presented the two-day conference as an alternative to the World Economic Forum. Nobody likes those people in Davos, and they’ve earned their scorn many times over. He said the purpose of this conference was to “come together despite our differences to create a new consensus.”
The idea of a new economic consensus on the right has been promoted by some groups in recent years. Support for free markets has animated the conservative movement since at least 1955, when William F. Buckley Jr. wrote in NR’s mission statement that “the competitive price system is indispensable to liberty and material progress.” Some now claim that position is outdated, and conservatives must keep up with the times by supporting more government interventions in the market . . .
Both libertarians and traditionalists “share a detestation of collectivism,” Russell Kirk wrote in 1981. “They set their faces against the totalist state and the heavy hand of bureaucracy.” But contrary to Pino’s assertion that the conference’s message amounted to “central planning with conservative characteristics” — “free markets, entrepreneurship, and, fundamentally, liberty are not top concerns,” he writes — the fundamental debate, as I see it, is not between free markets and central planning; it’s between those who believe that free markets should exist within the context of a nation-state, and those who counter that first principles compel conservatives to accept them as a transnational, globalized force . . .
Energy
It’s positive that Scholz is at least considering the issue. Christian Lindner, Germany’s finance minister and the leader of another of the three parties in the governing coalition, the free-market FDP, supports extending the life of those last three nukes, if only until 2024. Lindner’s position is backed by both the CDU (Angela Merkel’s party: It was, infamously, Merkel who reaccelerated the phaseout of Germany’s nuclear power) and the CDU’s partners, the more robustly right-of-center CSU. The CSU would also support reopening some nukes that have already been shuttered. Sadly, that’s not going to happen, nor, sadder still, will there be a more general reconsideration of Germany’s rejection of nuclear power.
But when it comes to the last three nuclear power stations, Scholz’s problem is that superstitious dread over nuclear energy still permeates much of Germany’s politics.
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