Energy constraints rattle financial markets and global growth optimism
Energy supply shortages bit hard during September as gas, coal and oil inventories fell short of worldwide demand, sending energy prices to multi-year highs.
Gas stocks have fallen well below average as the Northern Hemisphere heads into winter, with Europe expected to be particularly hard hit. In the UK, panic buying at fuel stations prompted the government to put the military on standby. In China, coal shortages have meant factories in several cities have had to be shut down, putting the country’s economic recovery under threat.
With demand running well ahead of energy supplies as the world economy continues to recover from its 2020 Covid-19 recession, the price of gas in Europe has increased to $25 per million British thermal units, oil has topped $80 a barrel, and there’s talk of it reaching $100. Coal prices increased by almost a third during September to $218 per metric tonne.
In Europe, Russian supply bottlenecks and the lack of wind in the North Sea have intensified gas supply shortages over the last two months. Also contributing to the global gas shortages was a colder than usual 2020/2021 winter in the Northern Hemisphere. According to Reuters, inventory shortfalls in the US and Europe compared with the pre-pandemic seasonal average have reached 5% and 15%, respectively.
In the UK, a severe shortage of truck drivers has contributed to fuel shortages at gas stations. A Road Haulage Association (RHA) survey put the shortage at more than 100,000 qualified drivers. The government is planning to address the problem by issuing thousands of visas into next year.
Meanwhile, China is experiencing nationwide power cuts, initially contained to the manufacturing sector, where production schedules have been reduced or halted. The electricity blackouts have since extended into residential areas in China’s north-eastern regions. Not only is this expected to result in zero growth in the third quarter, but it is expected to exacerbate supply chain blockages that have haunted the global economy this year.
A worrying aspect of the unfolding energy crisis is the extent to which it reveals the challenges countries are likely to experience in transitioning to a net-zero global economy fuelled by renewable energy sources. China’s power shortages are directly related to the government’s ambitious goals to achieve carbon neutrality by 2060 and the resultant low coal stocks.
Global energy shortages also expose the downside of purely relying on intermittent power supplies like wind and solar-generated electricity and the importance of maintaining always-on nuclear power in the electricity mix.
For now it appears that crude oil prices will remain strong going into the end of the year. OPEC+ recently announced they will maintain the exsiting agreement for a measured increase in the supply of oil, despite a nudge from the U.S. and other countries for a larger increase to meet burgeoning global demand.
In contrast to the skyrocketing price of energy-related commodity prices, iron ore sold off sharply to US$94/tonne in mid-September versus a record high of US $237.57 a tonne four months ago. Demand for the base metal has sharply contracted on the back of diminished Chinese demand, largely due to the Chinese government putting caps on steel output due to environmental considerations.
K-shaped recovery prevails
Hopes of a V-shaped recovery which seemed quite possible early in the pandemic have dwindled. At this stage in the recovery, it looks more like what economists refer to as a K-shaped recovery, in which some people do better while others fare worse.
There’s mounting evidence that people earning lower incomes have gone backwards, while higher earners have seen their incomes advance since the onset of Covid-19. According to the Opportunity Insights Economic Tracker, the recession has ended for US high-wage workers, but job losses persist for low-wage workers. The latest figures in June show that since February 2020, high-wage employment has risen 9.6%, whereas low-wage employment has declined a significant 21%.
Another distinctive feature of the recovery is that some sectors are struggling to find the right talent because individuals are not taking up the available jobs. One contributing factor is that the lack of childcare facilities due to health concerns, or the high cost of those available, has meant that adults caring for children cannot get back to work. The labour shortages may also be due to the level of pent up savings, which may see people only getting back to work when these have run out.
Although growth rates remain elevated in developed economies, there has been evidence of the momentum losing pace and, in some cases, economic fragility appearing. Thus central bankers considering when and how to rein in their stimulus programmes by tapering their bond purchases and increasing interest rates will have to adopt a delicate balance.
At the latest Federal Reserve meeting, Fed Chair Jerome Powell indicated that tapering was likely to begin soon, and the majority of the governors expected interest rates to start increasing next year, a shift from the June meeting when the majority expected rates to increase in 2023.
Risks to the economic outlook
A seemingly intractable risk to the recovery is the supply chain bottlenecks that continue to disrupt the smooth flow of goods to their destinations, putting upward pressure on producer prices. Slower job growth is another. The Delta variant, which has spread like wildfire globally, also threatens to undermine the economic recovery this year, with the impact on economic activity of the latest second or third waves in countries yet to be revealed.
Inflation remains on the rise, with the debate about whether it will be transitory or become more entrenched still alive and well. Central banks continue to contend that price pressures will come off as soon as supply constraints ease up. For now, wages are not rising as fast as the inflation rate and thus are declining in real terms.
According to the Conference Board’s latest Salary Increase Budget Survey, inflation in 2021 is expected to be “well above” salary increase budgets, with this year’s average increase lower than in the pre-pandemic years.
Meanwhile, in an environment of still elevated inflation, research shows that energy commodities have been the best-performing asset against inflation during eight inflationary regimes because energy, particularly oil prices, historically move very closely with inflation, according to JP Morgan Asset Management, “given the higher weight in the CPI inflation basket and the flow-on effects as this commodity is used in all parts of the economy, from fueling transportation to heating homes to powering factories.” However, the bank says this relationship may change in the future, as the world shifts from fossil fuels to renewable energy sources.
China shakes up the status quo
China dominated the news in September, with Beijing imposing regulatory crackdowns on several sectors, souring their prospects and scaring off investors. These included tech companies, the private after-school education sector and gaming companies. The Chinese government also surprised crypto-optimists when it banned Bitcoin – and introduced the prospect of other governments around the world doing the same.
Most damaging to the Chinese economy could be the potential default of property giant, Evergrande, buckling under a mountain of $300 billion debt. The company alerted investors to the cash flow problems it was experiencing and failed to pay one debt tranche owing towards the end of September, but still has a 30 day grace period to pay before it is deemed to have officially defaulted. The property development company is also struggling to sell off assets to generate cash to pay its debt. Chinese authorities have been adding liquidity to financial markets to avert a full-blown market meltdown but are not expected to bail out the company. More trouble could be brewing as rating agencies have cut the ratings of Fantasia Holdings and Sinic Holdings, two other developers, due to their weak cash flow. In fact, Fantasia missed a repayment earlier this week. The situation in the real estate sector is concerning given that the sector accounts for 15% of China’s GDP. Additionally, China has been an engine of global economic growth for the better part of two decades, so a distressed sitution in any sector may increase contagion risk.
Brazil also stands out in the emerging market universe, having managed to achieve and sustain a strong recovery, notwithstanding the economic disruptions and huge loss of life experienced due to Covid-19. According to the IMF, deaths have exceeded half a million people, but Brazil’s economy has still managed to get back to pre-pandemic levels, according to the IMF. Economic growth has been buoyed by the biggest government stimulus package in the emerging market universe, strong trade and vigorous private sector growth.
Canadian elections are a non-event
In Canada, election results saw little shift in the distribution of power, with the Liberal Party winning but failing to get a majority of seats. Many voters were unmoved because they didn’t see the relevance of having the elections at all and the results were so similar to the election two years prior.
With the elections out of the way, however, Canadians are watching to see whether Prime Minister Justin Trudeau’s Liberal Party will make good on their promises to address pressing issues, including climate change commitments to reduce national greenhouse gas emissions by 40% to 45% by the end of the decade and addressing the housing crisis by building, preserving or repairing 1.4m homes over the next four years, banning blind bidding and increasing funding of the National Housing Co-investment Fund.
Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at email@example.com