By Lars Schernikau for RealClearEnergy
Coal and gas prices have reached all-time highs. Electricity prices have skyrocketed in several western markets. I am not surprised.
For years, I have argued that there is a structural-energy raw material shortage driven by underinvestment in 80% of our primary energy (oil, coal, and gas) and overinvestment in so-called variable renewable energy (VRE) – mostly wind and solar, which, in 2019 and 2020, received about 13 times more investment than oil, coal, and gas combined.
To this structural misalignment can be added other global factors, including but not limited to: huge financial stimulus and resulting drastic demand increase post-Covid that global supply chains could not meet; and geopolitical “games,” notably Russia using its gas leverage and China’s boycott of Australian coal.
As David Baker and his co-writers argue for Bloomberg Green, this is the first of many energy crises of a clean-power transition expected to take decades. “In the throes of fundamental change, the world’s energy system has become strikingly fragile and easier to shock,” they write. Wind and solar have soared, but both renewable sources are “notoriously fickle.”
That banks, governments, and institutions shy away from investments in many mining activities, especially if the investments have anything to do with fossil fuels, however, is a long-term trend and an increasing problem for the world at large. That trend will cause disruptions to global industrial operations to an extent hard to foresee. While energy expenditure is “only” around 2% to 5% of global GDP, energy is at the core of all our economic activity. Without energy, there are no Teslas, no iPhones, no food products, no clean water, no vaccines, no schools, no bridges, no Netflix, no shoes, no F1 races. You get the point.
It’s a point that needs making in the context of the demonization of coal. The coal industry provides over one-fourth of global primary energy and over 35% of global electricity. Those who compare coal to the tobacco industry don’t understand energy markets and how our world depends on them. Comparing a discretionary “pleasure” product such as tobacco to energy is ludicrous. Coal’s non-private benefits can be seen in Britain, which boasts about “powering past coal” yet pays for coal-fired capacity to help keep the lights on.
So why do I say “coal, gas, and energy prices cannot remain this high?” Coal prices in Europe touched 300 USD a ton (from less than 50 USD in 2020). Asian LNG prices topped 40 USD/mmBtu (from less than 2 USD in May 2020). As a result, power plants in Europe make almost 100 EUR/MWh more when burning coal instead of gas, despite record-high CO2 emission allowance prices of over 60 EUR/t – this at a time when electricity exchange prices topped 400 EUR/MWh in Europe. Remember when they were around less than 40 EUR in 2020?
Very simply, industrial energy raw material consumers cannot be expected to continue their production at such high input prices. Cement mills will stop producing cement, power plants will stop producing power, brick companies will stop producing bricks, paper mills will stop producing paper, steel companies will stop producing steel. The first signs can be seen in India, China, Germany, the UAE, Pakistan, and many other countries.
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Governments would have to step in – to increase often-controlled power prices, or to force industries to produce at a loss, or to allow produce prices (such as for cement) to skyrocket.
Either way, fewer products will be produced (including fewer Teslas, because Tesla’s supply industry suffers from a lack of coal in China), and demand will dwindle as scarce products become more expensive.
Equity prices will tumble as companies stop making products. Loans cannot be repaid when companies don’t produce enough. Business plans will be thrown into the trash can.
On top of that, we face the prospect of a looming credit crisis. Which importer or trader has sufficient bank lines to trade hundreds of millions of tons of raw materials at triple/quadruple prices (see article “World’s Largest Commodity Traders Face Massive Margin Calls As Global NatGas Arb Explodes” at ZeroHedge here)? Credit is tight, product flow will cease (or at least reduce), and performance risks increase. More and more companies will run into a liquidity crisis. In the end, the consumer will suffer.
At the same time, supply is adjusting. High prices are motivating even young and inexperienced entrepreneurs in South Africa, Indonesia and other exporting countries to start digging out more coal and “hand-carrying” it to a vessel.
This supply adjustment may come just at the time when demand starts to fall, making it even worse.
That is why I believe these high prices cannot be sustained. Prices will have to adjust fast. If they don’t adjust, the market will be sure to force prices to adjust more violently later. The later prices adjust, the greater and more painful the adjustment will be.
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This is not contrary to my earlier statement that we are entering a time of energy and resource scarcity with all its consequences (including increased risk of blackouts). My view remains that a new raw material super-cycle has started, with generally high raw material (including fossil fuel) prices.
I foresee a significant price drop or at least greater volatility before New Year’s, despite the looming energy shortage during the upcoming winter. This price drop, however, will still keep prices far above 2019/20 levels and consequently above marginal costs of production – so, for producers, no worries.
Dr. Lars Schernikau is an energy economist, entrepreneur, and book author. Prior to joining the commodity business almost 20 years ago he worked for the Boston Consulting Group in the U.S. and Europe.
Syndicated with permission from RealClearWire.