European Energy Crisis-a multitude of supply issues combining to create a major crisis that no one especially in Germany, thought possible.

With crowds of people protesting outside the UK energy regulator OFGEM and social unrest looking more and more likely, i think its necessary to explain why we are in this place and in my view, what can be done and some straightforward solutions to contemplate, no matter how distasteful they might be to some.

The problem is clearly not the profit of the suppliers nor the regulator, the supplier’s profit is regulated at 2%. Removing the profit of energy suppliers makes no difference frankly. The regulator is just doing its job under the mandate given to it by government. Only the government can come up with solutions. I have proposed one below that I believe is a good one and they should consider it strongly.

Oil and gas producers are also not to blame. Profits for oil and gas producers are fair for the enormous risk they take.

In 2020 oil was selling for a quarter of what it cost to produce, and they reported huge losses and write-downs on their assets. To tax them when we need them more than ever to invest in new exploration and production is not correct and pandering to the communists.

Profits are being re-invested and transferred as dividends to mainly public and private pension funds who of course are working for our benefit.

We need a business-friendly environment for oil and gas exploration and production in the North Sea. The futures curve is telling that in the future oil prices are likely to be lower so there is a reluctance to invest in large projects that cost tens of billions and lead times of half a decade or more and a government that threatens a windfall every time they make a profit will not help. Dec 2027 Brent futures are trading for just over 70 dollars. Hardly a great return on investment on your cash today and the risk involved.

The race to net zero and a ban on ICE vehicles makes the longer-term future uncertain, however in the short term "Houston we have a problem".

Oil producers can choose where to be domiciled and where to produce oil and gas. They do this usually based on profit and the regulatory and tax environment they expect to deal with. Windfall taxes in my mind are a very bad idea and with the problem faced in the hundreds of billions will hardly make dent into what’s needed right now.

Huge amounts of gas is presently being flared from Russia to Azerbaijan to Africa to Saudi, Qatar, Iran to the US, Mexico and Canada to name just a few. The problem is getting this gas into the right place and providing security of supply. This flared gas needs to be treated and put into the pipe as a medium-term solution.

Large gas projects in Tanzania, Mozambique, Qatar, Australia, Trinidad and Tobago, UAE, Egypt and potentially Greece and Eastern Med and Russia will come on stream eventually and bring prices down to more sensible levels. However, in the short-term things are set to get far far worse for consumers and bills are exploding.

Jan NBP futures closed at 876pence per therm yesterday. One year ago, it was 80 pence only so a 1000% + rise. UK Bills so far are up 300% only. If nothing improves the UK cap will be ￡7000 by April for 85% of citizens. That is just the average. No one will escape. Even middle-class earners will be hit hard with bills of ￡10,000 or more. The rich with palaces could see bills of ￡30-50,000 as commonplace. As a result, spending is going to drop precipitously and lead to recession if we are not at that place already, the bank UBS think we are already there.

Those on low incomes will suffer the most without help. 67 pounds a month is obviously not enough when the bill will be 300-400 pounds per month in the winter months taking up to half their income and in some cases more than rent. Many are on pre-paid meters so without cash to fill the meter many people especially pensioners will not survive a super cold winter.

My solution would be that the EU governments offer an interest free loan to suppliers of 2000-3000 pounds per household to offset the increase in bills over the next 12months.

The suppliers are then authorized to increase the annual bill for the next 10 years by 200-300 pounds to pay back the government. This will only work of course if the problem is short term in nature and I am not sure frankly there is a will to resolve all the problems because it is not just money and investment needed.?

France have regulated an increase of 4% from 2021 so EDF is having to sue the government for 8bn euro which happens to be its main shareholder and shortly its only shareholder. EDF is facing a catastrophe as a business. Its generating units are down during the highest prices on record and having to import from Germany at stratospheric prices and then sell at much lower regulated prices to its customers. I do not rule out total blackouts across Europe if gas is curtailed and there is no wind , super cold weather and solar blanketed in thick snow. 8bn was before prices went up 100% so that number needs doubling.

Electricity prices hit 1130 euro per MWh in France and Germany hit 1000 euro per MHh yesterday for the first time ever for a 1year forward contract. These levels are unheard of before and far higher than the USA where the average level is around a tenth or less of these prices. The European area’s energy intensive economy is in big big trouble.

Germany bailed out big supplier Uniper as it was days from collapse. Germans are now seeing enormous rises in energy costs like the UK but far worse. Pressure on the greens may lead to a collapse of the government but certainly enormous pressure to reopen coal and nuclear plants to try and cap price spikes. So far its not working with prices hitting 1000 euro per MWh. With France importing and soon the UK will need to import for winter the demand is solid and higher than available supply. Small and medium sized business are suffering the most and price rises are coming down the line which will drive inflation even higher than 10% currently in the UK

Many UK and European suppliers have actually gone bust over the past year in fact as many sold fixed price tariff agreements but didn’t have the balance sheet to protect themselves financially by hedging a rise in prices nor able to cover astronomical peak pricing which led to them bleeding cash.

High prices are due to several factors many previously thought impossible to happen at the same time. The coincidence of these events is just hard to fathom whether it be act of nature, war, economy, the recovery from the pandemic, geopolitics but all happening within months of each other leading to enormous cumulative loss of supply.

Firstly, everyone who is familiar with the energy market knows that renewables are not the sole solution. Anyone who thinks that is totally delusional.

When the wind doesn’t blow there is no generation. When the solar panels are covered in thick snow, they are not effective. Tidal seems to be so far immune from these issues but its generation is tiny but I think it will grow rapidly.

Due to the heatwave and low wind (the wind has generated less than 2% of generation on many days.) It’s possible to have 50%+ some days but that’s not good enough to run a country or a commercial business.

Reservoirs and rivers have run dry causing hydro power to collapse across the world from China to Brazil not just in Europe and Scandinavia. This has led to a spike in demand for diesel and LNG. Rains have recently come, and the heatwave broken, and more rain is set for next week in Europe which is extremely welcome. If rains continue through September and October, the peak may well be in for energy prices.

A perfect grid historically and more so now needs high stable baseload nuclear output. France was the leader in the past with at one point in 2018 71.67% coming from nuclear but that has dropped to 40% recently with lack of investment, maintenance and problems with cracks at some old reactors.

This is not a quick fix either, it can take months or years to solve. A base of 50-70% minimum in general should be targeted for nuclear generation for the future using the latest newer smaller modular plants that can be placed close to major cities. This will be essential and needed to charge the EV's. If the grid cannot cope now, how will it cope in 10-20years time when demand rises for electric vehicle charging. Elon Musk is a big fan of nuclear and tweeted as such in the last 24hrs. He tweeted

“Countries should be increasing nuclear power generation! It is insane from a national security standpoint & bad for the environment to shut them down.”

I agree totally.

Hydro, Gas, New Coal fired plants with capture and storage of emissions, Solar, Wind then all have a role to play to provide sufficient power for a stable grid. All should be supported.

The problem is and has been, why invest in nuclear when power prices were low and how to share the income from end users and residential customers.

Nuclear must be protected for the service it provides. Stable baseload generation. If the price is 90euro so be it.

The generators must be paid that price for 30years no matter what the price is on the market. It’s certainly better than 1000 euros at present. When the price is 50 euro that’s the problem, but customers need to suck it up to avoid the crisis we are in right now.

A 10% margin of error should be kept ensuring that supply always stays ahead of demand and that we are always self-sufficient.

Politics has also played a role. Germany has for decades made itself reliant on cheap Russian gas for its industry. Political leaders in Germany and Gazprom executives were extremely close, too close. That has all changed not just due to the war but due to the greens and liberals (anti fossil fuel groups) in government. Bad decisions were made to rely on renewables as the solution and close coal and nuclear plants after the tsunami in Japan. Germany is not in an earthquake zone.

The only way to end the war is a peace agreement and that will never happen with NATO countries sending cash and weapons to Ukraine.

A stalemate could continue for years. With Russian dominance however militarily and lack of NATO forces on the ground or in the air the end result is not likely to be a Ukrainian victory I am afraid to say so weapons given to Ukraine is just kicking the can down the road and is causing untold damage to the European and Worldwide economy.

Russia is getting weapons from China, Iran, Turkey and has a huge military force. This is an 8-year war not a 6-month war. 10,000 died before the invasion even started and now Russia has come in on the side of the people close to its territory. Eventually Russia wants to offer a referendum on separation from Ukraine like offered in Crimea.

It is possible however that this war will last another 8 years without political pressure on all sides.

It reminds me of Northern Ireland troubles. Hundreds were killed and it only stopped when a peace agreement was reached. Ukraine needs to wake up and smell the coffee. The problem is Zelensky, he is not a politician. He is a comedian and no experience of making tough decisions or negotiating peace agreements.

It may well be that it takes an enormous nuclear disaster to stop the war. The situation at the nuclear plant is extremely dangerous. Russia wants this plant to supply Crimea and has held it since March 2022 and Ukraine needs its power generation for the grid. It has become a big part of the war and control is essential for both sides.

For me only a partition of Ukraine will solve this problem so Russian speaking pro-Russian citizens in the Donbas region can become part of Russia and the rest of Ukraine can forge its own future maybe as part of the EU. It will have to agree to give up any hope of NATO membership which the USA would love to see since Russia will never allow it.

But as I mentioned the higher prices are not due to the war entirely, obviously gas flows are substantially lower than normal which is the main reason but also a sense of panic at gas companies that gas flows may stop completely. I think that is unlikely as Russia needs revenue and is doing especially well at current prices 10 times normal levels.

Psychology is clearly a huge factor, but most traders / corporates / countries cannot risk not having gas. The markets are physically delivered so it’s one way to ensure supply. For some countries like Italy with gas central heating widespread there is no alternative.

For me though market liquidity is low and prices unjustified. I mean its 10 times the price in the USA. How can business in the EU compete on a global basis? I am seeing fertilizer plants across the EU close. This has implications for food for 2023. The EU must act to end the war. With time the market will do its job and force companies to close. For example, hundreds of fish and chip shops are closing due to sharply rising prices of gas and electricity fish, cooking oil and potatoes. the prices they are charging simply do not cover the costs. That’s an unsustainable business at present and they are not alone, far from it. As business’s close demand goes down. Simple 101 economics.

In summary I see the following 12 points as the main reasons for higher gas and electricity prices in Europe

1. Sanctions on Russia and lower gas flows in retaliation.

2 Germany blocking Nord Stream 2 and now Russia is flaring 10mn pounds of gas per day close to Finland.

3. Lack of rainfall leading to lower hydro production and nukes having to scale back due to lack of cooling water and unable to release super-hot water into low rivers.

4 France a lack of investment, cracks on reactors and failure to maintain and repair quickly and delays until 2023 for their return. Maybe in January we will see a decent recovery in output.

5. German decision to close its nuclear and coal plants and push for renewables. (wind just 2% during most of august) (pandering to green party / liberals in Berlin coalition government)

6. EU countries must burn more gas due to all of the above leading to enormous gas use as all gas plants run flat out.

7 Higher demands globally due to exit from the pandemic. ?

8 UK closing coal plants and permanently demolishing cooling towers so coal plants cannot be brought back online. Running the UK grid for years without sufficient spare capacity or thought for future demand needs. It’s not just energy infrastructure, the release of raw sewage is making the public so mad, so angry at the incompetence of the water utilities and those in government and those who regulate them to do better. Flowing raw sewage onto out beaches and rivers in the middle of summer is never a good look. It just seems everything is broken right now in the UK and most comes down to failed investment.

9 Liberal Democrats when in government refused to approve nuclear build when in JV with conservatives 12 years ago and rejected fracking. Not just UK but a successive failure of EU governments to invest in expensive nuclear energy. Now that mindset is changing. But for this crisis it’s too late.

10. Lower Scandinavian exports to Europe due to lack of water.

11. Lower Libyan gas sent to Italy due to war and lower Algerian gas sent to Spain due to geopolitical disputes and their ability to send elsewhere by LNG at higher prices.

12. Massive LNG demand due to drought in Latin America, East Asia and China and now Asia competing with Europe for gas for winter LNG supplies.

Its complex but pressure will come from consumers to ease sanctions on Russia on EU government officials. I see it already many political groups, Italy (far right) and Alternative for Germany, unions, employers, business leaders and corporations in Germany are already looking for way out of this crisis. Opening the Nordstream 2 pipeline for me must happen to stop this exponential rally in price.

EU energy intensive companies will go bankrupt or be forced to close with rapid rises in unemployment and recession highly likely.

So, in my mind there may well be a blow off top in price but frankly demand will eventually drop off baring a total stoppage in Russian supply, and gas / electricity prices must come back down to earth.

As electricity cannot be stored the crash can be as violent as the spike.

The solution to me is clear.

Longer term 2 trillion euros of investment in nuclear plants and more renewables/all forms of power generation.

Shorter-term and medium-term offer incentives to roll out solar across all factories and residential properties across Europe. At current prices solar pays for itself in 3-5 years so anyone who can afford it should do it.

Immediately remove sanctions on Russia on condition gas flows return to 2019 levels.

I predict Russian revenues will not increase if sanctions are removed since the prices will crash.

Other sanctions like a lack of McDonalds and western clothing only hurt the Russian people and do nothing. End stealing of assets and sanctions on oligarchs, that is also just petty and, in my mind, illegal.

One thing is clear sanctions are having no effect on Russia's ability to wage war or its revenues. Its currency and stock market are back to pre-invasion levels.

The only countries hurting from sanctions are mainly in Europe, so a rethink is necessary.

Blocking the Nord Stream 2 pipeline is just madness.

The pipeline is built and ready to flow large amounts of gas the EU badly needs. This should be opened as a priority today. The flaring of gas is causing an environmental catastrophe and must end.

As for my business Zafiro offers managed accounts and advisory on energy. The focus is mainly oil but I am paying a close attention to European Energy markets of course.

Without an end to the war at current gas prices there will certainly now be a rush to diesel and oil from gas. This is only bullish oil. The scenario for oil I see is one very similar to EU energy markets.

There has been a lack of investment for years. The coming deficit in 2023 looks large with many of the same issues facing oil that are facing gas and electricity now.

If sanctions continue Russian oil industry cannot keep production at current levels without spare parts and western expertise. It will drop precipitously. On top of this EU sanctions coming at the end of this year can cause a further drop of 2mnbpd of exports. Saudi already has hinted they will cut to make way for Iran. So there is essentially an OPEC+ level they don’t want it go to below and that is around $90. Forward oil is trading far below this level including futures for the peak demand period in Q3 and Q4 2023.

Biden has fired almost all his bullets selling the SPR almost 1mn bpd and the plan is to restock it but from where? For me i think it will turn out to be a disaster. Can we see oil go up 300% or even 1000% soon? Don’t rule it out.

When things get tight prices just go parabolic. German baseload electricity for January 2023 trading last Friday, up 38% in 1 day. The chart is going vertical.

If you wish to know more about any of my strategies or investment idea’s, please do not hesitate to contact me. I am seeking managed account investments from $1mn but ideally $10mn and up.

Best,

Stephen

Stephen Smethurst?

Chief Investment Officer, Zafiro Capital.

[email protected]

Zafiro Capital Sarl, Chemin Boissier 27, Cologny, 1223, Geneva, Switzerland

Tel: +41 79 744 76 78

https://www.dhirubhai.net/in/stephensmethurst/

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