Time to be Vigilant, not Complacent

We have now reached mid-year and are in the peak of the holiday period. For most, the focus has turned to enjoying the good weather and trying to get away on a blue-sky holiday before children need to report back to school.

Looking back over the first half of 2024, energy prices were fairly well-behaved. Both North American and European energy prices have basically traded in a fairly narrow band, and the extreme volatility experienced in the months following the Ukraine War has largely faded. This is principally due to a second consecutive mild winter, which allowed both regions to emerge from the period with robust stocks of natural gas. Moreover, the inventory build for both regions has been reasonable, with natural gas stocks significantly ahead of historic/average levels – e.g., German natural gas storage sits above 88 percent full. With this backdrop, it is easy to understand how many have become complacent and believe that we have come through a difficult period and have now returned to the good days of stable and comparatively low prices.

From the standpoint of pure fundamentals, those who are of the view that the back half of the year will be much like the front half have a strong argument. Presently, energy supply (whether crude oil or LNG) is robust and global inventories are high. Moreover, demand seems to be soft. Specifically, economic growth in the US appears to be slowing (hence all the discussion around the Federal Reserve starting the rate-cutting cycle in the coming months), European growth is flat, and China was sub-5-percent (very respectable for most other regions but significantly below China’s historic growth rate). So, the fundamental story is supportive of stable prices for the remainder of 2024.

In our view, the problem when looking at the remainder of 2024 and 2025 is not the underlying fundamentals it is the “other” factors – particularly geopolitical factors.

First is the Israeli War in Gaza. While the war was initially provoked by the Hamas attack on Israeli citizens on October 7, the conflict is now approximately 10 months old. Despite pleas from most of the international community, there does not appear to be an end in sight. There seems to be precious little information from the Netanyahu government about what comes after the war. To date, the conflict has not spilt over into the wider region; however, there is still a real danger of this occurring. In fact, the likelihood appears to be growing that the simmering tensions between Israel and Hezbollah in Southern Lebanon (and an Iranian proxy) may be boiling over. The Gaza War continues to represent a significant risk to the stability of the Middle East.

Second, the Ukraine War. Russia attacked Ukraine (putting its taking of Crimea in 2014 aside) in February 2022. In the early months of the war, the battle lines shifted wildly. However, over the past year or so, the battle lines have largely stabilised, with Russia holding the majority of the Donbas through Kherson. The military carnage and human toll on both sides have been tragic, while clearly, Ukrainian civilians have taken the brunt of the consequences since the war is being fought principally on their home soil. The point is that the Ukraine War, despite the recent lack of news, continues to be an important flashpoint for Europe that could (depending on the upcoming US elections) once again become a front-and-centre issue in 2024.

Third, China’s claim to Taiwan. Since 1949, when the then-current government of China (Republic of China – ROC) fled the mainland to the island of Taiwan, China (the Peoples Republic of China – PRC) has claimed sovereignty over the island nation. For decades, these claims were largely pressed politically due to China’s underdeveloped economic and military status. This is no longer the case. China’s economy and military are one of the largest in the world. With each passing year, China seems to be applying more pressure on the government and the people of Taiwan. In the past few years, China has stepped up its military activities around Taiwan and seems to be practising a full takeover of the island. One of the reasons China is apparently hesitating in launching its attack is the promise of US support (and possibly witnessing the problems encountered by Russia in its attack on Ukraine). In fact, President Biden, 2022, went so far as to say that the United States would defend Taiwan, which was a break from the position of prior US administration policy of “strategic ambiguity.” While Taiwan ranks 21 in global GDP, it is the world’s largest producer of high-end semiconductor chips.

Finally, and maybe one of the most consequential geopolitical events is the upcoming US elections. While it seemed that the 2024 elections would be a repeat of the 2020 with President Biden squaring off against former President Trump. A horrible debate performance by President Biden resulted in him giving up his bid for reelection (only after significant pressure was brought to bear on him from his party and major donors) and supporting his Vice President, Kamala Harris, to take his place. In the past two weeks, Harris appears to have cemented her position as the Democratic nominee. The next President of the United States will have a major impact on all of the issues previously highlighted above.

Should Vice President Harris win, we should expect a continuation of the current administration’s policies concerning Gaza, Ukraine and Taiwan. Moreover, she will continue to support the US’s energy transition to renewables and, at least, deemphasize traditional “dirty” energy sources. In reality, like President Biden, she will most likely accomplish this through regulations and policy rhetoric, for she could not afford for energy prices to rise too steeply and reignite inflation, which has materially impacted the average American citizen.

Should former President Trump win, things will most likely look very different. He has clearly stated that his policy for domestic energy will be “drill, baby drill” and the elimination of regulations on the energy sector. This most likely will result in some marginal additional production. The reality is that it takes years and significant investment to develop brand-new production (i.e., projects not already on the drawing board or approval process). As to the other geopolitical issues. Trump has said he would only provide Ukraine with additional weapons if it entered into peace talks with Moscow, which would mean territorial concessions. This would place Ukraine, Europe and NATO in a very difficult position. Moreover, Trump has stated that Taiwan effectively stole the chip fabrication business from the United States and that it should pay the United States for its defense.

In short, much could upend the current calm in the energy markets in the coming months. Now is not the time to be complacent - it is the time to be vigilant.