Unveiling the reason behind Energy spikes across the world

I am sure you all are also puzzled with headlines of coal shortages in China and all of this happening in the age of abundance.??China’s rationing of electricity first appeared in May and spread through the summer, driven by strong industrial demand. The power cuts spread more broadly after the National Development and Reform Commission called on Chinese provinces that had lagged in cutting energy intensity to control their energy usage. This year’s target to?reduce energy consumption per unit of GDP by 3%?is tied to China’s politically important climate-change goals: to achieve peak carbon emissions by the Year 2030 and carbon neutrality by the Year 2060.

Spiking energy prices are a global problem. The advanced economies like the UK have faced outages in nuclear power, a fire early last month damaged a cross-channel power transmission cable to France. The lack of wind this year has cut wind farm output to just 11% of its average output. Moreover, the UK's just-in-time approach to energy provision means its gas storage capacity is just 9.3 terawatt-hours (twh)—a few days’ worths—compared to 151 twh in Germany and 168 twh in Italy. A slight imbalance is resulting in volatile outcomes in the energy market.

The biggest victims of the current power cuts are naturally the biggest users of electricity: heavy industries.??The heavy industries in China like cement, steel, non-ferrous metals, chemicals, each account for an average of 14-16% of the industrial usage (70% of the total electricity usage).?Along with strong demand for manufactured exports, the boom in the domestic heavy industry drove the surge in demand for electricity that has strained supplies.??The Chinese electricity consumption is approx. 7x higher than Indian consumption.

It appears that energy problems across the world can persist for a long time. Unlike?previous?cycles, when higher energy prices usually meant more exploration, more capital spending, more oil rigs, and so more hydrocarbon extraction, this energy bull market is being met with?very tight?capital budgeting?by companies?due to regulatory constraints?and scrutiny.?This partly explains the rally in copper, lithium miners, coal, natural gas,?and uranium over the last 12 months. All the carbon-generating stakeholders have genuine?concerns that governments will subsidize green?energy leading to unfair competition.?Recently, the latest Intergovernmental Panel on Climate Change published a report warning of the dire effects of greenhouse gas emissions.?The long and short answer lies in transitioning energy supply away from carbon, even if that means spending hundreds of billions on?unproductive investments supported by real negative interest rates.?

That mass migration of funds to Environmental Social Governance (ESG) mandates is also underway.?Assets under this umbrella have reached $35.3 trillion globally as of the beginning of last year, according to the Global Sustainable Investment Review for 2020, up 15% from the start of 2018 and?representing 36% of all professionally managed funds,?fueling?further curtailment of funding for traditional energy producer industry.?This is restricting investment in traditional energy industries thereby creating supply constraints.?The outcome of the spike is going to be inflationary for the world. It may be time to tilt the portfolio away from energy consumers to energy producers.?Indian companies started making the transition to self-sustenance of energy in the last decade.?They invested heavily in Captive power plants, Waste Heat Recovery, Solar & Wind?due to deep-rooted insecurities related to the energy cost which was controlled by state DISCOMs, in the past. They are likely winners in this energy inflationary environment. Globally, we are moving in an environment where inflation is sweeping faster than thought and going to have a huge impact, on global financial assets.?

From Manish Bhandari, CIIA,?Portfolio Manager, Vallum Capital.?