Geopolitical tensions are now well and truly back at the forefront of investors’ minds as Russia threatens to cut all gas to Europe.
We knew Vladimir Putin had a powerful card to play if he felt cornered by the west. Now the proposal from the G7, led by the US, to cap the price paid for Russian oil has triggered Putin to play that card.
Russia has cut off all gas flow through the Nord Stream 1 pipeline, resulting in supply to Europe now falling below critical levels.
If Europe follows through on its additional proposal to cap the price of Russian gas, we expect all other Russian pipeline routes to be cut off.
But Europe cannot have its cake and eat it too.
At the same time, higher demand for liquefied natural gas (LNG) from Japan, Korea and China to build their own storage in advance of winter is affecting Europe’s ability to plug this ever-growing gap in energy supply.
Gas generators may see a temporary levy on surplus profits.Consequently, European energy prices have ratcheted up.
At around €500 (£436)/MWh, German base load power is 10 times its historical norm.
The European Commission has wasted no time proposing a maximum €180/MWh revenue cap on all non-gas power generation, which covers about 80 per cent of power generation in Europe.
This proposal will see revenue earned by non-gas power generators above the cap clawed-back by the government and distributed to support consumers, and gas generators may see a temporary levy on surplus profits.
Policymakers estimate this could amount to around €140bn in support to consumers and it provides greater certainty to generators around the ambiguity of a windfall tax.
The plan also includes a proposed mandatory 5 per cent reduction in peak electricity demand.
The European Parliament is expected to finalise the proposal by the end of the month.
Supply and demand for energy in Europe remains very delicately balanced through winter 2022 – peak annual consumption – meaning adverse winter weather could have an outsized impact on energy availability.
We do not think it is all doom and gloom though.
Gas storage levels in Europe have been building in advance of winter. Member states have reduced demand in line with the European Commission’s directive to get to 90 per cent storage fill by November. For example, Germany gas storage facilities are at more than 80 per cent capacity.
Given the extent to which the weather remains a key yet unpredictable variable, the range of outcomes is wide.Alternative fuel sources are being sought eg fuel oil, and rising energy prices have led to incremental demand destruction as non-profitable, low value add industries shutter capacity eg nitrogen fertiliser, aluminum.
As Europe fills the void of Russian gas, it will come with a price tag. We estimate 2 to 4 per cent of GDP.
Given the extent to which the weather remains a key yet unpredictable variable, the range of outcomes is wide.
On a 12 to 18-month view, Europe is building additional re-gasification terminals to increase LNG imports to feed the gas between member states, as well as using alternative energy sources where possible.
Exposure to European stocks may feel uncomfortable. But at 12 times forward earnings the market is already pricing in a tough scenario around energy.
Our European exposure is focused on multi-nationals – leading franchises that generate revenue and profits globally and are not dependent on just the European economy.
Jacob Mitchell is the chief investment officer at Antipodes Partners
