Europe on the brink of a major energy crisis

In 2022, the housing and utilities sector (-8%) outperforms the global index by 12%. This sector is defensive in nature and usually performs best during economic downturns or recessions.

U.S. utilities outperform European utilities as Europe faces a major energy crisis that is hurting major historic power producers.

2022.07.08.Performance 2022

Russia has sharply reduced gas exports to Europe. French energy companies have raised the alarm about the responsibility of the French to reduce their consumption in order to replenish reserves as much as possible for next winter. This will not be enough, strong and, unfortunately, binding political acts are needed. For all of Europe.

German energy company Uniper is doing badly, very badly. Its main activity is the purchase and sale of gas and coal, transportation and storage, and the operation of several coal and gas-fired power plants to generate electricity. The price of its shares fell by 60% after the Russian invasion of Ukraine. Uniper’s revenue in 2021 was 163 billion euros. Due to a sharp increase in gas prices and a sharp reduction in supplies from Russia, Uniper is in a difficult financial situation. 54% of volumes purchased by Uniper came from Russia. If Moscow completely turns off the gas valve, Uniper will go bankrupt and will have to support Berlin. Uniper is cash-strapped and has received less than 40% of gas from Gazprom contracts since mid-June. Before the war, Uniper was already in a precarious position. Uniper has relied on Russian gas and coal, while its competitors Engie and RWE have significantly increased their renewable energy capacity.

This is starting to sound like Lehman Brothers in European energy. Bankruptcy would be devastating to Germany’s energy economy and security, dragging hundreds of municipal utilities and energy suppliers with it; and possibly outside of Germany. Domino effect.

30 years ago, Europe would have liberalized the energy market in order to lower prices for consumers. Today, she understands that she cannot leave energy in the hands of the market, and we will witness a wave of nationalization. Berlin should nationalize Uniper, France should do the same with EDF, and the UK should do the same with Bulb Energy. The reason: there is not enough fossil fuel for everyone, and Russia is limiting gas exports. France is struggling with its aging nuclear power plants (it stopped investing 10 years ago). The price of Dutch gas, the benchmark price in Europe, has increased 8 times in 8 months and the trend remains unchanged for 2023. The cost is becoming enormous for households and for industry, in particular for chemicals and steel. Experts do not expect the market to rebalance before 2024. Next winter promises to be harsh, and there is no doubt that rationing measures will soon follow to replenish the reserves by 100%. After Covid “at any cost”, European states are putting tens of billions on the table in direct subsidies and tax cuts to ease household bills.

The G7 is looking for a mechanism to limit oil and gas prices in Russia. The JPMorgan study points to a serious risk of seeking to cap Russian energy prices as Russia could cut its oil exports completely, i.e. 5 million barrels per day, with no significant impact on it. For JPMorgan, such a scenario would push the price of oil up to $380 per barrel! The main difficulty will be to convince a large number of consumer countries and insurers. We doubt that everyone adheres to such a mechanism.

Despite everything, we recommend investing in power producers, in particular those with a significant share of renewable energy sources. They will come out of this crisis stronger, especially small players. The sector is “too big to fail”; there will be nationalization or partial participation. We buy RWE, Iberdrola, Orsted and SSE in Europe and Excelon and Constellation Energy in the USA. We buy Neoen, Solaria and Encavis from small European growers.

Geravest SA is an independent boutique top-down investment advisor and investment solution provider.

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