In today’s Exponential Investor:

  • Russia’s not-so-subtle Nord Stream plan
  • Energy independence and the transition
  • Unhedged players see bankruptcy risks rise

Here’s the 30-year chart for natural gas prices:

Source: Koyfin 

They’ve been accelerating upward recently.

Foul work at play?

If you were the leader of a country with an enormous availability of natural gas, and a gas pipeline to Europe which was under threat for political reasons, what would you be wishing for every time you found a four-leaf clover?

You’d probably wish for a gas crisis in Europe.

If only, if only, there were some way to make that happen…

Well, some are suggesting that Russia might really be behind this.

It has a clear motive, as operation of its Nord Stream 2 pipeline is being held up for political reasons, even though as of this month it is now complete and ready for action.

The United States is against Nord Stream 2 (because Europe will be more dependent on Russian gas and less so on the United States), as is Ukraine, which will be cut out of some lucrative intermediary fees (which is also why Russia is so keen on the new pipeline).

The state-owned fossil fuel giant Gazprom is a key player in all this. It has fulfilled all its contracts to European customers, but it hasn’t put up any of its surplus for sale into the spot market, and it hasn’t topped up its European storage. This has both tightened the market for gas and put other participants on edge.

Essentially, the largest state player in the gas market is holding Europe to ransom, on behalf of its own country.

Charmingly, the boss of Gazprom came out last Friday and said prices could reach new, record heights this winter. As the man with perhaps the most power to do something to prevent that, it reads less like an analysis of storage levels and seasonal patterns than a thinly veiled political threat.

The geopolitics of renewables

My road or the high road seems to be the message from energy suppliers to energy importers.

While Nord Stream dallies, Norway has just agreed to ramp up its gas exports to Europe starting in under two weeks.

And maybe this will simply reinforce the importance of local energy resources (solar, wind, nuclear, hydro). It has not been spoken about much lately, as fossil energy prices have been quite soft, but only about 10% of the countries in the world currently supply the rest with their energy.

This incredible asymmetry has led to much of the conflict we see in the world today, especially around the Middle East. Securing energy supplies is just so crucial.

I’m also a believer in something called the Resource Curse, in which having plentiful resources of a precious commodity like oil can actually be bad for an economy. It encourages corruption and economic concentration, slows social progress and leads to short-termism.

The list of oil-producing countries looks very different from most people’s bucket list of tourist destinations, and very different again from the most equal and advanced societies.

What renewables offer is the chance for countries to achieve a much greater degree of energy security, or independence.

Reliance on something like gas, which can be manipulated into extremes by the interested parties, leaves us vulnerable to the vagaries of the market and the whims of antagonistic nations. This is what’s happening now, as consumers are feeling the pinch and companies are going bust. It reminds us that the current system isn’t exactly perfect, and the intermittency of renewable sources like solar and wind doesn’t look so bad next to soaring prices and shortages.

Reliance on imports also makes us politically limited in terms of what we can do to Russia or Saudi Arabia when they commit crimes or limit freedoms.

Renewables are by no means some golden ticket to a utopian future and this whole episode does highlight how tricky and volatile the transition is likely to be. But they should help to ameliorate the issue of energy concentration in the hands of a few supplier nations.

When the tide goes out…

If you are a company, one of the key risks to manage is the costs of acquiring your key product.

So, if you make cars or operate in a foreign country, you are at risk if steel prices start rocketing or the foreign currency starts going haywire.

Hedging is the most common way to mitigate this risk.

Forgoing some of the potential upside, a company will use a hedging strategy to ensure that if prices or currencies go against them in the future, they won’t be left exposed.

Essentially, they offset their exposure to price fluctuations by taking an opposite position in the futures market for steel, or the yen-dollar currency pair, or whatever. This is what hedging is all about.

The concept dates back to the 1800s when the Chicago Board of Trade standardised futures contracts in 1865, to farmers and dealers to trade grain and other “soft” commodities at future transaction dates throughout the year.

The concept has spread, and it is obviously now true in the gas market too.

And with the tide (of reasonably low gas prices) going out as described above, we are starting to see who is swimming naked (in terms of lack of hedging), so to speak.

Companies which buy gas to supply customers with electricity can hedge so that their fixed contracts with customers are always above what they’re paying out in costs.

But a number of companies don’t do this. They don’t hedge, they simply buy on the spot market, and they are now suffering the consequences. As the spot prices for gas have soared, many have found that they can’t afford to supply homes at current prices.

One company, ironically named Green, has warned that it may not make it through winter if this continues. It supplies 250,000 homes in the UK.

Large suppliers would usually take on their customers in the event of bankruptcy but may not be able to do so profitably with prices so high, and so are having to ask for government support.

The key thing here is that the government is keen to maintain its cap on consumer electricity bills, but this means businesses can’t pass on higher costs to the consumer.

It will be interesting to see how this one plays out.

In the meantime, giant Chinese property company Evergrande is rocking markets as it struggles to pay its debts…

It could be an interesting week or two.

Until next time,

Kit Winder
Co-editor, Exponential Investor