Mohammed Nalla, CFA, is the founder of Moe-knows.com and Magic Markets.
What are the implications of the current energy crisis and what can we do to plan for a more resilient future?
A little over a year and a half ago, oil futures turned negative. It was in the midst of the worst of the pandemic lockdowns. There was no movement, no demand and given the costs of storing crude oil, the near oil futures price fell below zero. That is, people would pay you to take their oil.
It’s almost surreal that, as we fast-forward just 18 months, we’re talking about crude oil at a three-year high, over $ 80 a barrel at the time of writing. Some call it the worst energy crisis since the 1970s, although much of it depends on where you are.
The UK has experienced a ‘windless summer’ limiting overall energy supply and bringing together a myriad of structural energy constraints in this geography. An acute shortage of natural gas has spurred a switch to petroleum-based electricity generation to keep the lights on and lend to a global surge in energy prices. Queues for fuel and doubling of gas bills are reminiscent of Armageddon. The European fall was cooler than usual, resulting in higher demand than in normal season.
In China, some factories are only required to operate two days a week due to energy shortages and power generation shutdowns. In India, states with excess electricity are instructed to notify the national government as authorities work to coordinate redistribution of electricity and mitigate sales on electricity exchanges and potential price increases. In North America, while supply is currently good, the immediate adjustment of prices at the pump has accelerated rapidly, with consumers already feeling the effects.
With all of this background, I wouldn’t be too dramatic to use the ominous slogan, “Winter is Coming”. Demand is expected to remain strong while supply remains tighter than usual. OPEC + has also been quite slow in using its reserve capacity of 4 million barrels per day. Natural gas giant Qatar has supplied all of its customers and has no spare capacity to supply additional gas at this point. Even coal producers in the United States, who have increased production as demand for energy increased, are struggling to produce quickly enough. North American oil producers have been slow to invest in new capacity as they prefer to hand over money to shareholders after a scorching few years.
At some point, demand and supply imbalances should act as a natural circuit breaker. Supply is expected to respond to higher prices, but long lead times between investment and production, coupled with other global supply chain constraints, mean investment is slower. This leads to a relatively inelastic supply.
Demand is also inelastic to a certain extent. People need heating and transportation, but discretionary spending is falling off a cliff, leading to an overall destruction of demand, in theory. Except that after two years of the pandemic, stocks have been exhausted and production must take place to prevent the shelves from emptying.
As such, the adage “the cure for high prices should be high prices” might not hold up in the short term. There are timing shifts that lead to pressure points. Geopolitical changes like China allowing a temporary truce on Australian coal, or a hardening of the EU’s stance on the UK’s Brexit, leaving them in the dark are all macro flashpoints.
At a more micro level, energy constraints will hamper production along the value chain and have a ripple effect on global growth. The IMF has already lowered its estimate, saying the momentum has eased.
Resources like aluminum have already seen a sharp rise in prices. As these upheavals bring windfall for commodity-producing countries, the whole world had better look through cyclicality and plan with more force for a more resilient future. What do I mean?
The confluence of events we now face is the perfect storm of a pandemic, climate change, and bureaucratic and government failures. To build resilience to the storm, policymakers inadvertently introduced a new set of risks.
As such, it is essential to highlight the concept of anti-fragility defended by Nassim Taleb. Anti-fragile differs from resilience in that resilience resists the storm but remains the same, while anti-fragile learns from the storm and improves.
In an interconnected global architecture, vulnerabilities in specific industries and geographies can quickly escalate into spillover effects. Rather than just creating redundancies for survival, while trying to smooth cycles, we should embrace cycles.
South Africa is an energy constrained country and as such a global energy crisis can have more serious effects if not managed properly. Energy is more than Eskom. SA is also a net importer of oil and SA’s logistics are still heavily dependent on the road.
When shaping its own energy future, South Africa would do well to learn from the global crisis in that dependence on a single producer and a single source of energy is risky. Relying on the road rather than the rail is risky. What is riskier is not having enough storage and buffers, both energetically and financially. It is about having and creating an option in all aspects of the economy. Addressing fragility should frame the discussion of policies and strategies.
And finally, when you predict a rainy day, it is not enough to have an umbrella. Maybe a boat is more suitable, but just make sure the fuel tank is not empty.