European Power Crisis: A "Long Recession" Is Likely Imminent

As of last week, the entirety of the Eurozone is in the throes of an electricity crisis. Almost very significant country in the Continent is now operating at electricity prices north of EUR 600/MWh.

For context, the previous decade's average electricity cost was in the EUR 20-30/MWh range, signifying a nearly 20X increase over a 10-year period. In the year-ahead timeframe, both Germany and France are particularly hard hit and showing very strong correlation - with France's electricity costs now exceeding Germany's. 

This is a particularly trenchant problem for a country’s economy: electricity is a necessary “input” for factories, offices and tech companies to continue operating. With even the year-ahead price trajectories spiking upwards, the prospect of increasing costs affecting companies’ profits – even if they do well – would shift stock valuation goalposts further upwards.

The main factor for this is, of course, Russia reducing gas supplies to the European Union nations in the wake of sanctions imposed on Russia after the start of the "special military operation" in Ukraine. However, another massive factor has been a decade-long tendency in the Continent's legislative bodies to sacrifice energy independence by prioritising the pursuit of clean energy infrastructure while simultaneously shutting down domestic coal-fired and nuclear energy plants instead of phasing out the latter after the clean energy network became viable. Thus, while Russian actions do play a hand in the current situation, so do historic executive decisions by the Continent's leadership. 

As of the beginning of last week, Germany's 1-year ahead power price shows a very strong correlation with the Gas Price benchmark for the Eurozone. This is, of course, a long-term trend. 

However, it bears remembering that gas isn't just used in electricity generation. For instance, in Germany, gas consumption in the power generation industry accounts for only 10% of total consumption. 

Industrial usage and household heating collectively vie for the top spot in energy consumption at 37% and 31% respectively. This trend largely holds true across most European "powerhouse economies" (such as France). 

In light of the energy crisis, the German government has initiated a number of restrictions:

1. Maximum temperature in offices will be 19° C.
2. Tenants are no longer obliged to heat homes to specific temperatures.
3. Ban on heating private pools
4. Illumination of billbords must be switched off at night
5. Public buildings are no longer required to have warm water if electric options are available.

Also, European nations have been attempting to address their massive dependence on Russia by diversifying their supplier base. The world's largest gas producer - the United States - has now become the world's largest gas exporter. European nations have been the largest beneficiaries of this shift by a massive margin. 

However, this has come at a significant cost to "emerging nations" in South/Southeast Asia and Latin America such as India and Brazil.

In terms of Europe's geopolitical influence, this has not boded well. In many of these "emerging nations", political leadership, media commentariat and populace question why they pay the price for forced errors of another bloc. As long ago as June, India's Foreign Minister Dr. Subramaniam Jaishankar took on European think-tanks and polity head-on at the GLOBSEC Forum held in Slovakia's capital Bratislava in the wake of repeated calls for India to "repudiate" its ties with Russia:

Europe has been silent on many issues. Europe didn't speak on many issues in Asia... somewhere Europe has to grow out of the mindset that Europe's problems are the world's problem but the world's problems are not Europe's problems. 

Since then and given the shift in energy supplies, India's energy imports from Russia has seen a rapid increase, with talks now ongoing between Russia, Iran, India and various ASEAN nations to start denominating energy trades (as well as trade in general) in domestic currencies instead of the US Dollar or the Euro. 

The economy is a multi-factor interlocking network of inputs and outputs, both qualitative and quantitative. The lack of long-term vision in the energy sector and the resulting pressure on geopolitical ties via increasing hardships on populations entirely uninvolved in the conflict might have been "rationalized" if energy was the only factor awry in Europe's economic rubric. However, this is not the case. For almost two years now, European consumers have been under considerable pressure, as exemplified by plunging consumer confidence in Germany.

This drop encompasses both an increasing unwillingness of the German consumer to part with hard-earned Euros for consumption of high-priced goods and services as well as the fraying purchasing power of said Euros in the wake of long-standing inflation, which has not seen any materially significant remedies by the government. This form of stasis is evident in virtually every country in the Continent. As a result, the pressure on geopolitical ties is largely for naught and only delays the inevitability of a "long recession" in the Continent to a small extent. 

The increasing relevance of US companies in the European energy markets might be a strong factor in the rise of the S&P 500 ($SPDR S&P 500 ETF Trust(SPY)$) over the course of the previous week: virtually every riser has been an energy company.

For those seeking to interpret the rise in the S&P 500 as evidence of an economic recovery in the US should bear in mind the momentum seen in the constituents of the "tech heavy" Nasdaq-100 ($NASDAQ 100(NDX)$ ) over the same period: nearly every leading company has registered a fall in returns. 

For investors (particularly retail), this once again highlights the potential of a tactical investing mindset and the need to shift perspective from an intangible "horizon" to the more tangible "immediate". Exchange-Traded Products (ETPs) help do just that, with losses limited to amount invested and no further. For example, investors can consider:

• $QQ3S for a -3X exposure on the tech-heavy Nasdaq 100
• $SPYS for a -3X exposure on the broader S&P 500.
• $LS -3X SHORT GERMANY 40 ETP(DAXS.UK)$ for a -3X leveraged exposure on the downside of the German DAX 40 and $LS 3X LONG GERMANY 40 ETP(DAX3.UK)$

However, it bears noting that ETPs are structured products with specifically-designed characteristics, risks, and potential for delivering portfolio value. These are quite distinct from ETFs, ETNs and other structured products. 

In the interest of educating investors on this matter, I shall be holding a 30-minute webinar with a Q&A session on the 15th of September at 10PM (SG/HK):