SIMON BROWN: I’m chatting with Mohammed Nalla, a good friend of the show. You’ll find him, of course, at Moe-Knows.com. Mohammed, I appreciate your time again. This week [there is the] energy crisis [in the], UK and Europe. Even in north-eastern China, they’ve got what we would call ‘load shedding’. Partly it’s trucks and petrol and UK service stations, but actually a lot wider than that. And it’s a lot wider than just the UK….
MOHAMMED NALLA: Yes. Simon, thanks for having me on the show. Always a pleasure. I love chatting to you and to the listeners as well. This energy crisis, some would say [has been] a long time coming; others would say it kind of crept up on us. The fact of the matter is when you’ve seen natural gas prices literally jump in the first quarter of this year around from call it $2.40 to earlier this morning call it $6.40, that is a massive, massive shock to the system.
I’ve seen a lot of narrative out there, with some people saying, oh, well, this is related to a broader push for green in Europe, and that’s the problem; and some people are saying, well, that’s absolute rubbish, net zero is not the problem. It’s Covid that’s the problem. Others are saying it’s geopolitics. So I’d like to unpack a whole bunch of all of those factors, because the fact of the matter is that it’s probably a little bit of each of those.
SIMON BROWN: That’s just it. I went down the rabbit hole and some people were blaming the Danes for having no wind, so there was no green power. Others were blaming Covid for storage [not being maintained] last year, so it was done this year and they never got enough storage into it. Let’s start with that net neutral.
MOHAMMED NALLA: Let’s start with net neutral, because I think it’s fairly contentious to some who still support the fossil-fuel industry.
We know that in the UK there has been a big push towards clean energy, and I don’t think that’s the problem. What I think the problem is, is that the UK pushed towards a single type of clean energy, and that was wind, and so naturally when the wind stops blowing you end up having problems. But this goes a step further, because if we delve into some of the energy dynamics in the UK, I actually saw a very interesting thread on Twitter this morning from an energy expert. I can’t claim credit for this, but effectively this guy was saying that the UK has used gas to balance out the inconsistencies in the energy demand that is rather seasonal in the UK, and that spread in terms of energy demand is almost two to three times.
Now you can understand that it gets fairly cold out in the UK. People need to heat their homes and so demand in the colder months can reach as high as two to three times what it is in the summer months. Now here’s the scary thing, Simon. We’re not in the winter months yet, so it is an aspect of demand dislocation. But if we superimpose on that some of the other aspects, if we superimpose on that the fact that Covid has constrained supply chains, not just in the UK but globally – and I’ve got fantastic anecdotal stories I can tell you in the US – where their supply chain shortage is impacting business there. There’s some of that.
There’s the fact that there is a labour shortage. Again, post pandemic, people have been slow to go back into work. That is now complicating the moving of energy across the UK. There’s a shortage of truck drivers. We’ve heard stories of soldiers driving fuel trucks there. So it’s a combination of that.
And then, last but not least, it’s also geopolitics. There are lots of talks around Russia turning off the taps.
There’s also the Brexit story. Here’s where I think: there’s actually a lot of merit to the argument that the UK has isolated itself from Europe.
Europe had a very nice balancing mechanism in its energy markets in that when you get surpluses in some regions and when the wind stops blowing in the UK, historically you’d be able to utilise the energy surplus that comes through the rest of the EU and push that onto the UK. The UK now is literally an island unto itself, and that undoubtedly is having a material impact on some of what we’re seeing right now.
SIMON BROWN: So in essence it’s a combination of events [where] almost each on its own is not going to be a challenge. Collectively they become a significant problem.
MOHAMMED NALLA: Yeah. There’s an old concept around Minsky. Hyman Minsky was someone who had actually spoken about the fact that the longer stability continues, it actually leads to these veins of instability that creep up on you, and eventually the entire sand pile comes crashing down. That’s really this confluence of events that we’re seeing in the UK.
Now what’s really concerning me, Simon, is that the lead times on energy, for example, are exceptionally long. It takes a long time to build up capacity. It takes a long time and here’s the main rub. It’s why it’s always so fascinating, because when you sit in an emerging market you seem to think that these problems are just the purview of emerging markets, but in the UK their energy regulator warned them that they may be facing shortages and constraints on their system in and around March this year. That’s the reason why earlier I was saying, in March, natural gas prices were around $2.50. They are now almost three times that.
So it’s a failure in that your authorities did not pay attention to their own warnings. They did not plan accordingly. They do not have nearly enough storage, which is the other constraint on the gas system. They just don’t have the storage, so they can’t really ride through some of these demand dislocations. That’s when the confluence of events comes back and bites you very, very severely.
SIMON BROWN: The implications of this – there are the three obvious ones: there’s going to be the tragic one. There are going to be some people who literally can’t heat their homes over Christmas because of costs, and we might see some fatalities related to that. There’s the consumer who’s going to have less disposable income because they’re paying more in energy. And I’ve also heard that some of the European fertiliser manufacturers, because of the increased cost in energy, are cutting back on fertiliser, which is going to impact food. It suddenly becomes an inflation issue at the same time.
MOHAMMED NALLA: Yeah. Let’s unpack that. I think the first one is the human toll, which we often ignore. Literally they’re coming out saying that people are going to have to rely on blankets. Now, as we go into winter, you can’t rely on blankets, especially if your insulation is not fantastic. Some of those UK homes are not as well insulated as thankfully the homes are here in North America; there will be a human cost, unfortunately – we hope not – but that is a real risk going over to the economic cost. Already I think the number when I last saw it was that there were five utilities, you-pay utilities that have gone bust in the last month. And obviously there’s only so much reshuffling you can do. Those customers are moved over to the larger companies – Shell, British Gas and so forth – but there’s that cost.
There’s also the fact that if you have a look at what’s happened with sterling, the pound is down over 4% in a month [to the US dollar]. For a developed-market currency that’s more akin to emerging-market currency performance. So 4% in a month technically is looking as though – it’s around 1.35 (GB pound/US dollar) at the moment, and technically 1.33 is your support. If that goes, it could go all the way down to 1.20. So keep an eye on that.
There’s the fact that the gilts, the yields on UK bonds, have risen to their highest since 2019. Yes, they’re still at just north of 1%, but that is an increased cost of funding for the UK government. And there’s the real economic impact downstream. As you indicate, fertiliser companies may have to actually shut down shop.
And I think, if we throw on top of that a logistical challenge that is a global phenomenon right now, [if] we unfortunately don’t flick a switch and solve these problems now this could very well bolt into an inflationary story that is less than transitory. I know I’ve historically been in that transitory or transient inflation camp, but some of these supply-chain disruptions are really building to a point where that narrative is going to have to change and policymakers are going to have to grapple with how you cool inflation without really destroying the economy.
SIMON BROWN: It sounds like a horror story that we’re looking at in the future, a sort of a slow train wreck, in that unless there’s a very warm northern hemisphere winter, this is going to play out to one or another degree. The extremes might not quite be there, but this is going to play out.
MOHAMMED NALLA: I think so. Obviously there’s the whole aspect of what the winter looks like.
That is also related to, again, the mega trend around climate change. A lot of these dislocations we’re seeing are manifestations of that mega trend. So for the denialists out there, I would say go and have a look; it’s starting to appear directly in front of your eyes.
The other dimension here, Simon, is that energy markets globally are being kept tight. We saw Opec earlier this week keeping supply tight there. So all of this feeds through, and the question mark for me is we can very quickly shift from what was historically a narrative on deflation into a narrative – I don’t think it’s actually inflation – I think the story here is stagflation. And the problem with stagflation, maybe a discussion for another day, is that there are no policy tools that we’ve come up with in terms of combating stagflation. For listeners, not familiar [with it] stagflation is when you have high sustained inflation, but no growth. And the reason we don’t have those tools [is that] the last time the world saw this was during the energy or the oil-price crisis in the seventies. The only reason that we got out of that stagflation mess is because oil prices collapsed. That was not a policy response rather than a market response. Perhaps that’s where this goes, especially if you have a look at what’s happened with the parabolic curve on natural gas prices.
SIMON BROWN: Yeah. Stagflation – there’s a word that should keep folks awake at night.
Mohammed Nalla from Moe-Knows.com, I appreciate your time as always.