What will be the consequences of the energy crisis for Europe?
What will happen to Europe on energy and beyond. The analysis by Niall Gallagher, Investment Director European Equities of GAM Investments
We are currently in a downward phase for European equities, with the energy crisis at the top of the global agenda. Gas prices in Europe have increased enormously; they are trading at about 15 times the five-year average through 2021. Furthermore, they are completely unrelated to gas prices elsewhere, particularly in the United States. Considering an equivalent energy base, gas prices are trading at several hundred dollars per barrel of oil equivalent and for electricity the ratio is even higher.
In the short term, Russia's invasion of Ukraine has caused a gas shortage in Europe, which has become much more gas-centric over the past 10 years due to the phasing out of nuclear and coal and the addition of intermittent renewable sources. However, we believe that Europe would have faced an energy crisis during the energy transition process even if the conflict between Russia and Ukraine had not occurred. Europe needs to drastically reduce carbon dioxide emissions over the next 30 years, but it remains to be seen how lawmakers intend to proceed.
There are several elements that could help Europe reach a firmer foundation for the energy transition. In the short term, a resolution with Russia would allow us to re-import Russian gas. This, however, is highly unlikely, as European solidarity with Ukraine is not destined to fail. Furthermore, the French nuclear park is currently underutilized by around 50%, with a significant number of plants closed for maintenance; those running at full capacity would help. Even a mild winter with a lot of wind would reduce the pressure. But even if this were to happen, Europe would still need serious demand-side measures to reduce gas consumption, particularly in Germany.
In the medium term, Europe needs a much more diversified gas supply and to take energy security much more seriously. National governments could consider the opportunities for fracking and the development of gas reserves. As things stand, the EU is unlikely to phase out gas use over the next 20 to 30 years and therefore long-term contracts with US and Qatari producers would ensure a long-term supply.
It is also necessary to increase investment in renewable sources, eliminating bottlenecks such as the problems of transmission grids in Germany. We also believe that the transition to the Net Zero goal is unlikely to occur without significant investment in nuclear energy. In much of Europe there is some consensus that nuclear is the future. There are also longer-term solutions, such as modular nuclear reactors that can be adapted and industrialized for power generation, and we believe we will see investment in this area.
Applying these analyzes to European equities, we believe a very significant recovery in investment is needed. This will coincide with the transition to Net Zero, as there are many areas where we see the possibility of making significant investments and the current energy crisis will, in our view, accelerate attention on them. It is necessary to invest more in energy networks to guarantee security of supply, for the benefit of oil and gas companies, but also of some industrial entities that supply these value chains. One of the most important measures we can take to reduce our energy demand is to invest more in buildings. For example, building insulation will make a huge difference in reducing energy consumption.
The last aspect of the current crisis is that oil and gas companies are benefiting from much higher prices. Prices will remain high for some time and these companies will generate significant cash flows. Obviously, to maintain their social license to make these kinds of profits, they will have to invest heavily, particularly in renewable energy, and we believe they will likely do so in terms of expansion towards more renewables and low-carbon technologies, which will be part of the long-term solution.
Overall, Europe is in a difficult situation from an economic point of view. However, we believe that this market is well understood and taken for granted and that while some areas are likely to experience a sharp decline in earnings due to the need to reduce activity or the impact of much higher prices, from the other are areas that would benefit from much higher levels of investment that will be needed to make the energy transition plausible.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/energia/quali-saranno-le-conseguenze-della-crisi-energetica-per-leuropa/ on Sat, 01 Oct 2022 05:02:23 +0000.