By Lars Schernikau for RealClearEnergy
Prices for coal and gas have reached new highs. In many western countries, electricity prices have risen dramatically. This isn’t surprising to me.
For years, I have argued that there is a structural-energy raw material shortage driven by underinvestment in 80% of our primary energy (oil, coal, and gas) and overinvestment in so-called variable renewable energy (VRE) – mostly wind and solar, which, in 2019 and 2020, received about 13 times more investment than oil, coal, and gas combined.
To this structural misalignment can be added other global factors, including but not limited to: huge financial stimulus and resulting drastic demand increase post-Covid that global supply chains could not meet; and geopolitical “games,” notably Russia using its gas leverage and China’s boycott of Australian coal.
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Bloomberg Green’s David Baker and co-writers claim that this crisis is just one of many in the wake of an energy transition to clean power. This will be the beginning of many more. “In the throes of fundamental change, the world’s energy system has become strikingly fragile and easier to shock,” they write. Wind and solar have soared, but both renewable sources are “notoriously fickle.”
However, the trend of banks and governments avoiding investments in mining activities is becoming a longer-term problem. This trend is likely to cause major disruptions in global industrial operations, which will be difficult to predict. While energy expenditure is “only” around 2% to 5% of global GDP, energy is at the core of all our economic activity. Energy is the key to all economic activity. Without it, Teslas, iPhones, food products, clean water, vaccines and schools are not possible. There’s no F1 race, Netflix, shoes or bridges. This is the main point.
It’s a point that needs making in the context of the demonization of coal. Over one-fourth global primary energy is provided by the coal industry, and more than 35% global electricity. Those who compare coal to the tobacco industry don’t understand energy markets and how our world depends on them. Comparing a discretionary “pleasure” product such as tobacco to energy is ludicrous. Coal’s non-private benefits can be seen in Britain, which boasts about “powering past coal” yet pays for coal-fired capacity to help keep the lights on.
So why do I say “coal, gas, and energy prices cannot remain this high?” Coal prices in Europe touched 300 USD a ton (from less than 50 USD in 2020). Asian LNG prices reached 40 USD/mmBtu, an increase of less than 2 USD since May 2020. As a result, power plants in Europe make almost 100 EUR/MWh more when burning coal instead of gas, despite record-high CO2 emission allowance prices of over 60 EUR/t – this at a time when electricity exchange prices topped 400 EUR/MWh in Europe. Do you remember when they cost less than 40 EUR per MWh in 2020?
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Industrial energy raw materials consumers can’t be expected to produce at high prices. Power plants and cement mills are going to stop making power. Brick companies won’t be producing bricks. Paper mills won’t produce paper. Steel companies won’t make steel. You can see the first signs in India, China and Germany as well as Pakistan and other countries.
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Governments would have to step in – to increase often-controlled power prices, or to force industries to produce at a loss, or to allow produce prices (such as for cement) to skyrocket.
Either way, fewer products will be produced (including fewer Teslas, because Tesla’s supply industry suffers from a lack of coal in China), and demand will dwindle as scarce products become more expensive.
As companies cease making products, equity prices will plummet. Loans cannot be repaid when companies don’t produce enough. Businesses plans are thrown out the window.
A credit crisis is also possible. Which importer or trader has sufficient bank lines to trade hundreds of millions of tons of raw materials at triple/quadruple prices (see article “World’s Largest Commodity Traders Face Massive Margin Calls As Global NatGas Arb Explodes” at ZeroHedge here)? There is a lot of risk associated with credit. Credit will be tight and product flow may stop or decrease. Companies will experience a greater liquidity crisis. The consumer will ultimately suffer.
Supply is also changing. High prices are motivating even young and inexperienced entrepreneurs in South Africa, Indonesia and other exporting countries to start digging out more coal and “hand-carrying” it to a vessel.
The supply adjustment might occur just as demand begins to drop, which could make it worse.
This is why I think these prices can’t be sustained. The market will force prices to change quickly. If they don’t adjust, the market will be sure to force prices to adjust more violently later. The more prices are adjusted later, the more severe the adjustment will become.
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This does not contradict my previous assertion that we are now entering an era of energy and resource shortages with all of its associated consequences, including increased risks of blackouts. My opinion is that we are entering a new phase of the raw material cycle, which will see prices rise for all raw material types (including fossil fuel).
I foresee a significant price drop or at least greater volatility before New Year’s, despite the looming energy shortage during the upcoming winter. This price drop, however, will still keep prices far above 2019/20 levels and consequently above marginal costs of production – so, for producers, no worries.
Lars Schernikau (energy economist, entrepreneur and author) is an energy economist. Before joining the commodities business nearly 20 years ago, he was employed by the Boston Consulting Group in both the U.S.A and Europe.
RealClearWire permission granted this syndicated version.
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