The Breakdown - Could the European Energy Crisis Become a Debt Crisis?

Starting point is 00:00:00 The reason that energy is so important is that it is one of the absolute fundamentals of economic functioning. When it breaks down, it brings with it social unrest, political turmoil, and much more chaos. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com. chain aliasis and FTX, and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, September 6th, and today we are talking energy, inflation, and more. Before we dive into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation,

Starting point is 00:00:47 come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also, a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. All right, team, it is after Labor Day that means in America, the summer is over. And last week, we talked a lot about why we might see an autumn of action, and it certainly seems like this week is living up to that idea. In Cryptoland, we've got ETH merge discussions really heating up, which includes, of course, tons of hype and excitement, but also many questions, concerns and debates. We're also seeing more discussion of centralized stable coins. Binance has just announced a reduction in their support for USDC on their exchange,

Starting point is 00:01:34 which is creating its own back and forth about how much this is just financial efficiency for them versus how much it shows that these really are a different type of centralized finance infrastructure. However, as I've been discussing all summer, what's really driving economic considerations everywhere are much bigger factors than just what Binance does on its exchange, or even what Ethereum is doing in terms of proof of work or proof of stake. And so it is to those type of larger economic factors that we go today. In terms of those larger factors, inflation has, of course, been the biggest driver of the macro environment. However, when Russia invaded Ukraine

Starting point is 00:02:09 earlier this year, it added a whole new dimension to the inflation crisis. Both Ukraine and Russia are major exporters of wheat, grain, and other foodstuffs, meaning the invasion was inflationary in particular for places like the Middle East, where a meaningful portion of the wheat they used for bread comes from affected areas. In Europe, of course, the bigger consideration has been energy. Russia historically has supplied a significant part of Europe's energy needs, specifically in the form of natural gas. Following the invasion, there have been huge political debates around what to do. Initial sanctions didn't include energy, but many in Europe saw their reliance on Russian energy as a strategic weakness, knowing now how bellicose the country really was.

Starting point is 00:02:48 Of course, on the flip side was the reality of how fast changes could theoretically be made, especially with winter coming and with a Europe that has in many places like Germany, reduced energy capacity through the closing of nuclear power plants, and just a general shift in policy over the last few years. In the discussion of Russia's energy relationship with Europe, one of the key assets is the Nord Stream pipeline. Nord Stream is actually a pair of pipelines, with Nord Stream 2 meaning to come online earlier this year.

Starting point is 00:03:16 However, Germany's suspended certification of that pipeline in response to Russia's invasion. Actually, technically, it was in response to the recognition of two regions within Ukraine as independent states in the lead-up to the invasion, but that's neither here nor there. Since then, there have been serious questions about what would happen with Nord Stream 1, one of the key ways that natural gas gets to Europe. In the middle of the week last week, Nordstream went offline for scheduled maintenance. The question many had was, would it be coming back? Many thought that the opportunity would be seized by Russia, and that's basically what happened.

Starting point is 00:03:49 On Friday, hours after G7 leaders agreed to implement a price cap on Russian oil, Russian energy monopoly Gazprom announced that the Nord Stream pipeline would remain closed indefinitely. This cancelled plans to reopen following three days of maintenance, which were scheduled to conclude on Saturday. Gazprom blamed oil leaks, a claim that Siemens Energy, who provides technical support for the pipeline as well as the German grid agency, said did not justify cutting off. gas flows. EU leaders decried the action almost immediately as a weaponization of the energy supply. Charles Michel, the president of the European Council, wrote,

Starting point is 00:04:24 Gasprom's move is sadly no surprise. Use of gas as a weapon will not change the resolve of the EU. We will accelerate our path towards energy independence. Our duty is to protect our citizens and support the freedom of Ukraine. Now, while Nord Stream is the primary gas pipeline into Germany, secondary Eurozone pipelines through Ukraine and Turkey continue to operate. Dmitri Peskov, the chief Kremlin spokesperson, delivered the most clear call to end sanctions to date around this. As quoted by the Interfax News Agency, he said, The problems pumping gas came about because of the sanctions Western countries introduced

Starting point is 00:04:57 against our country and several companies. Russian Deputy Prime Minister Alexander Novak also said that Russia will refuse to sell oil to any country or company that supports the price cap. To get into this a little bit more, with gas prices and electricity, prices more than four times higher than a year ago, the EU is now considering drastic market interventions. These include price caps, energy rationing, and windfall taxes on profits from energy companies. Talks of market reform from EU Commission President Ursula von der Leyen pushed prices down last week, which ended a week's long squeeze higher. The euro also slumped

Starting point is 00:05:30 to a 20-year low as the ramifications of an ongoing energy crisis on Eurozone businesses became clear. German Chancellor Olaf Schultz coalition has agreed to a $65 billion euro relief package to assist households with rising energy costs. The measures there include a pledge to cap and maybe even redistribute energy company profits, increased payments to pensioners, students, parents, and the unemployed, and tax breaks worth $1.7 billion to $9,000 energy intensive companies. Schultz said at a press conference that the measures were, quote, a substantial big step to provide relief to citizens, while noting that the crisis is, quote, Putin's responsibility. This package is the third since Schultz took office in late 2021, with total relief currently standing

Starting point is 00:06:10 at 95 billion euros. Some are comparing this energy bailout to other bailouts, noting that it pales in comparison to the 300 billion euros allocated to pandemic emergency spending in Germany, or the 750 billion euro IMF and EU combined bailout fund utilized during the 2012 Eurozone financial crisis. Of course, then, others are pointing out that this bailout comes in the context of already extremely elevated inflation. The German government has also decided to extend, then the operation of two nuclear plants and several coal plants that were scheduled to close shortly. The German energy regulator said on Saturday, quote, the situation is tense and a further deterioration of the situation cannot be ruled out.

Starting point is 00:06:47 However, gas supply in Germany is stable at the moment. Security of supply in Germany continues to be guaranteed at present. German natural gas storage hit 85% on Saturday a month ahead of their target for doing so. The economic ministry, however, commented on Friday, quote, we have already seen Russia's unreliability in the past few weeks, and accordingly, we have unwaveringly and consistently continued our measures to strengthen independence from Russian energy imports. Jacob Mandel, a senior associate for commodities at Aurora Energy Research, said, quote, supply is hard to come by and it becomes harder and harder to replace every bit of gas that doesn't come from Russia.

Starting point is 00:07:20 When weather turns cold and demand starts to pick up in the winter in Europe and Asia, there's only so much liquefied natural gas out there that Europe can import to replace Russian gas. Ursula von der Leyen again said, Putin is using energy as a weapon by cutting supply and manipulating our energy markets. He will fail. Europe will prevail. The EU Commission is preparing proposals to help vulnerable households and businesses to cope with high energy prices. The EU Commission proposal will aim to reduce energy demand or peaks, price cap on Russian pipeline gas, help vulnerable consumers and businesses with revenue from the energy sector, enable support to electricity producers facing

Starting point is 00:07:54 liquidity challenges linked to volatility. Now, there's a lot of commentary about giving people money in the face of already high inflation. It's obviously much more complex than the Twitter version of this, but to understand the Twitter version, the market dog writes, Every European country will give citizens money to burn gas instead of investing in energy sources for the future. Now, for the slightly more complex version of this, let's turn to Dylan Leclair. He writes, Energy deficits of this magnitude are not resolved without major casualties along the way.

Starting point is 00:08:23 Winter is coming. Increasing political upheaval and social unrest is coming to the EU. Households and businesses will demand assistance from sovereigns. Any aid provided will eventually require massive debt monetization from the ECB to contain spreads and ease conditions, leading to more debasement. In the meantime, the Fed has gone full-blown hawk while the global economy begins to decelerate in nominal terms and contract in real terms. A result of a global energy crisis and collapse in economic conditions is the circulation of dollars massively slows. And it is not just Dylan asking this question about the relationship

Starting point is 00:08:57 between energy crises and debt crises. Fajiao writes a thread, We're about to experience a sovereign debt crisis caused by the European energy crisis, all a capstone on the 100-year Fiat experiment. Here's how I think the next six to eight months go down. Putin's strong arms Europe by shutting off energy pipelines, causing a spike in prices. This causes energy prices to skyrocket in Europe,

Starting point is 00:09:19 which is a major component of CPI. This causes inflation to explode higher. As CPI explodes, higher electricity prices get passed onto consumers. Eventually, at the risk of civil unrest and revolution over refusal to pay this, Euro government has two options. Given to Putin and let him have Ukraine and stop the sanctions to get energy flowing again, decide to deploy price caps on energy for consumers and print the difference. To achieve this, I believe ECB needs to install yield curve control to keep sovereign bond yields intact and avoid fragmentation of EU sovereign bonds. The game theory I've ascribed to this makes me think that

Starting point is 00:09:51 the West is too far deep into this mess to give in to Putin and will rather print the difference. The saying goes, no government ever willingly went broke through austerity. They will always resort to printing. Now, his thread then goes on to full-blown speculation about how it might play out, but the short is dollar wrecking balls all the way down. Jim Bianco also wrote a threat about this, saying Europe is in an intolerable position and the public is getting angry, and it is not cold out yet. Jim points out effectively that while storage is decently full,

Starting point is 00:10:20 about in the middle of the range seen over the last five years, It has taken enormous cost to fill these facilities. Specifically, he says the cost of filling storage this year has already cost more than 6.5x to fill storage in any other full season. They have it and paid huge for it. He points out that this extra cost has already happened and will be passed on to the population, either directly through higher energy bills or indirectly through higher taxation for bailouts. He sums up, so what does all this mean?

Starting point is 00:10:50 Europe has all the gas it needs as long as they drain their bank accounts to pay for it. because the cost has already happened, it cannot be undone. NXO is a security-first platform built for the long run with everything you need for your crypto. Five key fundamentals, including real-time auditing and insurance on custodial assets, safeguard your funds, making NXO the right place for you to buy, exchange, and borrow against your assets safely. Learn more about NXO's reliable business model and start your crypto journey. at nexo.io. That's nexo.io. Eager to make more informed decisions around crypto, chainelysis is here to help. Chainalysis demystifies cryptocurrency by providing industry-leading

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Starting point is 00:12:24 One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFT. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. One of the parts of, well, formerly Europe now, with some of the biggest challenges heading into the winter is the UK. Average annual household energy bills were due to rise by 80% in October to over 3,500 pounds and are expected to top 6,000 pounds per year in 2023. This is the reality that new Prime Minister Liz Trust comes into. Trust has been elected leader of the Conservative Party and will now become the next Prime Minister

Starting point is 00:13:10 of the United Kingdom, replacing Boris Johnson. She defeated her rival Rishi Sunak, the former Chancellor of the Exchequer, and the head of the UK Treasury by a little over 20,000 votes. Now, it's worth noting here why I've been paying attention to this. One is, of course, the UK's relationship to all these big-picture power shifts, i.e., it's the first major economy to formally hit over 10% inflation post-COVID. It is, as we're discussing, a major center of this emerging energy crisis, but there is also a crypto dimension. Truss's main competition, Rishi Sunak, was the person most responsible for the about-face in the country's tone on crypto, which saw the UK come out blazing with desire to be a global hub for the industry. Obviously,

Starting point is 00:13:48 as someone in this space watching Rishi's political progress was relevant. Now, when it comes to Liz Truss, there's very little info on her takes about crypto or, frankly, very much at all. However, what we do know is that at the very least, she seems not openly hostile. In 2020, acting as trade minister, she said that the country could, quote, create great opportunities in areas such as blockchain. In 2018, during her tenure as chief secretary to the treasury, trust tweeted, quote, we should welcome cryptocurrencies in a way that doesn't constrain their potential. But that's really about it. So there just isn't much here right now. However, I will say that whatever crypto policy Liz Trust might have had in a different time, it's hard to imagine that it's not a fairly low priority

Starting point is 00:14:27 given what the government faces. Outside of all of the challenges, there is not a lot of confidence here. UGov polling suggested that only 12% of the British electorate expects her to be a good or great leader, with 52% of the population expecting poor or terrible governance. Markets seem to agree and appear to be less than enthusiastic about the incoming PM as well. The pound fell back to multi-year lows against the dollar, a level only seen previously in March 2020 and 1985 before that. Short-term corporate debt rates also ballooned by a half percent over recent weeks, up to 5%, which is the highest level in a decade.

Starting point is 00:14:59 Now, Truss has said that the three priorities for her government are going to be, quote, a bold plan to cut taxes and grow our economy, delivering on the energy crisis, dealing with people's energy bills, and delivering on the National Health Service. She's really, really focused on tax cuts and making the UK pro-innovation. Yet still the most pressing topic is energy. Under newly drafted plans, the government will freeze energy costs at the current rates, effectively abolishing the existing pricing regime and sideline the energy regulator. ministers will instead set pricing for households. The price caps are projected to be in place for 18 months and are projected to cost 130 billion pounds. That represents around 5% of GDP and a larger expenditure than the pandemic-era furlough income support scheme which cost 78 billion pounds. The scheme is intended to be funded by guaranteed financing to energy providers to cover pricing shortfalls with the cost of the loans to be paid back over the coming decades via increased energy pricing. Critics point out that the plan removes any incentives to limit energy usage and also are upset that there is no intent to tax energy companies as a way to help fund interventions.

Starting point is 00:16:04 Truss's political opponents are already going in. Richard Burgone, a Labor MP for East Leeds, writes, Already, it seems Liz Truss's energy price freeze is a slight of hand. Reports say you'll pay back a temporary freeze via higher bills over 10 to 20 years, while oil and gas firms keep billions in excess profits. No, make them pay. Take all their excess profits in a windfall tax. This theme is repeated across the Labor Party,

Starting point is 00:16:27 with Bill Esterson saying the leaked trust energy crisis plan, put the public into debt for 20 years, let the oil and gas companies who are making record profits off scot-free. If that's her plan, her premiership is a disaster, and she hasn't even taken office yet. Now, the point of all of this is to point out the drama, the urgency, and the politics of energy crisis in the context of a weak economic situation already. The reason that energy is so important is that it is one of the absolute fundamentals of economic functioning. When it breaks down, it brings with it social unrest, political turmoil, and much more chaos. The next few months are going to see governments debate a lot of seemingly bad choices and ultimately have to pick something.

Starting point is 00:17:11 So that is the update from here as it comes to the European energy crisis. For now, I want to say thanks again to my sponsors, nex0.io, chainalysis and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event, the investing in digital enterprises and asset summit or ideas. The event facilitates capital flow and market growth

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The Breakdown - Could the European Energy Crisis Become a Debt Crisis?

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