The Breakdown - Europe’s Energy Crisis

Episode Date: August 31, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.   European energy markets have been roiled as the price of energy futures rockets to up to 30 times the five-year average. In the U.K., restrictions on the cost of energy have been lifted, increasing prices by two to five times overnight. Across Europe, governments are considering radical interventions. NLW breaks down what’s going on with the European energy crisis.  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company safeguards your crypto by relying on five key fundamentals including real-time auditing and insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - I.D.E.A.S. 2022 by CoinDesk facilitates capital flow and market growth by connecting the digital economy with traditional finance through the presenter’s mainstage, capital allocation meeting rooms and sponsor expo floor. Use code BREAKDOWN20 for 20% off the General Pass. Learn more and register at coindesk.com/ideas. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “The Now” by Aaron Sprinkle and “The Life We Had” by Moments. Image credit: SEAN GLADWELL/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

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, and ftX, and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, August 30th, and today we are discussing Europe's energy crisis. Before we get 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, 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, guys, well, it is fairly quiet in crypto, which is in part sort of what you'd expect at the end of the summer. However, it also reflects the fact that right now, all eyes are on the macro. And by that I mean, of course, the battle between, on the one hand, inflation and on the other, reduced growth. One of the chief combatants in this fight is the Federal Reserve. And as we discussed yesterday, part of what's causing this latest leg down is that markets are getting the memo that this is a Fed that is going to be higher for longer. It is going to continue to push rates up until it feels like it has completely broken the back of inflation. What's more, it's a Fed that's making it very clear that there will likely be pain as a price to pay for getting inflation down.

Part of what that pain looks like is reduced growth. We are already in a period of contracting GDP, and frankly, the U.S. is in a lot better shape than some other parts of the world. Europe is, of course, not just dealing with the inflationary fallout of the pandemic, but also a new geopolitical reality of war that is significantly disrupting energy among other commodities. And so today, it is to European energy that we turn. To get a sense of the vibe out there, Kyle Bass, the CIO at Hayman Capital Management, tweeted,

French power prices for 2023 are trading at 900 euros per megawatt hour, with winter prices above 1,500 megawatt hours, or an eye-popping 30x the five-year average price. I'm surprised this isn't front-page news all over the West. And while Kyle may be right that it is being underreported relative to its significance, market watchers have definitely been keeping their eyes on European energy calls. Over the weekend, natural gas prices on the continent hit levels more than seven times the price seen in markets just a year ago. Let's talk first about the UK.

The UK is feeling the pinch of high energy costs in a particularly strong way, as a price cap on energy bills has just been lifted. This means that businesses and households are now having to renegotiate their energy supply and a wave of posts highlighting new costs hit social media over the weekend. These posts tended to show between a two and five times increase, in energy costs for the coming winter. The Rosen Crown, a British pub, wrote, Just thought I might update you on the latest best energy deal available for a pub of our size,

best in quotes, by the way. The chart that they tweeted showed a 10x increase in their electricity quote. Gerard Brody, the head of national policy and chief economist at the Irish Business and Employers Confederation, wrote, on average, companies I've talked to are facing a three to five times increase in energy bills. For most, their choices to fix at today's record price, or pay the whole sale price. Example of a small shop going from 50,000 pounds annual bill to 150,000 pounds in 2022, and worst likely ahead. Now, rubbing salt in all of this for UK businesses and individuals

has been a series of increasingly absurd energy saving and budgeting advice delivered by the UK government. The Times ran an article last week, for example, encouraging people to return from work from home arrangements to their workplaces in order to free load showers and phone charging to save 28 pounds a week. The population, who knows, that saving 28 pounds a week isn't going to change the dynamics have thus become even more discontented and angry. There was a small protest weekend outside of the energy regulator, and one biting op-ed pseudonymously published in The Guardian last week closed by saying, I don't want to be told how to cook or what I should buy for 30 pence or ways to keep warm, or the best tricks to save

electricity. Why do they think they can be poor better than I can? I've done it for a lifetime. Now, all of this to people just smacks of a lack of honest engagement between the UK establishment and the citizenry about the real ramifications of runaway energy costs. The UK, even with restrictions on energy prices, was facing record inflation. In July, inflation hit 10.1%, which is the fastest growth in the UK since 1982, and represented the first major economy post-COVID to hit double digits. The Bank of England estimated that fall inflation could hit 13% when those restrictions change, but some others think that that's actually low.

Goldman Sachs yesterday came out with a report that said, that UK inflation could top 22% if natural gas prices stay high. Goldman's report argues that if prices stay at current levels, the UK will be, quote, forced to increase its energy cap by a further 80% in January, which they say would push inflation to 22.4% and lead to a 3.4% decline in GDP. Even in a moderate scenario, Goldman Sachs is predicting a peak inflation rate of 14.8% in January. Lest we think this is just one errand bank, last week, Citigroup also predicted 18.6%. All of this is leading to expectations that the next UK leader will need to provide more fiscal support. The frontrunner to replace Boris Johnson is Liz Truss, and Goldman expects to see at least

30 billion pounds in fiscal stimulus from the new government. Now, of course, the energy crisis is not just confined to the UK. The price rises are generalized across the Eurozone due to natural gas being a cornerstone of energy generation for Europe. German and French electricity prices both hit levels over 1,000 euros per megawatt hour last week. This is extremely elevated above prices from the beginning of the year of 200 euro per megawatt hour. What's more, these numbers have been rising quickly, with both markets seeing 100 euro per day rises last week. German firewood prices have also skyrocketed as households seek

to substitute heating fuel. They've more than doubled over the past six months. Wall Street's Silver writes, households in Germany are stockpiling firewood. Not sure there will be much price relief by switching to wood. People are going to just start buying axes and chopping down trees in the parks. Uh-oh. Russia was the top supplier of wood pellets to the EU last year. Now, to the extent that there was good news, German economic minister Robert Haybeck said on Sunday that Germany was ahead of schedule in filling natural gas storage for the winter. He predicted that the target of achieving 85% of capacity that had been set for October would be achieved by early September. Quote, companies will then be able to withdraw the gas in the storage facilities as planned over the

winter in order to also supply industry and households. These are undoubtedly difficult times, but despite the difficult circumstances we are making progress. Adding more complication, Russian gas supplier Gazprom announced that it would again stop delivering via the Nord Stream pipeline to perform maintenance on Wednesday. The maintenance is scheduled to take three days, and from there, we'll have to see. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side. Nexo is a security-first company that manages risk by relying on mechanisms such as over-collateralization, real-time auditing, and insurance on

custodial assets. Learn more about Nexo's reliable business model and start your crypto journey at nexo.io. That's nexo.io. Eager to make more informed decisions around crypto, chainalysis is here to help. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigations support for all crypto assets. For organizations like Gemini, Crypto.com, and BlockFi. Gain unparalleled visibility and maximize your potential with the leading blockchain data platform by visiting us now at Chainalysis.com slash CoinDesk. The breakdown is sponsored by FTXUS.

FDXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCX, you pay no gas fees. Download the FTCX app today and use referral code Breakdown to support the show. Now, just like there is speculation about what the British government will do,

there is also discussion of what the European government can do to help people in the Eurozone. A big announcement was the news that the European Council is preparing to step in to intervene in the energy market. Their goal appears to be breaking the structural linkage between gas prices and the electricity market. European Commission President Ursula von der Leyen said on Monday, we have to develop an instrument which makes sure that the gas price no longer dominates the electricity price. We're seeing now with these exorbitant high gas prices that we might. musty couple. She went on to say that urgent steps were necessary to address skyrocketing prices, which she attributed to nervousness in the market and speculation. French PM Emmanuel Macron also

called for electricity market reforms in a meeting with the Polish prime minister on Monday. He stated that his aim was to construct a market regime, quote, protected from elements of speculation and with new pricing formulas. EU member states are increasingly calling for price caps. The Czech Republic, who hold the current rotating presidency of the EU, will host an extraordinary meeting of energy ministers, on September 9th to discuss solutions to the crisis. The Prime Minister of Belgium said on Monday, I really think that we should intervene because the cost of uncertainty is really becoming impossible. I believe that we should intervene and for my country we have been advocating price caps in the gas market and the wholesale price market for a long time. This is a short-term solution,

a temporary intervention. Meanwhile, the economic ministry for Germany is considering an excess profits tax on energy companies. Quote, the companies would still earn this money, but then it would be taken away from them and be used to preserve the social cohesion and also to finance any aid for the companies, as long as we have developed and implemented the new market design. Simone Taglia Pietra, a senior fellow at the Bruegel think tank, said, as Europe finds itself amid extraordinary circumstances, extraordinary interventions do make sense. However, a number of tradeoffs exist and the key challenge for European policy makers will be to avoid throwing the baby out with the bathwater.

On market design failings, President von der Leyen said, quote, skyrocketing electricity prices are now exposing for different reasons the limitations of our current electricity market design. It was developed under completely different circumstances and completely different purposes. Now, whether or not an emergency market redesign or other EU interventions are likely or feasible, the announcements are having a profound effect already. The Eurozone benchmark Dutch gas futures front month contracts plunged by 21% on Monday, which partially reversed the 40% increase the contract had seen across the previous week. Now, as you'll have just heard, European politicians seem to be really concerned

about the market structure of European energy in general. A couple things to note about this. First, this is a period of low liquidity. There have been a string of bankruptcies in energy providers across Europe and margin calls rippling through the market. This allows small orders to move the market an inordinate amount, which is why you've seen a number of crypto traders compare European energy right now to a shi-coin.

Secondly, the trade is increasingly one-sided, as energy providers who would normally step into sell contracts are being repeatedly burned by steep rallies as short-sellers scramble to cover their positions. Finally, in the European energy market, the off-market wholesale price is calculated in reference to the final order of the day, meaning that a speculator looking to drive up the price only needs to squeeze prices at the end of the day to set prices across the entire market. Javier Blas, the energy and commodities analyst at Bloomberg writes, 1. Margin calls driving trading. Liquidity is extremely low. Two, more state support would be

needed in the next 24 to 48 hours for European utilities to stay solvent. Three, the calls for suspending the forward electricity market are getting a lot louder, and as expected, the European utilities are calling on governments for bailouts. Now, building on this theme, Savas Yacud and analysts says that some of the apocalyptic scenarios that are being shared on FinTwit are really about a misunderstanding of the relationship between energy markets and energy costs when they actually manifest. He writes, FinTwit is making apocalyptic scenarios out of this one single chart and alarming everyone, i.e. Lehman moment, no electricity in Europe this winter, etc. A small threat on electricity prices in Europe.

Pilemic TMM perfectly explains forward energy price is the cost of hedging rather than what prices will actually be its spot. So looking at forward prices and thinking next year someone will pay 8x the current cost would be naive. Then what is driving these sky-high prices? Low liquidity. A small order can move the prices in a big way

due to low liquidity. Is there a disconnect between fundamentals and price? As of last week, it seems so. A few traders speculating scarcity for no reason, even when rationing is on the table, and markets become dysfunctional. Overall, I don't expect an apocalyptic scenario in Europe this winter, but still, some consumers will suffer, high prices on their energy bills.

Also, it is clear that the market is not functioning as it should. A bunch of speculators can make speculative decisions for millions of people in Europe about how they should live. I hope European regulators are closely watching this space. Now, of course, to our American sensibilities, the idea of European regulators stepping into reorganize energy market structure might feel a little anathema. However, the reality of the situation is that there's not really a good option that they have. It's basically subsidies, bailouts, or nationalizations, none of which are particularly appealing. The UK has already seen six energy providers enter bankruptcy during the first wave of energy price increases.

Earlier this week, Austria's largest energy supplier announced that it was functionally insolvent. In Germany, energy giant Uniper requested a second bailout, and so on and so forth. But of course, this is what has people now starting to really think about the second or Order effects. Dylan Leclair writes, why the hell are European politicians doubling down on terrible policy? Future prices for January 2023 of 28x since 2020. If nothing changes, Germany is literally going to freeze in the dark, absolutely insane. European debt markets are going to collapse if this continues on. The ECB might be forced to print into an inflation spike in energy crises. What an absolute disaster. Stack Hodler, meanwhile, takes a look at what the second order effects are in terms of regular people.

workers are beginning to demand higher wages, and soon everyone will be demanding fiscal support. The money they print for UBI will reduce the purchasing power for energy. It will be a wage price spiral on steroids. They also write, don't worry, European energy prices will fall. Businesses that can't afford the high prices will shut down, many permanently. Others will relocate. That will reduce demand and lower prices. Europe could be left with droves of unemployed workers begging for a UBI.

Preston Pish writes, these energy prices will not be accepted by the masses. They will demand government intervention via price controls. Intervention will create manipulated demand for energy that's already in short supply. The spiral is just starting. Now, to put some numbers on this in the UK, Ian Mulherin, the Executive Director of Policy at the Tony Blair Institute, writes, helps to think in aggregate terms when considering the scale of household energy bailout need. In 2021, UK households spent about 30 billion pounds.

Next year, the bill will be 170 billion. How much of the 140 billion pound difference can we realistically expect households to pay. The rest is for Her Majesty's Treasury. Given the limited targeting mechanisms available, my guess is households would struggle to do much more than another $30 billion, and the health, economic, social consequences for asking them to do so would be pretty dire. The market dog sums up every single time in history. Central Banks printed money in an irresponsible manner it led to a crisis. The difference is that in the past, speculation was going into railway stocks or ninja loans, but now it's going into future lumber, oil, gas, electricity contract.

All in all, I'm left most in agreement with Lynn Alden who wrote, The first rule of economic policy is to make sure you do not run into acute energy shortages. The second rule of economic policy is to make sure you do not run into acute energy shortages. And yet, here we are. For now, I want to say thanks again to my sponsors, nexo.io, chain alysis and FDX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

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