7 Sept 2022
Global Macro-economic and Geo-political Update
In previous newsletters we outlined that an inflation risk mitigation strategy was investing in store value assets. The Ukraine war has further highlighted the importance of this strategy because of the global energy shortage.
Energy Makes the World Go Around
Energy and food (which is energy) make the world go around. The wealth of a nation can be measured by the energy it wastes, e.g., the food left on a plate, type of travel adopted, or use of air conditioners and heating. With increasing energy costs those countries that are energy deficient, e.g., Japan, UK and Eurozone will suffer economically much more than those countries which are not, e.g., US, Australia, Norway and Canada.
The Russia/Ukraine war has exacerbated this energy shortage, although it is not the primary cause. In recent times, it has become politically unacceptable for Governments to support fossil fuel initiatives meaning that corporations have stopped investing in new exploration and production. Unfortunately, now that the energy shortage has become evident, the lack of capital expenditure means it will take years before new production can come online. In this interim period while the world waits for new production to come online, the laws of supply and demand will apply, i.e., the price of oil, coal and gas, the key energy products will increase.
China is suffering a major drought and water shortage which has reduced the use of hydroelectricity causing an increase in the use of coal powered power stations. This along with the Chinese Government’s zero Covid policy is impacting on the availability of food and manufacturing production.
It is well documented that Europe is suffering a major energy crisis with Russia reducing the amount of gas flowing to Europe. France is restarting 32 nuclear reactors that had been shut down as part of its switch to renewables. The wholesale price of electricity has increased from Euro85 to Euro1000 per megawatt hour. The French Government says it will absorb some of this 1175% wholesale price increase while at the same time has asked consumers to reduce gas and electricity consumption by 10%. Russia has now closed Nord Stream 1 pipeline putting further pressure on energy prices.
Australia has ample gas reserves. The reason for increasing local gas prices is because Australia 20 years ago entered a fixed price contract at a very low price to supply natural gas to China. Australia is now exporting about three-quarters of the gas it produces, while unable to satisfy domestic market demand.
The US Energy Information Administration has forecast that global consumption of petroleum and liquid fuels will average 99.4 million barrels per day for all of 2022, which is a 2.1 million barrels per day increase from 2021. It further forecasts that global consumption of petroleum and liquid fuels will increase by another 2.1 million barrels per day in 2023 to average 101.5 million barrels per day. Spare capacity is limited and even if the Iran nuclear deal (JCPOA) is revitalised it will take at least 12 months for Iran to get back to full production capacity.
According to the IEA’s July 2022 coal market report, global coal consumption is forecast to rise by 0.7% in 2022 to 8 billion tonnes. Coal continues to be a key energy source.
Codelco is the world’s number 1 copper producer. It recently downgraded its production forecast for this year from 1.61 million tonnes to between 1.49 to 1.51 million tonnes. The reasons include water scarcity, increasing energy costs, declining grades, depletion rates, skinny pipelines, industrial action and increasing regulatory costs. In 2021, Chile produced 25% of the world’s primary copper production of 21million tonnes. The importance of this cannot be understated and may be best understood that Chile in the copper world is the equivalent of OPEC in the oil industry.
Shortage of USDs
As outlined in previous newsletters about 70% of global trade continues to be either in USDs or a USD denominated currency meaning that countries either have a surplus, e.g., China or a deficit, e.g., Singapore of USDs.
We have previously outlined that there are effectively two US dollar markets, as a consequence of the USD being the world reserve currency. There is the domestic US economy and there is the Eurodollar market (USDs outside the US boarders) which is not regulated by the US Federal Reserve or any central bank. When the US Federal Reserve creates money, it does so for the US domestic economy, it cannot create USDs for the Eurodollar market which is significantly larger than the US domestic economy. With the USD rising in value and interest rates going up across the globe this is causing an increase in demand for USDs, as those countries with USD denominated debt need more USDs to service it. This demand is increasing at the same time the US Federal Reserve is reducing the USDs available across globe through monetary policy which is adding to the shortage of USDs globally.
Even though we believe holding USD is a sensible strategy, we do not believe investing directly in USD investments now makes sense as it is relatively expensive and US treasuries are still negatively yielding. We believe there are good investment opportunities, subject to market conditions in Australian based store value assets, and specifically the energy sector, as energy is a base input into the production of all goods and services.
As usual if you have any questions, please feel free to contact us.