The recession of 2023 is by far the most anticipated and predicted recession ever seen. However, as much as anything can wait, the experience can still contain surprises.The outlook for inflation is at the forefront of this debate. The latest eurozone data showed prices for services, goods, and food rising, but energy inflation slowed.
What happens to energy prices over the next 6–12 months is key to understanding the broader macroeconomic picture in Europe and the outlook for infrastructure assets globally. Because of the banking crisis, higher inflation forces the Bank of England to keep raising interest rates.
Although there remains hope for a peaceful and quick resolution to the war in Ukraine, the tragic reality is that this is unlikely to happen soon, given the accumulation of weapons in the region. Therefore, the energy market related to the supply of Russian gas is expected to be tight during 2023.
However, the winter has been mild so far, with temperatures above average for this season. As a result, gas consumption in Europe decreased by 20-20% from August to November compared to the previous year.As such, the storage facilities are full during the seasons, and the common perception is that there will be no shortage of gas. I believe the market reaction was premature, and that the threshold of energy inflation will be reached in the second half of 2023.
Fed opts for the “lesser of three evils” with a 25 bps hike.
A warmer winter and full inventories will push gas and electricity prices below the 2022 summer peaks, but still high compared to 2021.
Unless Russian gas starts flowing to Europe again, which is almost unthinkable, electricity prices will remain high compared to before.
Russia’s illegal incursion into Ukraine and a sudden shortage of cheap Russian gas have prompted European governments to look for other energy sources and increase imports of liquefied natural gas (LNG) via ships and ports, often from the United States.
But diversifying energy sources is only part of the picture. The key factor that kept the lights on in Europe this winter was China. As Western demand for gas increased, China remained closed, leaving the country’s energy needs significantly lower than if the economy were fully open.
Everything is about to change. China’s reopening will accelerate only in the second half of the year. People are returning to the workplace, factories are reopening, and demand for energy is increasing, as are prices.This demand shock is exacerbated by the global phase-out of fossil fuels. The war in Ukraine made the energy transition even more important as governments realised that renewable energy was the key to achieving energy independence.
The rise in UK inflation is “unlikely to last,” but it has the potential to become sticky.
Massive expansion of renewable energy infrastructure is part of the solution, but not all renewables are created equal. Offshore wind is efficient, but it takes a lot of time and money to build. Battery technology has an exciting future, but it’s still decades away. Natural gas, therefore, inevitably plays a large role as a transitional fuel in the transition to net zero.
China knows that too. The country is working to phase out coal in power generation in favour of natural gas, which currently accounts for only 8.5 percent of its energy sources. Switching from coal to gas would reduce the country’s carbon footprint by 55%.
Demand for natural gas will explode in the second half of 2023 as both Europe and China seek to boost their energy reserves ahead of winter and ease the transition away from fossil fuels. Even as the West turns to the US, China, and perhaps Russia, increased demand for LNG could massively inflate energy costs everywhere, a factor many European investors seem unaware of.
So, what does all this mean for infrastructure investors?
Energy security remains an important issue. Investments in US pipelines that deliver gas to Europe and companies exposed to higher energy prices are likely to be the main winners.
Exposure to commodity prices generates more alpha if weather conditions worsen in the future. Otherwise, electricity price protection protects companies from falling energy costs.
The energy transition is also important. The increase in money spent on the development of renewable energy must be accompanied by a greater amount spent on network development and the transformation of transmission networks into “smart” networks, as well as a sharp increase in electrification.
When inflation returns, many infrastructure investments offer protection through concessions and contracts.
One advantage of infrastructure investment is that higher financial costs are passed on to consumers with a small delay that does not significantly affect businesses. Finally, the inherent defensiveness and exposure to long-term cash flows in infrastructure give the industry resilience during downturns and make it a place to hide during them.