Market Analysis

The EU's Natural Gas Conservation Plan Has A Couple Holes

Rationing may yet happen, but we don’t think this week’s agreement guarantees it.

Here are two things that seem related but—on a closer look—we don’t think are: Tuesday, the International Monetary Fund (IMF) sounded the global recession alert, citing the potential for a severe winter energy shortage in Europe.[i] Also Tuesday, the European Commission agreed a natural gas conservation plan for European Union (EU) member states.[ii]

The IMF’s latest projection may or may not prove correct about those shortages, but in our view, that is less important than the fact that it echoes the past several weeks’ worth of recession warnings from commentators we follow, which we think stocks have already moved on.[iii] Therefore, what matters from here is how reality evolves compared to baked-in forecasts, in our view. That is where we think the EU’s move comes in. If you read the finer points, we think it becomes clear the conservation plan mostly kicks the can down the road and doesn’t automatically tee up tough cuts that would take German industry offline and guarantee a eurozone recession.

The EU’s plan is not energy or electricity rationing. It isn’t even rationing. It is a loose agreement for most member states to voluntarily reduce natural gas consumption by -15% from the average amount each used over the past five years.[iv] It won’t apply to islands (Ireland, Cyprus and Malta), which are disconnected from Continental supply lines. It doesn’t have a clear enforcement mechanism, which is jargon for a clear answer to the question, or what? It doesn’t mandate how to curb consumption. It leaves loopholes for countries that have full gas reserves, “are heavily dependent on gas as a feedstock for critical industries,” or have sharply raised consumption over the past year (potentially exposing them to severe hardship if they go -15% below the prior average).[v] It also offers exemptions for countries that don’t draw much gas from Continental pipelines and feed gas into the system for their neighbors. And whilst it leaves room for the cuts to become mandatory if the European Commission declares a “Union alert,” details on what would trigger that aren’t sketched out yet (beyond a request from five member states to do so).

In other words, this appears to us like a loose plan with several escape hatches, which makes sense, in our view, considering the Commission’s original plan drew objections from many EU governments.[vi] We think it seems mostly about appearing to do something whilst appeasing the member states in opposition to the plan when it was first floated last week. It nods kindly to nations that would take a severe hit to living standards and economic output—much like the EU’s energy sanctions against Russia did.[vii] It also nods to those, like Spain, which aren’t reliant on Russian gas for energy and don’t appreciate having to sacrifice for others, like Germany, that haven’t diversified their suppliers over the years.[viii] In that way, in our view, it is a fun-house mirror image of member states’ stances on bailouts during the eurozone crisis.[ix] To us, it is another example of the age-old collision of solidarity and self-interest.

But we digress. It appears to us that the main goal here for the EU, which may or may not work, is to cut consumption enough that gas from all sources can flow to the nations that need it this winter if Russia keeps supplies through the Nord Stream 1 pipeline at a trickle or less. We don’t question that a -15% reduction is a big ask, but we don’t think it is insurmountable. In France, for instance, nuclear energy is the main source of electricity, with natural gas largely confined to heating and air conditioning.[x] So, in our view, reducing demand there basically amounts to turning down the thermostat.[xi] Spain and Portugal appear to be eyeing the exemption for well-supplied countries.[xii] Germany has more of a pickle, but fall-back plans there are already in the works to restart idled coal plants to fill a potential energy shortfall.[xiii] There is also talk of pausing the final steps of the nuclear phase-out, allowing the remaining reactors to stay online.[xiv] Additionally, the exemption for countries that rely on natural gas as a feedstock for key industries could also help, given its importance to Germany’s mighty chemical industry.[xv]

We don’t know how all of this will shake out. But it does seem clear that there are too many questions and too much complexity for it to make sense to pencil in a rationing-induced Continental European recession today, in our view. Even if one does occur—and even if a European recession in general is underway now—we think it is questionable whether it would mean much for stocks at this juncture. Several European countries are in bear markets (broad stock market declines of -20% or worse) in euro, meaning, their declines aren’t a product of currency depreciation.[xvi] That is pretty consistent with stocks’ pre-emptively incorporating an economic slide into share prices, in our view. Commentators we follow have warned of this slide for months, with energy shortages cited as the chief driver. So if voluntary or eventually mandatory cuts indeed play into this, we mostly see it as reality mirroring the warnings that stocks have already priced in. That doesn’t point to a severe market downturn from here, in our view—rather, we think it would be right in line with stocks getting confirmation that the headline risk that drove them lower is coming to fruition. In our experience, often, that enables markets to get over uncertainty and get on with life.

[i] “Global Economic Growth Slows Amid Gloomy and More Uncertain Outlook,” IMF, 26/7/2022. A recession is commonly defined as a decline in broad economic output.

[ii] “Member States Commit to Reducing Gas Demand by 15% Next Winter,” Council of the EU, 26/7/2022.

[iii] Source: FactSet, as of 27/7/2022. Statement based on MSCI World Index return with net dividend in GBP, 31/12/2021 – 26/7/2022.

[iv] “Member States Commit to Reducing Gas Demand by 15% Next Winter,” Council of the EU, 26/7/2022.

[v] Ibid.

[vi] “EU Divided Over How to Step Away from Russian Energy,” Michael Race, BBC News, 2/5/2022.

[vii] “EU Agrees Russia Oil Embargo Gives Hungary Exemptions, Zelenskiy Vows More Sanctions,” Kate Abnett, Jan Strupczewski and Ingrid Melander, Reuters, 31/5/2022. Accessed through Yahoo! News.

[viii] “A German Word for How Others See Germany’s Gas Crisis: Schadenfreude,” Matthias Matthijs, The Washington Post, 26/7/2022. Accessed through MSN.

[ix] “Greek Bailout: IMF and Europeans Diverge on Lessons Learnt,” Dr. Angelos Chryssogelos and Matthew Oxenford, Chatham House, 16/8/2018.

[x] “France,” U.S. Energy Information Administration.

[xi] “EU Agrees to Cut Natural Gas Use Amid Supply Fears,” Staff, Associated Press, 26/7/2022.

[xii] “Spain Has Capacity to Become Gas Hub in Europe, PM Sanchez Says,” Staff, Reuters, 27/7/2022. Accessed through Yahoo! News, and “Spain, Portugal Reject EU Plan to Cap Natural Gas Use,” Joseph Wilson, Associated Press, 21/7/2022.

[xiii] “Germany to Reactivate Coal Power Plants as Russia Curbs Gas Flow,” Kate Connolly, The Guardian, 8/7/2022.

[xiv] “Germany’s Gas Crisis Generates Nuclear Dilemma for Ruling Greens,” Riham Alkousaa and Andreas Rinke, Reuters, 15/7/2022. Accessed through Yahoo! News.

[xv] “German Industry: Gas Rationing Plan Would Cripple Economy,” Nik Martin, Deutsche Welle, 30/3/2022.

[xvi] Source: FactSet, as of 27/7/2022. Statement based on Germany DAX Index, Italy MIB Index and Austria ATX Index returns with net dividends in euro. Currency fluctuations between the pound and euro may result in higher or lower investment returns.


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