If we were to hazard a guess about which single word best sums up European consumers’ feelings right now, that word would be: Ouch. Or perhaps: Oof. Either would be an entirely logical reaction to electricity prices’ astronomical spike this month, which smacked households all over Europe and the UK. Governments across the Continent are racing to try and relieve the pressure, and their efforts thus far are largely a mixed bag. Unsurprisingly, pundits on both sides of the Atlantic warn this will drive inflation even faster, creating headaches for the Bank of England (BoE), European Central Bank (ECB) and stocks. We don’t doubt this spike will show up in eurozone September inflation when the preliminary report hits Friday, but beware extrapolating that into something bigger or presuming central banks can do anything about it. Electricity prices in Europe these days stem largely from structural and political factors, not monetary ones, and their impact probably is a lot milder than pundits allege.
Not that we are dismissing the pain for households and businesses, which is real. The UK, which has taken the worst of it, saw wholesale power prices top £480 per megawatt-hour intraday on Wednesday, according to The New York Times.[i] FactSet data show they settled by closing to about £415—still over 9 times their pre-pandemic average.[ii] They are lower across the Continent, but not by much, leaving politicians scrambling. Italy’s government is reportedly planning to use public funds to curb households’ energy costs, according to Bloomberg. Spain’s government announced a suite of electricity tax cuts, which should help, as well as measures to promote clean energy (which makes zero sense as a solution to the current issues, as we will discuss momentarily) and plans to cap utilities’ profits through special taxes, which probably do more harm than good in the long run as they dissuade investment. Meanwhile, the UK is already proving the law of unintended consequences, as price caps enacted in 2017 have forced providers out of business—including two that fell last week as prices spiked. Fewer producers mean less competition and, you guessed it, higher prices.
None of the measures announced thus far address the root cause of today’s high prices: Power supply. Whether you think this push is spot-on or not, European governments are major proponents of lower-emissions energy generation, which means switching domestic energy production from coal to renewables.
In Germany and other key nations, the “renewable” category doesn’t include nuclear, tied to the political push to phase out reactors following Japan’s Fukushima disaster a decade ago. That leaves wind and solar—intermittent sources of energy that produce well when the wind blows and the sun shines, but not otherwise, and effective storage is lacking. Hence, European nations are heavily dependent on natural gas, which burns cleaner than coal. But that natural gas comes chiefly from Russian pipelines and other nations’ tankers, not domestic sources, leaving supply and prices vulnerable to “President” Vladimir Putin’s whims and seaborne freight prices, which are up.
European wind power output was already tepid this year entering last week, when the wind stopped blowing in the North Sea. Wind-based electricity generation tumbled. Much of Europe took a hit, but the UK bore the brunt because when it switched to imported energy, it became dependent on undersea cables from France. UK prices were already significantly higher than Continental prices when one of those cables caught fire Wednesday, which the National Grid estimates will put it out of commission for half a year. To fill the shortfall, the Brits are turning back to their four remaining coal-fired plants. Ultimately, however, the real solution will likely be for the wind to start blowing again.
This isn’t the first time the shift to wind and solar has had a similar effect. South Australia dealt with spiking prices and rolling blackouts back in 2017, and Californians are quite familiar with them. They are a headache, but only a temporary one—and one economies are pretty adept at overcoming. Which is good, because there just isn’t a lot governments can do to turn the lights back on instantly. No matter how many wind turbines the Spanish government promotes, for example, they are all for naught if the wind doesn’t blow. Politicians can’t make the sun shine 24/7/365 either. The ECB can’t build pipelines, approve nuclear reactors, enter the fracking business (which governments on the Continent largely haven’t permitted anyway) or spearhead new technologies. About the only manmade solution we can think of is to put all of Europe’s politicians on a barge in the North Sea and let them blow all their hot air at the turbines—and even then, it probably wouldn’t help Southern Europe.
That is the bad news. The good news: This isn’t as big of an inflation driver as you might think. In the eurozone, energy’s weighting in the Harmonized Index of Consumer Prices is 9.5%.[iii] In August, energy prices’ 15.4% y/y contributed less than half of the 3.0% inflation rate—excluding energy, prices rose 1.7%. So, it had an impact, but not a ginormous one. In the UK, total utilities—water, electricity, gas and other fuels—are 14.3% of the Consumer Price Index (CPI) basket.[iv] In August, CPI rose 3.0% overall and 2.8% excluding energy—even as energy prices rose 9.5% y/y.[v] So even if this were something central banks could fix through monetary policy, there is scant evidence that would actually be necessary.
Lastly, we would be remiss not to address the elephant in the room: Utilities stocks. We haven’t seen anyone argue this is a boon for them, which is correct. Wholesale and retail prices alike are up, so none of this points to soaring profits, outside maybe a few isolated scenarios in Spain, which the government is planning to “fix” with excise taxes. So we aren’t at all surprised Utilities stocks aren’t outperforming right now. They had a very brief burst in mid-August but are largely in line with the MSCI World Index over the past month—and remain one of the worst-performing sectors year to date. We don’t think that is likely to change any time soon, given the sector’s defensive and value-oriented characteristics.
[i] “A Fire in a Power Cable From France Sends British Electricity Prices Soaring.” Stanley Reed, The New York Times, 9/15/2021.
[ii] Source: FactSet, as of 9/15/2021. NORX UK Power Day Ahead Daily Average, GBP/MWh, 10/11/2013 – 9/15/2021.
[iii] Source: Eurostat, as of 9/15/2021.
[iv] Source: Office for National Statistics, as of 9/15/2021.
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