There’s never a good time for an energy shock. But for Chinese President Xi Jinping, now is a devastating moment to grapple with shortages and big price spikes mirroring the 1970s.
The sudden crunch has a few causes: technical speed bumps, a lack of investment, green-power enthusiasts getting ahead of their skis. This triple whammy, though, coincides with surging demand as the globe reopens from Covid-19 lockdowns and as supply chains disrupted by the pandemic struggle to return to something approaching normal.
The scarcity bubble first emerged in Europe. It has since hit China so quickly and ruthlessly that Tesla’s Elon Musk is having to recalibrate his enthusiasm over China’s recovery. The giant factories Musk moved to Asia’s biggest economy now could be facing power shortages for some time.
The crisis is threatening to spread to more nations and shake global recovery hopes. It’s also upending all that investors thought they knew about the trajectory of energy sources.
Excitement about the green revolution, it turns out, ran far ahead of nations’ ability to pivot away from fossil fuels in reliable and pragmatic ways. This price shock is reshaping the trajectory of coal, a commodity virtually everyone thought was dead.
With UK wholesale gas prices surging to record highs, Brits have fresh reason to wonder if Brexit was such a great idea. The crisis is even morphing Vladimir Putin’s Russia into a white knight of sorts. Moscow says it stands ready to stabilize markets with increased natural gas supplies.
And it’s putting a fresh spotlight on the potential of hydrogen power.
For all the chatter about digitalization, today’s power-price dynamics are the “revenge of the old economy,” says analyst Jeff Currie at Goldman Sachs Group.
Currie worries the global economy is cascading toward a “multi-year, potentially decade-long commodity supercycle” with many catalysts including climate change and government stimulus aimed at reducing income inequality.
At the same time, recent events betray gaps in the transition toward cleaner and sustainable energy sources, says Nikos Tsafos at the Center for Strategic and International Studies. The push toward greener growth, while wise and inevitable, is outpacing the energy sector’s ability to store and transport power sourced from renewables.
“The need to balance the energy system will remain, with all the challenges and price volatility that such a task entails,” Tsafos says.
This uncertainty over the energy mix is colliding with more than a decade of ultraloose monetary policy fanning inflation. The aggressive Covid-related easing in 2020 came before central banks had a chance to exit earlier “Lehman shock” stimulus back in 2008.
Those tidal waves of cash generally flocked to asset markets, driving up stocks and property values. Now that largess is helping fuel energy-price speculation. And at the very worst moment for a China plagued by debt-market turmoil.
China’s converging woes
Beijing has quite enough on its plate already in handling the China Evergrande Group default drama. The globe’s most indebted property developer keeps missing debt payments while nervous investors scrutinize the stumbles of smaller players like Fantasia Holdings Group.
In recent days, Fantasia failed to make a US$206 million-denominated bond payment. A month ago, no one cared about China’s 64th most consequential real estate name. Now, its health is a source of great drama and trepidation about China’s outlook.
The energy crunch is the threat few saw coming for China as 2022 approaches. Blackouts in the globe’s No 2 economy – or sudden bursts of inflation – could shoulder-check a world economy trying to regain its footing.
As of now, China’s powerful National Development and Reform Commission admits at least 20 provinces aren’t meeting their 2021 carbon goals. They include Guangdong and Jiangsu, which generate more than one-third of China’s gross domestic product (GDP). By year-end, the damage is sure to increase exponentially.
Last week, economists at Nomura warned of the potential for “another major supply-side shock” and that the risks of further disruption have “been underestimated or even missed.” These foundational questions are bumping up against some of Xi’s self-inflicted economic troubles.
Though the energy crunch is among them, the tech crackdown over the last 11 months already had investors on edge. It started with the shelving of a November 2020 initial public offering by Jack Ma’s Ant Group. It has since mushroomed into a full-blown tech-industry inquisition that shook investors’ confidence in China.
Top Silicon Valley venture capitalist Chamath Palihapitiya, CEO at Social Capital, speaks for many when he worries the “game is over” for investors as Xi polices the tech sector. “I think there will be lots of volatility,” he warns. “The question is where will it come from.”
While that clampdown set the stage for today’s China uncertainty, the energy shock is becoming the main event. It highlights the cracks in one of Xi’s top priorities: energy security.
For the most part, planned reforms for China’s power market have been in slow-motion mode since 2015. The process is of getting municipal-level officials and powerful coal-related interests on the same page.
Overlapping subsidies that warp supply and demand dynamics and poor power-storage options also proved to be roadblocks. Then came the Shanghai stock crash in the summer of 2015, which greatly reduced Beijing’s appetite for disruptive economic change.
It’s all about chaotic price dynamics, says Michal Meidan, director of the China Energy Program at the Oxford Institute for Energy Studies. To be sure, Beijing’s recent stance “sends a message to the market, and mainly to OPEC, that China is dissatisfied with high global crude costs.”
But domestically, he says, the “missing link is price distortions with benchmark prices being capped and international prices being so high.”
Particularly since 2019, China has been phasing out older coal power plants. Some of this was driven by deep losses related to mismatches between coal prices and pressures stemming from more dynamic pricing mechanisms in the US and Europe.
It’s also entirely possible that Xi’s desire to placate global pressure to go green ran ahead of China Inc’s readiness to shift its energy mix. Still, the energy crunch is the last thing Xi’s team needs as new waves of Covid-19 infections challenge the outlook. And as global investors watch the Evergrande saga ever more closely.
Diana Choyleva at Enodo Economics is not convinced that Evergrande, per se, is a major risk. She says that the chance of a major mainland bank getting into trouble due to Evergrande is unlikely, but banking trouble not related to Evergrande “is somewhat likely.”
The bigger risk is Evergrande forcing a change in direction. As Choyleva puts it: “A sharp policy U-turn by Beijing, halting deleveraging and propping up growth indiscriminately – unlikely – although the current energy crisis won’t blow away quickly, exacerbating China’s tough transition.”
The worry, says Julian Evans-Pritchard at Capital Economics, is the Jenga-like nature of Xi’s efforts to recalibrate China’s growth engines. As his regulators remove one block at a time – say, clamping down on bank lending – it risks the whole game. Moves to police property lending and rein in shadow banking, after all, helped push Evergrande toward insolvency.
“The current disruption highlights the economic costs inherent in China’s push for self-sufficiency and decoupling with the West,” Evans-Pritchard says.
All this leaves Xi having to decide between several policy options as energy prices cause the clock to tick faster. And that’s true of world leaders everywhere.
There is an “unattractive range of options” to deal with the “parabolic rise” in energy prices, says analyst Louis Gave at Gavekal Research.
One option is rationing. “The problem with following China’s lead is that it will cause further problems in already-disrupted supply chains, further boosting inflation when it is already uncomfortably high and crushing growth,” Gave says.
Option No 2 is to forget going green and double down on coal and oil again.
Option No 3 is to impose price controls. Yet “the problem with price controls,” Gave adds, “is that as input costs – whether oil, coal etc – continue to rise, preventing electricity distributors or oil refiners from passing on increases in their input costs would rapidly drive them into bankruptcy – or lead them to stop selling at a loss. This would threaten to create more problems than it would solve.”
Option No 4 is to go even further to subsidize energy consumption. This, of course, would accord Beijing pariah status at the Glasgow Climate Change Conference summit that begins October 31.
Option No 5 is reducing energy exports, which would kill any hope for global solidarity.
And the last option: just let energy prices skyrocket, which would cap consumption soon enough.
“In other words,” Gave says, “let the market clear itself. Like a second marriage, this option resembles a triumph of hope over experience. There are few reasons to think that leaders in France, the UK, the US, Canada or elsewhere are likely to gravitate towards such a solution. And even if they were to opt for the market solution, we should probably expect the simultaneous imposition of windfall taxes on the profits of energy producers.”
Nominally, Gave adds, “these windfall taxes would be earmarked to fund the green energy transition. Of course, their imposition would further discourage investment in conventional energy, raising the probability of more energy shortages in the future.”
Hence the bull market in Google searches for insights into the energy crisis of the 1970s.
None of this means the long-term goal of carbon neutrality is in peril. It is, however, a wake-up call for governments. The transition to a more environmentally sustainable system requires increased investment, more intensive planning and greater patience.
Any large, complex system can grow wobbly when undergoing epochal change. This is where the global economy finds itself today. And why governments everywhere are looking ahead to 2022 with a new source of trepidation.