With gas shortages, rationing, and potential blackouts all a possibility, it’s shaping up to be an uncomfortable winter for Europe. Governments across the bloc are working to fill gas storages in case Russia stops the flow of gas, but they’re likely to provide only enough fuel for two or three months. So as summer winds down, it’s a good time to think about the five big consequences that are likely to play out this winter, and how to prepare your portfolio for them…
#1: The consumer suffers while gas producers profit.
Higher gas prices might be good news for gas producers, but not so for European consumers and industries. And worse, it’s an issue with global spillover effects.
Take the Dutch TTF gas price, for example, the European benchmark represented in dark blue below. Its prices have increased sevenfold since the Russia-Ukraine war began in February.
The lack of pipeline gas in Europe also means that the bloc has had to turn to other energy sources, such as liquified natural gas (LNG), to supplement its needs, bidding its price (bright orange line) up to four times its recent four-year average. Europe may be able to avoid blackouts this winter, but it’ll only be able to do so by outbidding other countries, and that means LNG prices are likely to remain higher for longer.
With those higher energy costs squeezing household budgets, it might be wise to avoid European consumer discretionary stocks for a while. Rather, consider investing in European gas producers like Equinor, Royal Dutch Shell, or BP, or in companies that stand to benefit from strong LNG demand: Chesapeake, EQT Corp, Antero Resources, Golar LNG, and Cheniere Energy, for example.
#2: Europe’s heavy industries take a knock.
Gas rationing sounds ugly and it likely will be, especially for energy-intensive industries like chemicals, autos, paper and pulp, and steel. The chart below shows the gas usage by industry relative to their contribution to economic activity in Germany.
These sectors have already seen their expenses increase from higher electricity prices, but they could see an even bigger hit to their bottom lines if rationing forces them to reduce output. Their profitability would shrink: fixed costs would remain the same but spread out over fewer goods produced. What’s more, for industries that compete on a global cost curve – chemicals, paper and pulp, and steel, for example – the higher costs per unit will make these European industries less competitive compared to their peers in Asia and the US.
So you might want to avoid European chemical, steel, and paper and pulp manufacturers. Instead, consider US chemical makers like Dow, LyondellBasell, and Huntsman: they’ll probably benefit from higher chemical prices as European supply is challenged. A good strategy could also be to short European chemicals and go long US chemicals.
#3: A European recession approaches.
Lower consumer real disposable incomes, higher costs for industries, and the risks of production cutbacks all point toward slower economic growth and stronger inflationary pressures in Europe.
Economists at abrdn say a European recession is likely to happen as early as this year. They estimate that growth will take a 1.5 percentage point hit, but would see a greater shock of 4.5 percentage points if Russia completely halts gas flows. And they estimate that higher gas prices will add 1 percentage point to inflation this year, and 2 points next year.
A recession in Europe would not bode well for European stocks, so you might want to look to the US for better prospects. However, if you really want European exposure, your safest bets are in more defensive industries like pharma, and food and beverage, where demand and production would be more insulated even in the event of a blackout.
#4: The euro becomes weaker, and stays weaker.
The euro has weakened a lot against the US dollar, and there’s likely to be more pain to come. Sure, the European Central Bank (the ECB) has begun hiking interest rates and is likely to hike some more. (Higher rates tend to benefit a country’s currency as it increases investors’ demand for it.) However, the ECB has been slow in hiking rates and is relatively limited by how much it can hike, depending on how the economy responds. The ECB is caught between a rock and a hard place – keeping the region’s higher-than-average inflation in check while keeping a sharp economic downturn at bay. A recession would only weaken the euro, compounding the inflationary problem that Europe faces as it increases the price of imports for consumers and businesses.
#5: Permanent demand destruction sets in.
The longer the gas shortage persists, the greater the risk of permanent demand destruction, as consumers and industries adapt to a higher energy price environment. What’s more, ending Europe’s dependence on Russian gas will result in much higher gas prices across the bloc, which will reduce the competitiveness of Europe in manufacturing and shrink investment.
And at the same time, we could also see new business investments and manufacturing shift to regions with lower energy costs. For example, new business investments in petrochemical sectors could follow the lead of European refining as it shifts to cost-advantaged regions like the US, where industries benefit from lower gas prices.
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