Saxo Q1 Outlook: Fuelling the energy crisis
Saxo Bank, the online trading and investment specialist, has today published its Q1 2022 Outlook for global markets, including trading ideas covering equities, FX, currencies, commodities and bonds, as well as a range of central macro themes impacting investors and markets.
“Since late 2020, we have held the view that the real economy is far too small for the financial and economic agendas of governments, central banks, and the green transformation,” says Steen Jakobsen, Chief Economist and CIO at Saxo Bank, in the introduction to the Quarterly Outlook and adds:
“The critical chokepoint for real economic growth from here is de facto the energy crisis we are experiencing—one that will only continue due to decades of underinvestment in the space and the continued lack of financing for the fossil fuel energy that still drives the bulk of energy inputs into our economy.
This lies at the centre of our “world is too small” theme. In 2021, we saw rises in energy and electricity prices that have not been seen since the 1970s. Electricity prices in Europe rose to ten times the long-term average, in part on supply disruptions from abroad, but also aggravated by the lack of baseload as Germany shutters nuclear plants and the new alternative energy sources are unable to replace the critical baseload.”
Going green is fuelling the energy crisis
“In short, we have created a monster in which the policy priority—going green—is fuelling the energy crisis. The more we operate without a tangible plan for securing a smooth path to the hoped-for future of green energy, the more our economies will be disrupted in chaotic fashion due to inadequate baseload when famously inelastic energy demand exceeds generation capacity.
The policy response so far has been to propose an even deeper commitment to green energy and to ignore the required improvement in grids, transmission, and better use of conventional energy. The worst oversight by policymakers is the inability to admit the reality that alternative energy alone cannot power the future at current living standards. What the world needs is a Manhattan Project 2.0, not to build a bigger bomb, but to find and develop new higher-density, low-carbon energy sources, most likely based on nuclear fission and fusion.
The big revolution in 2022 will be to begin building our energy future on a foundation of realism, not fantasy,” says Steen Jakobsen.
Equities: The energy crisis could turn energy stocks into a secular winner
“Last year a global energy crisis emerged slowly before exploding in the hands of Asia and Europe in the late part of the year with European natural gas futures soaring 2,381 percent since May 2020. Higher energy prices—the main theme of this quarterly outlook—are a tax on consumers and businesses. They can push up consumer prices and shrink margins through higher direct operating expenses and secondary inflationary pressures hitting industries differently. They can also push interest rates higher, directly lifting the discount rate on future free cash flows and thus lowering equity valuations.
There are many reasons to believe energy prices will remain elevated for the foreseeable future due to underinvestment, ESG, and the green transformation. This will entice investors to get exposure to the overall energy sector to balance their portfolio against an overweight in technology and growth stocks,” says Peter Garnry, Head of Equity Strategy at Saxo Bank.
Energy sector has diminished to an insignificant role in equity markets
“In January 1995, the energy sector had a 10 percent weight in the S&P 500 and was thus the fifth largest sector by market capitalisation in the world’s largest economy and equity market. From this onset, the energy sector experienced an incredible boom period, peaking in June 2008 when the Brent crude price hit $140/barrel. During this period the global energy sector outperformed the global equity market by 7.5 percent annualised, delivering a total USD return of 16.2 percent annualised”.
Starvation of investments in the physical world
“There are many reasons behind the current energy crisis—some short-term and others long-term. Some of the most obvious are China’s U-turn on coal power, Germany’s abandonment of nuclear power, Russia’s geopolitical play, a global natural gas market through LNG, underinvestment in the supply of oil and gas, and extraordinary weather patterns reducing electricity production from hydro and wind turbines.”
Commodities supported by greenflation and tight supply
“We see another year where tight supply and inflationary pressures will support commodity returns. The decarbonisation of the world will increasingly create so-called greenflation, where rising demand and prices of commodities needed to support the process will be met by inelastic supply—partly driven by regulations such as ESG—prohibiting some investors and banks from supporting mining and drilling activities,” says Ole S. Hansen, Head of Commodity Strategy at Saxo Bank.
Energy: In Europe, the fragility of an energy market focused on decarbonising energy production has become increasingly apparent during the past six months. The result has been greenflation, driven by punitively high prices of gas and power prices putting heavy energy-consuming industries at risk while hurting consumers’ propensity to spend and to keep the economic recovery on track,” says Ole S. Hansen and continues:
“While gas is being viewed as the bridge between coal and renewables in Europe, Asia remains stuck with coal as a key source of energy, not least in China and India where surging power demand last year was met by increased demand for coal. As a result of this and despite the need to decarbonise the world, the amount of electricity generated worldwide from coal surged by an estimated 9 percent to a new record high in 2021. The International Energy Agency estimates that demand will reach a new record this year at a level where it may remain over the following two years.”
Industrial metals rose strongly in 2021 but with most of the 32 percent jump in the London Metal Exchange Index occurring during the first half, the year ended with some degree of uncertainty. While the energy transformation towards a less carbon-intensive future is expected to generate strong and rising demand for many key metals, the outlook for China is currently the major unknown, especially for copper where a sizeable portion of Chinese demand relates to the property sector. But considering a weak pipeline of new mining supply we believe the current macro headwinds from China’s property slowdown will begin to moderate through the early part of 2022.
Precious metals was the only sector suffering declines last year but considering the headwinds from rising bond yields and a stronger dollar, gold’s negative performance of around 3.6 percent was acceptable from a diversified portfolio perspective. Being the most dollar- and interest rate-sensitive of all commodities, gold will take some—but not all—of its directional inspiration from these two markets. Gold is often used by fund manages as a protection against unexpected events, whether they are macroeconomic or geopolitical developments.
Agriculture: The UN FAO’s Global Food Price index ended 2021 showing an annual increase of 23 percent with the sugar and vegetable oil sectors seeing the strongest rises. While we see some moderation in 2022, climate and weather risks remain a concern at a time when supplies have been tightening. Adding to this is a gas-related surge in fertiliser prices which—together with higher fuel costs—may drive a move towards crops with a lower fertiliser intensity.
Macro: The EU’s unwise energy policy
“The EU’s energy crisis has been years in the making. 2021 ended with a month of record-high prices. Natural gas in Europe is now more expensive than oil. Instead of COP26 resulting in a phasing down of coal, the sad reality of the green transition in the EU is that coal is growing,” added Ole S. Hansen. (See our Q4 Outlook for a detailed analysis of the EU green transformation).
A policy failure
Over the past years, the EU has actively promoted intermittent renewables, which cannot provide a constant supply of energy source, while pushing for the closure of nuclear reactors—one of the low-carbon baseload backbones of the EU. These are the two original sins of the EU’s green transition policy, and this is why consumers are now paying a much higher energy bill. Instead of getting away from fossil fuels, Europe is increasingly dependent on natural gas imports, keeping up coal plants and nowhere close to decarbonising.
While the situation is critical, all is not lost. During the Christmas break, the European Commission released its proposed taxonomy, a classification system that establishes a list of environmentally sustainable economic activities. Both fossil gas and nuclear are included as green electricity sources, with conditions. It is a wise decision to include nuclear. Now, the European Parliament and the Council will have four months to scrutinise it and object to it, should they find it necessary.
“Anti-nuclear countries (Austria, Germany, and the Netherlands) have protested against nuclear inclusion but they don’t have a qualified majority to reject it in the Council; that requires at least 20 member states representing at least 65 percent of the European population. An objection from the Parliament is perhaps more likely since it only requires a simple majority. We should have an answer by July. Hopefully, nuclear will remain a part of the taxonomy,” says Christopher Dembik, Head of Macroeconomic Research at Saxo Bank.
Fixed Income: The bond bear market will not spare anyone
The energy crunch will have serious consequences on the bond market because it will keep price pressures sustained, eroding the convenience of holding fixed income instruments that offer moderate spreads over their benchmark. High inflation translates into more aggressive monetary policies worldwide, even for central banks such as the European Central Bank that have notoriously been more dovish than others. Therefore, it is inevitable that investors will avoid facing the risk of higher rates
this year and this will increase market volatility. Yet, in light of solid economic growth, lower-rated credits might prove not to be as vulnerable as high-grade bonds,” says Althea Spinozzi, Senior Fixed Income Strategist at Saxo Bank.
Euro area: Credit spreads will remain supported while rates rise
The ECB is finding itself between two fires: higher inflation and stalling growth. As long as policymakers believe that inflation is not a credible threat, the central bank will keep its monetary policy highly expansionary. However, if inflation does become a likely menace, the ECB will be forced to engage in more restrictive monetary policies. Under the symmetrical inflation framework adopted last summer, inflation needs to average around 2 percent.
Fixed-income investors should pay attention to the periphery, particularly the BTPS/Bund spread
“The recently imposed restrictions amid another Covid wave will take a toll on Italy's high growth rates. Additionally, the departure of Mattarella as president of the republic opens up the possibility of another political crisis, which could culminate into a new election if Mario Draghi decides to move to the Quirinal. Therefore, it is safe to assume the BTPS/Bund spread will widen throughout the year, with a significant part of the rise during the first quarter of the year as political uncertainty remains high. In the most bullish scenario, which sees Draghi continue to lead the government as prime minister, the BTP/Bund spread could rise to 160bps. However, suppose the former president of the ECB decides to leave his current role to pursue the presidency; in that case, the BTP/Bund spread is likely to rise to 200bps. It could even briefly break above this level if it comes down to new elections,” says Saxo Bank’s Senior Fixed Income Strategist, Althea Spinozzi.
Foreign exchange: Mean reversion for the big 2021 moves and lots of volatility
USD and CNY(CNH): The fiscal cliff and a Fed that will hike until things break while China set to ease.
“Entering 2022, it seems that every appearance from the Fed is more hawkish than the last. Meanwhile China has signalled the opposite: that it will bring easing and support for a Chinese economy heavily impacted by official moves against excesses in its enormous real estate sector along with a crackdown on tech companies, both of which have dented markets there as well as the real economy. The overlay of a ‘zero tolerance’ policy on Covid has seen additional limits on economic activity,” says John J. Hardy, Head of FX Strategy at Saxo Bank.
EUR and JPY: Yen is far too cheap. ECB capitulation could support euro.
“The euro and particularly the JPY performed poorly in Q4 with Europe finding itself in a very bad place as natural gas and power prices soared to multiples of their former highs. This was in part down to reduced Russian natural gas supplies and the geopolitical situation over Ukraine that is still weighing heavily as of this writing,” adds John J. Hardy, Head of FX Strategy at Saxo Bank.
Cryptocurrency: The future in energy-intensive proof of work looks dim
Bitcoin risks the wrath of politicians amid electricity use
“Since launching in January 2009, Bitcoin has used the consensus protocol called proof of work to verify transactions on its network. The proof-of-work protocol is hugely energy-intense as it revolves around countless servers keeping the network alive. In return for a great deal of electricity and server capacity, the Bitcoin network returns the availability to solely execute 6 transactions per second,” says Mads Eberhardt, Cryptocurrency Analyst at Saxo Bank.
Bitcoin needs to adopt the alternative
“The discussion of energy consumption would arguably be another matter if there were no alternative to the proof-of-work consensus protocol. As this is no longer the case, extreme Bitcoin advocates who have for years substantiated the proof-of-work consensus protocol primarily for its superior security and track record, fall short on further arguments to insist on proof of work compared to the primary alternative, proof of stake.
The second-largest cryptocurrency - Ethereum - has for years prepared its transition from proof of work to proof of stake in an update known as ETH 2.0. The transition is expected to be finalised this year, and this will see Ethereum’s total energy use reduced by 99.95 percent. Ethereum’s transition demonstrates that it is not only possible to introduce new cryptocurrencies based on proof of stake but to adopt the framework while having been launched upon proof of work. Besides drastically decreasing Ethereum’s energy use, ETH 2.0 will make Ethereum significantly more scalable in terms of achievable transactional output,” says Mads Eberhardt and continues:
“In an era where the sustainability debate is much needed, while we simultaneously encounter the most heated energy crisis in decades, proof of work is a millstone around the crypto market’s neck. Bitcoin and the crypto market overall have many challenges laying ahead to genuinely evolve into more than a speculative asset class, and it does not help the case that the man in the street imagines an enormous data centre when thinking about crypto. Since the sustainability debate is expected to heat up in the future, individual investors, institutions, and developers are likely to reconsider committing time and money towards Bitcoin or other proof-of-work cryptocurrencies. As we see it, the proof-of-work consensus mechanism is simply too fragile to operate harmlessly through an energy crisis spiced with an ever-changing regulatory environment and the ascending intention to be sustainable.”
Australian equities poised to benefit from the energy crisis? Here’s how
“As we look ahead for what to expect in this quarter, we must reflect on what’s at hand. The energy crisis has seen a huge lack of global resources (supply) and rising global energy demands. This has caused energy prices like oil and gas to spike and taken energy stocks along for the northbound ride. Not only that, but much of the world has committed to net-zero emissions by 2050 while federal investment into clean energy remains paper thin; this has also pushed up the prices for lithium and many lithium stocks. Much of these constraints will likely continue in the rest of Q1 and Q2. We cover what has been affected, what to watch ahead, and some potential investment ideas,” says Jessica Amir, Australian Market Strategist at Saxo Bank.
What to watch ahead – the big picture
“As the market moves to a new cycle of higher interest rates while grappling with higher energy prices, volatility will continue.
Investment opportunities could lie in the commodity and energy sector, but also in quality and value names; companies have strong repeatable cashflows and are growing their market share in their field. Why? Interest rates are rising for the time in a decade in Australia, and ‘quality names’ have a history of outperforming the market. When rates rise and growth slows, given they typically carry less debt vs their earnings, they do well; companies with the reverse, or those that don’t make a profit, will likely feel the pinch, as illustrated in the outlook,” says Jessica Amir and continues:
“Separately, there will be opportunities in the logistics and cyber security themes as the world heads into the third year of flexible working arrangements amid Covid and increases its reliance on companies in these sectors.
Elsewhere, opportunities will also be in NextGen Medicine and, of course, in banking and insurance as margins (profits) increase as rates rise. Remember that Australian banks make up the second biggest part of the Aussie share market, behind iron ore miners. The market expects three rate hikes in 2022 and for the headline interest rate to sit at 0.8 percent by the end of 2022. This will likely boost banks’ profitability, dividend payouts, and insurance companies’ earnings.
Above all, consider working toward building balance in your portfolio, possibly with a mix of growth and defensive names and securities, to weather different investment cycles.”
Technical Outlook for 2022:
Brent Crude oil (LCOH2): “In the final quarter of 2021 Brent crude oil went through a correction phase before rallying strongly ahead of the year end and into the first days of 2022, thereby fast approaching its strong resistance at $86.75 per barrel. This is a level that represents the peaks from October 2021 and October 2018, and a break above is likely to pave the way towards the next strong area of resistance between $107 and $115 per barrel. The underlying trend is up, as illustrated by 21, 55 and 200 Simple Moving Averages all rising. In addition, a Relative Strength Indicator (RSI) above 60 is also supporting this uptrend,” says Kim Cramer Larsson, Technical Analyst at Saxo Bank, and adds:
“For this longer-term bullish scenario to be reversed, another rejection at the $86.75 per barrel level of resistance could result in a move below the longer-term falling trend line, followed by a drop below the December 2021 low of $65.72 per barrel.”
Carbon (CFIZ2): After a good run in November carbon got hit by a quick 20 percent correction in December, only to resume its uptrend during the dying days of 2021. If carbon breaks above the November 2021 peak of €90.75 per ton, we could very well see it reach €102–108 during the first quarter of 2022.
“For carbon to demolish both the short-term and medium-term bullish picture, a daily close below the December low of around €73 is needed. There are a few warning signs, however, of a weakening of the uptrend. On the weekly time period there has been divergence since the mid-December peak and more pronounced divergence recently illustrated by the RSI, where higher weekly closing prices have not been supported by RSI strength. In fact, the RSI has fallen while carbon prices have rallied - a divergence that could indicate an imbalance in the market. However, the medium-term uptrend will remain intact as long as carbon prices stay above the mentioned support at around €73,” says Kim Cramer Larsson.
To access Saxo Bank’s full Q1 2022 Outlook with more in-depth pieces from our analysts and strategists, please go to:
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