Turning Down the Thermostat

The government has announced a new energy strategy focusing on UK-produced energy supplies. This could also see 95% of Britain’s electricity being’ low carbon’ by 2030.

The US has been warning Europe for a number of years about the reliance upon Russia for energy.  It has taken the unexpected jolt of Russia’s invasion of Ukraine for politicians to wake up to reality.

The UK is not as reliant upon Russia as some EU members, but will need to accelerate the shift to go cleaner, with offshore wind and nuclear the preferred choices.  Nuclear currently provides 16% of the UK’s power and the plan is to lift this towards 25%. Hinkley Point C is currently under construction and will add 7% to capacity, but will not be operational until 2026 – so just another four Winter’s to get through then!

Given the scale of investment in individual nuclear projects – Hinkley is about £20bn, the government is stepping in to support the private sector. It is planning to take a 20% stake in the £20bn Sizewell C nuclear development in Suffolk alongside French energy provider EDF. The cost of building Sizewell C is expected to be similar to Hinkley and will provide a further 7% of the UK’s energy.

Meanwhile, the UK Treasury does not sound as comfortable about nuclear power as Boris, given   escalating cost. This view will not be helped by the recent news that EDF has increased the cost of building Hinkley Point C by £0.5bn due to building material supply chain disruption and inflation.

The only way to plug the Russian energy hole for the next few years appears to be using fossil fuels – coal, oil and gas – a political hot potato. Furthermore, it would be unpopular post COP-26 and in an ESG investing world.  UN Secretary General, Antonio Guterres, has warned the rush to fossil fuels, because of the war in Ukraine, is “madness” and threatens global climate targets.

The Middle East also remains a geo-political powder keg, so is switching Russian to Saudi Arabian oil a case of ‘out of the frying pan and into the fire’ in terms of future energy security?  Given more offshore wind and nuclear capacity will take some years to build, LNG (Liquified Natural Gas) prices are likely to remain elevated as everyone chases non-Russian gas.

Looks like we will all be turning down the thermostat for the next few years. The global economy also risks catching a chill if energy prices remain high.

What have we been watching?

Ukraine and US monetary policy tightening continue to overshadow markets.

Events in Ukraine have taken a darker turn and would appear to lessen the chance of reaching any kind of peace deal anytime soon. Putin needs an exit path and capturing or flattening Eastern Ukraine now seems to be the goal. Given the symbolism of May 9th -Victory Day – in the Great Patriotic War (World War II) with the defeat of Nazi Germany, western military analysts are suggesting this could now be a key date for Putin’s military forces. An all -out push to take eastern Ukraine by this date appears likely. In the meantime, further military support for Ukraine being provided by NATO seems likely, with reports that the UK has supplied anti-ship missiles to enable the Ukrainians to defend Odessa. The Czech Republic has become the first NATO member to send tanks and AFVs to Ukraine. More sanctions are being introduced by the US and EU, although German officials continued to express concerns about any moves that threaten gas supplies to the EU. The EU’s foreign policy chief pointed out that the EU has spent €35bn on Russian fuel since the start of the war, but so far has given Ukraine €1bn in aid. Meanwhile, Putin is portraying Ukraine as the aggressor and telling Russians that Western sanctions are the price that must be paid for freedom and independence!

Besides the war in Ukraine, markets continue to watch inflation and central bank monetary policy. The sell-off in US Treasuries continued last week. This followed the clear message from members of the Federal Reserve (Fed) last week that US monetary stimulus will now be withdrawn rapidly, through a combination of interest rate hikes and balance sheet reduction -QT (Quantitative Tightening) which will begin in May. The Fed meeting minutes suggest one or more 0.5% interest rate hikes may be warranted, while the Fed’s balance sheet could be cut by $1.1trillion in a year. The Fed has finally woken up to inflation but a policy mistake has left it in a very difficult position. Markets are concerned that the scale of the moves that the Fed are now likely to have to make carry the risk of causing a downturn in US economic activity or even recession.

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The war in Ukraine is now starting to have a visible impact on business sentiment in the UK. The latest business survey showed that production expectations have been scaled back to levels last seen in late 2020. ‘The speed of growth is unlikely to be maintained as supply issues still exist, the costs of living surge higher and now stuttering supply on certain goods are predicted to follow.’

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The latest Eurozone business survey also reflected Ukraine-related disruption weighing on confidence. ‘A recession is by no means assured but there is clearly a greater risk of the economy stalling or contracting during the second quarter.’ Ukraine has formed a key part of supply chains for many European businesses such as the automotive industry. The results of the first round of the French Presidential election were broadly in line with polling but the second round between Macron and Le Pen on 24th April looks like being a close call.

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Chinese authorities have extended their lockdown of Shanghai to cover all its 25million citizens after a fresh surge in Covid-19 infections. Four other major cities are also currently in lockdown. The Covid-19 outbreak is starting to hit spending with more damage to come. The Caixin service sector activity indicator dropped in March to its lowest level since the depths of the Wuhan lockdown.  Markets are now expecting further stimulus measures from the authorities.

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Brent oil edged back to $100 on the continued lockdown measures in China to combat Covid-19. Meanwhile, the EU is imposing more sanctions on Russia but on coal rather than oil.

Finally, while China is battling its largest Covid-19 outbreak since Wuhan we are not completely out of the woods ourselves just yet. Vaccines have certainly helped protect us. Unfortunately, the new Omicron variant is affecting business and the holiday industry is once again feeling the squeeze. British Airways and EasyJet have had to cancel more flights ahead of Easter, the first bank holiday since the end of restrictions due to high levels of staff absence. Yet another industry decimated by lockdown that has suddenly had to quickly re-adjust to the return of historic demand levels but having lost many trained staff. Terrible timing but hopefully this latest Covid-19 wave will pass quickly.


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