Sunday Supplement – 140822 – the beginning of the new beginning?

Aug 14, 2022



“In a world become blind, I beat the drum of the Deathless” – Buddha


by Adam Lawrence

Energy and the near future

As we hit the middle of August, and those of us without air-conditioning (97% of us according to a recent survey, an improvement on the 99.5% of us that didn’t have air-con in 2008) scramble to find somewhere to stay cool whilst at home, I thought a reasonable summary (should it be summery?) of where the energy crisis is at would be useful. There is also some interesting data from the US to discuss, and perhaps some indication of what we might expect to play out in the UK macro markets also – and maybe an opportunity too.


US inflation numbers look the best that they have done for over 12 months. I mean that inasmuch as they were, for July, below the vast majority of expectations. I’ve spoken a number of times about how important and meaningful it is to undershoot expectations when looking for the top of a trend, and this could well have been it. The consensus forecast was 8.7% and the actual number was 8.5%, so, not a million miles away but not a hair’s breadth either. 


The job market was also a long way above expectations – analysts keep expecting things to calm down, but instead over 528,000 jobs were added versus forecasts of 250,000 for July. This means, amongst other things, that the central bank can keep cranking the interest rate handle for a little longer, although the inflation news means that there has been some betting on a lower rate hike at the Fed’s next meeting (so “only” 0.5% rather than 0.75%). 


So the economy presses on. “Gas” as they confusingly call it on the other side of the pond, i.e. petrol, has fallen under $4 a gallon from a high of over $5 a gallon. “Actual” gas, or natural gas as the markets prefer, is testing new highs, however. Putin continues to hold all the cards on that front. 

I’ve used the US extensively as a bellwether over the past 18 months, not just because the UK market tends to follow a lot of what the US does, over time (this is true to an extent, but the correlation is not so high as for it to provide a crystal ball) – but because the US took its pandemic medicine before all others. Militant “red” states operating their own covid policies, or lack thereof. Fast and huge vaccination. Re-opening and offering the freedom that the land of the free prides itself on, before many others did the same. Indeed, zero-covid policies meant a significant contraction of the Chinese economy in Q2 of this year. Some analysts predict that China will continue its zero-covid policy well into 2023, having a significant drag on Chinese – and global – economic growth.


US versus UK – what’s different?

One major difference between the US and the UK is the level of energy security. The UK has a very predictable extra bump coming in inflation, because of the energy price cap that offers some element of protection to households. That protection timer is running down – there are 47 days left from today at the current cap before a huge jump upwards in household energy prices. Protection is not the same for businesses, of course – so that price jump has been being phased in as commercial fixed price contracts come to an end. The UK tends to use 1, 2 or 3 year price fixes which, like our mortgage rates where we tend to use 2 or 5, has exposed us to more volatility than in other countries – something I expect us to see playing out over the next several years with a dramatic shift in the base rate from 12 months ago to today, and dependent on the terminal destination of the base rate (the point at which inflation is clearly moving downwards over a number of months, which is irrevocably linked to the level of economic growth – or contraction – that we are experiencing in real time). 


What that October 1st date does do though, of course, is that it means pent up price rises come all in one go, and that filters through into significant year-on-year inflation. Once the prices are up, it is not as though they will never go back down – potentially – indeed, we would expect them to in the long run, but the long run could be 2 – or more – years away. The forecast for the January and April price caps (the price caps, from October, run every 3 months rather than every 6 to offer some more smoothing and faster opportunities to put the price down when the prices do start coming down – that’s the party line anyway) are higher, and higher again. The expectation for an average household will be a £500 a month energy bill this winter. 


Cold winter coming?

One thing I’ve been keeping an eye on is the longer-term weather forecasts for the UK, from a commercial perspective in terms of affordability, and also from an interest perspective because I have significant fears of a huge swathe of avoidable deaths this winter if it is particularly cold. The Met Office refuses to go more than 30 days out as a rule – and predict a warmer than usual September, out of interest – other sites go much further and of course we know little or nothing about their reliability or methodology. One highly ranked site on google suggests a couple of days at or around 0, and nothing below freezing in the UK this cycle. I try not to worry about that which I cannot control – but that would indeed be a significant blessing to the population as a whole.


What’s the Master up to?

This is not just risk management, or commercial considerations on the downside, though, of course. There is one real item of interest as someone who generally sticks to investing in index funds for my stock market exposure – and that’s the recent behaviour of Berkshire Hathaway Inc., run by my one true guru – “Uncle” Warren Buffett. 


The news around Berkshire has been a writedown in values of nearly $45bn after Q2 of 2022, but that is paper write-downs based on a falling stock market (which has recovered more than 50% of those losses since then – more on that in a short while). Looking a little closer, the investments have mostly been in Occidental Petroleum – a company Berkshire has repeatedly bought shares in this year when the value has dipped below $60 per share. The price sits around $66 today and has doubled in the past year, but clearly Uncle Warren still sees value below $60 in spite of the price 12 months ago. 


Let’s revise a few things we know about Buffett. He prefers concentration in a relatively small number of companies. He likes companies with really strong management – so you can read into significant confidence in the chief exec/board at Occidental, you would think. He also prefers to hold stocks for the long term, and to an extent, take control of businesses as required or at least place influential stakeholders on the board of directors. 

He isn’t in this for a quick buck. So… oil really a long term play in this world of ESG? Well, Uncle Warren thinks so and I can understand why. There’s this romantic notion that we all switch to electric cars (and everything else) and fossil fuels just die out. However, the brutal reality is that this transition is not being well managed at all. The market’s hand is being forced to starve oil explorers and producers of investment, meaning a genuine shortage of supply of oil is very possible indeed – and with a bad actor in the market in the form of Putin, controlling over 10% of the world’s oil supply and having a really significant influence over the other major suppliers too – there’s already risk. But there’s risk beyond this – too little oil will mean skyrocketing prices. 


What does the end of oil look like?

There’s one more piece to the jigsaw here (well, I’m sure there’s more but bear in mind I’m not a stock analyst nor do I know anyone at Berkshire!) – substitution. Oil prices have been on the melt upwards – that’s true – although crude is still back down near $90 a barrel when it has tested $120 this year thanks to Comrade Vladimir. Gas is far, far more volatile and is 1300% or more above the average price from a few years ago. Yes, there is no typo there – 1300%. Gas and oil are, of course, a long way away from being perfect substitutes for each other. However, as stores of heat they do have significant overlap.


Can you see the danger here? Lack of oil supply, then put under more pressure by switching away from gas towards oil – a problem for now, rather than an intergenerational climate change problem – means potential for prices to go ever further. $150? $175? $200 for a barrel of crude? If Putin decides to deepen the squeeze on the supply to Europe, who knows? Although $200 would be the highest by a massive margin that we’ve ever seen, the inflation-adjusted price would not be the highest “real” oil price ever. (Compare this to gas, which is at such significant highs).


That argument in general is obviously relatively simplistic, and there will be nuances that I have missed because I am not a commodities trader or an expert in this field. Merely an interested observer. But when Buffett acts I have to pay attention, and he seems to be positioning himself to cash in on these coming recession(s) around the world, whatever they are, by taking a larger, significant, long position in oil (traditionally, coming into a recession, you’d expect the oil price to fall significantly as demand for oil goes down). 


Just stop it all now? What if we did?

Of course – you may take the virtuous view – like the Norwegian Sovereign Wealth Fund, the Government Pension Fund Global (value around $225,000 per citizen) – that such investments are not ethical anymore, due to global warming. This is an incredibly simplistic answer to an incredibly complex question. Should we, as some think, slow global warming at all costs? I can’t see how this can be the correct position. What if 90% of the world’s population die as a result? The withdrawal of oil, gas, and many other fuels before the world is ready will (and this does seem to be what will happen, rather than what may happen) have consequences that mean many deaths as a result.

Naturally, the obverse position is still incorrect. Doing nothing regarding man-made climate change is also not the answer. The management of change to net zero 2050 and beyond is, in my view, the single largest challenge that humanity has faced thus far. There are so many lives in the balance on either side, and that’s why HSBC Asset Management’s now-former Head of Responsible Investing, Stuart Kirk, put together such a controversial speech earlier this year (which has, of course, cost him his job and potentially his career). You can take a look at that speech here (invest 15 minutes into it – it is utterly spectacular), and you can see his status update on LinkedIn after HSBC’s actions after this speech here. Financial and ESG sponsored cancel culture, in the flesh.


Energy inflation

What’s the point in all of this? To remind us to zoom out, on occasion – to look at the big picture. This energy crisis isn’t over in October, or Jan or April ‘23. Even worse – it isn’t over when Putin finally meets a sticky end, one way or another. It is ongoing. It is a gigantic problem of infrastructure, politics, lobbying and extremist groups, corporate interests and greed. The solution is well beyond the typical political cycles in developed Western Economies. It may even be beyond the reach of the one-party state – you’d think that Shanghai being only 3-5 metres above sea level would be a significant incentive, but of course they may prefer another solution to that specific problem. 


Energy costs more. Inflation pushes prices up, erodes nominal debt (a big plus for the property investors out there), and pushes wages up. Not, in itself, a major problem (although if you don’t address the cycle upwards, things get out of control and the monetary system breaks down). Always remember, the world has only one true religion – and that is money. The belief in the “payment of the bearer on demand” – called into question by a fraction of crypto believers, although my personal belief is that the major cheerleaders are operating a simple ramp tactic to those who are prone to listening – is the single strongest belief in the world. 


What to invest in given the energy situation

Energy is one more major consideration to factor into future investments. What does this mean? Well, for a start you should be valuing properties with superior energy performance more highly. The market is not yet doing this, but I can promise you it will be more and more of a consideration going forwards. The products are already out there – “Green” mortgages – and, if you consider it for a second, what’s more likely? This trend dies out (more likely that the Stuart Kirks die out), or this spread on the discount gets larger? It seems obvious to me. 


You may well need education on what to do on energy performance – or at least need to spend some time making friends with Domestic Energy Assesors (DEAs). There are some great ones out there sharing some great information. Don’t make the mistake of seeing the EPC (flawed too that it is, granted) as a waste of money and time and something that needs doing as cheaply as possible. What you have in a good DEA is an extremely cheap consultant if you, like me, view your property investments as 25+ year assets (perhaps not even for yourselves, but your company, your family, and your legacy). Invest some time and effort into them.


What about existing properties with solar PV? Often seen as problematic, but instead can often be generating an income, which is superb – and providing energy security and superior performance on multiple levels, as well as exporting back to the grid. What’s not to like? Basically nothing, but the market doesn’t usually want these. Another little edge, another 1% – just like the British Cycling Team philosophy instilled by Sir Dave Brailesford.


If you aren’t insulating internally on all your refurbs these days to achieve a C EPC or better, you are missing a trick and kicking a can down the road. Including this in your costings may well result in fewer, but better, deals – or, steer you towards transacting on properties that are already there on the EPC front. All of this is positive market activity that you need to be on board with as soon as possible in my view.


If you aren’t au fait with the High Heat Retention heater situation, which brands are on the list, and you do any investment in flats or similar, I would highly recommend getting hold of the list of approved heaters from any DEAs that you do form a relationship with. It is also worth educating yourself on the grant schemes that are available on this front, for tenants in receipt of certain benefits, since the average HHR heater fitted is costing somewhere in the region of £1000 (per heater). That may sound ridiculous, but at 160kgs a unit, it is perhaps not a surprise with the price of commodities and the labour involved in moving something like that around!


Before I sign off, one more point of consideration, and really the importance of being a contrarian. The technical analysts on the US market this week have been pointing out that the stock market has regained more than 50% of its losses so far this year. Only 1 time in the past 13 has the market then not gone on to reach higher highs from this point. 


I’m not being deliberately cantankerous here but I still feel it will be twice in the last 14 times, rather than following the popular trend. There’s limited reasons for surging forwards, and I’m sure some bad news still to come thanks to both Covid, and Russia/Ukraine. The stock market appears more at fair value or a little overpriced, rather than underpriced, as a whole. Oil companies aside…….of course……..until next week, keep cool and carry on!