Things fall apart; the centre cannot hold
The Second Coming (1920) by WB Yeats (1865-1939)
The turning point
First there was a global pandemic which paralysed our economies. Then came the threat of World War Three, although if a world war can be economic, it has already started. And even while that menaces us, we know the prospective return of stagflation will trash living standards right across the world – and that the poor will suffer most. No wonder policy makers in western democracies are now obliged to rethink some of the comfortable assumptions that they had based their policies on.
This week, the US announced a ban on Russian oil. The UK will stop importing Russian hydrocarbons completely by the end of this year. The EU has pledged to forego Russian hydrocarbons “as soon as possible” (whenever that is). According to European think tank, Bruegel, the EU has to pay Russia $850m every day, for its hydrocarbons. That’s why Germany and Italy blocked the move for the total expulsion of Russian banks from SWIFT.
On Tuesday (15 March) Boris Johnson announced that an energy security strategy (something I have been banging on about for years) will be set out before the end of this month. He indicated in his article in the Daily Telegraph that this will involve a rethink on oil and gas and significant expansion of nuclear power. He wrote:
“It is crazy that we are importing oil and gas from Putin’s Russia when we have our own resources in the North Sea…The process of weaning the world off Russian hydrocarbons will be difficult. But it can be done…Putin has been able to get away with too much for too long because he because he has exploited a Western addiction to his oil and gas”.
Regular readers will know that I regard the British government’s energy policy as a mess. Successive British governments have run down our nuclear-generation capacity, cut investment in North Sea oil and gas, outlawed fracking (hydraulic fracturing) and decommissioned large parts of our gas-storage capacity − all in pursuit of the notion of net zero by 2050.
While we have made advances in renewable-energy sources – wind and solar – these will always be intermittent and will require backup capacity from more conventional sources of power. On a windy day, wind turbines generate about 30 percent of our electricity; but there were calm days last autumn when that fell to under five percent. And unexploited shale-gas reserves could keep Britain warm for another 50 years, according to Cuadrilla Resources. The Bowland-Hodder field could contain four trillion cubic metres of shale gas.
The wholesale price of gas in Europe spiked recently to €335 per megawatt hour, up from €16 one year ago − a staggering 21-fold rise. The UK still sources much of the gas we use from the North Sea, but because we buy energy on the international markets, these price hikes affect UK businesses and households. The cost of petrol at the forecourts has also jumped from about £1.47 in January to around £1.65 now. Diesel has soared even more, with a litre of diesel not far off £2 in some areas.
Food prices are also starting to increase rapidly as the costs of energy and fertiliser soar. Fertiliser is essentially a combination of nitrogen and potash, and most potash comes from Russia and Ukraine. British farmers were paying about £200 a tonne for fertiliser one year ago – now it is more like £1,000.
And the energy policy of our German friends has been even madder, being founded mostly on wishful thinking and paranoia about nuclear energy. But the wake-up call of the war in Ukraine, and the prospect that Russia may turn off the flow of gas through the Nord Stream 1 pipeline, has triggered a historical shift in policy there. Germany has been importing 55 percent of its gas, 45 percent of its coal and 35 percent of its oil from Russia. Finding those hydrocarbons from other sources will be a monumental challenge for the Germans – but as of this week it seems that they have acquired the political will to reduce their dependence on the whims of a dictator.
Even at the height of the Cold War, the Soviet Union never turned off the gas taps. This incipient east-west economic war is something new.
I reported last month that 30 Tory backbenchers had urged the government to rethink its moratorium on fracking after Cuadrilla was ordered to seal up two of England’s shale-gas wells at Preston New Road, Lancashire – located in the “Blue Wall”. Last week we learnt that the two wells had been given a stay of execution. The moratorium was imposed in November 2019 (just before the general election) in response to popular opposition, but since then the fracking debate has moved on.
Fracking involves pumping water, sand and chemicals into certain underground rock formations (principally shale beds) under massive pressure. In so doing, natural gas is released from between layers of rock and then collected. Environmentalists claim that this causes earth tremors and that it can pollute aquifers. But fracking can be conducted while avoiding tremors of above 0.5 on the Richter scale, the current UK limit (the US limit is 2.0). That captures tremors much lower than those caused by large-scale construction projects like HS2.
Fracking is a widely used method of producing gas in the US, where gas costs about one tenth of what consumers pay here. Indeed, the US is a net exporter of natural gas. There is no credible scientific evidence that fracking has caused earthquakes in the US.
Cuadrilla is still officially obliged to plug the two wells by the end of June. Andrea Leadsom MP – who was Business Secretary when the fracking moratorium was imposed − has suggested that local communities might come round to accepting fracking if they were to be given free gas in return. Call it bribery if you will.
As we move towards the electrification of vehicular transport, we shall require additional gas-fired, base-load capacity as well as standby, electric-generation capacity. We are fortunate in having a prime minister who carries little ideological baggage and who can execute a U-turn with the deftness of a London cabbie. It looks like things are going Cuadrilla’s way.
Last week, government mandarins discussed the possibility of keeping our coal-fired power stations operational for longer than planned. EDF and Uniper, the owners of three remaining coal-fired plants, told ministers that they will need government funds to extend their plants’ lifespans beyond September. EDF runs two plants at West Barton, Nottinghamshire and Uniper runs one at Ratcliffe-on-Soar, also in Nottinghamshire. Keeping them operational would maintain 1.5 gigawatts of electricity capacity for the national grid. Another coal plant which could be kept on standby is the unit in Selby, North Yorkshire run by Drax.
Last year in the run-up to the COP26 climate summit in Glasgow, the prime minister suggested that the UK would be entirely coal-free by October 2024. In the current circumstances, that deadline looks unrealistic.
The German coalition government, which includes the German Greens, is also looking at extending the lifespan of certain coal-fired plants. This morning, I see from the National Grid Status Monitor that coal is contributing 2.66 percent of the power input into the grid. In Germany, the proportion contributed by coal is more like 25 percent. Coal is the dirtiest fossil fuel, producing much more pollution than natural gas.
But even putting environmental considerations to one side, where are the Germans going to find additional supplies of coal if they spurn Russian imports? The same issue pertains here. The UK has closed almost all its coal mines and what coal is burnt is imported – 36 percent from Russia, 22 percent from the US and 21 percent from Venezuela (another political undesirable).
Boris Johnson has been in Saudi Arabia this week to schmooze Crown Prince Mohammed bin Salman. If the Saudis could ramp up their oil production, then the UK and the EU could substitute oil imported from Russia with the Kingdom’s ‘black gold’. Eyebrows were raised at the timing of the visit – just days after the Kingdom executed 81 felons in a single day. And the civil war in neighbouring Yemen, where Saudi Arabia has its own military units, smoulders on at great humanitarian cost.
According to the International Energy Agency, Saudi Arabia and the United Arab Emirates have the capacity to bring another two million barrels of oil a day onstream very quickly and up to an extra four million barrels a day before next winter. Russia exports about seven million barrels a day. But the prime minister seems to have returned from the Gulf empty-handed. On the other hand, we can speculate that the deal with Iran this week, which secured the release of dual national hostages (Nazanin Zaghari-Ratcliffe amongst them) may also have offered the Iranians the prospect of recommencing oil exports to the West. We shall see.
The UK still has considerable, unexploited oil reserves in the North Sea. Bizarrely, the SNP, which once based its case for independence on the bountiful flow of “Scotland’s Oil”, is now adamantly opposed to any further extraction. No new fields have been approved in the North Sea for three years.
But now, with a change of tack in Westminster (which is the final arbiter of these matters), six new wells could get the go-ahead this year and prospectively another 25 next year. These new wells would not mean that we use more oil – only that we burn our own oil rather than imported oil. And we would be less vulnerable to geopolitical risk. If you think the Russian invasion of Ukraine is a game-changer (as I do), just imagine the fallout from a war between Saudi Arabia and Iran.
The heat-pump ‘pratfall’
Heat pumps, which transfer thermal energy from either the ground or the air into a property, using a refrigerant and a compressor, produce less CO2 than gas boilers. But they are not necessarily cheaper to run.
Kevin McCloud, who has been presenting the popular Channel 4 show Grand Designs, recently described the government’s plans to roll out millions of heat-pump installations as a “classic pratfall”. He thinks that the UK should prioritise insulation, ventilation and the use of shutters instead. MVHR (mechanical ventilation with heat recovery) systems, like those offered by Ventair, are relatively easy to install and boost heating efficiency.
A £450m UK government scheme (Boiler Upgrade Scheme) beginning next month will offer households £5,000 towards the installation of a heat pump. But the cost can be up to £20,000 when new plumbing and radiators are required. And heat pumps will not heat homes to an adequate temperature unless the homes are sufficiently insulated, according to a report by the House of Commons Business, Energy and Industrial Strategy Committee. What’s more, there are not enough “climate hero” plumbers to install them anyway.
With rising electricity costs, the economics of using heat pumps will not be so favourable. The Energy and Utilities Alliance, the trade body for the energy sector, has found that when energy bills rise next month (when the energy price cap rises 54%, from £1,277 per year to £1,970), the cost of running a heat pump at the minimum level of efficiency will rise from £919 to £1,251. The average cost of running a gas boiler will rise from £584 to £984. So, even though a gas boiler will emit about 1.4 tonnes more CO2 in a year than its heat-pump equivalent, it will be £267 cheaper. For larger homes, the disparity is even greater.
Energy Performance Certificates (EPCs) are calibrated according to what it costs to heat a home rather than the amount of CO2 emitted. As a result, homeowners risk downgrading their EPCs by installing a heat pump – and that could affect the market value of their homes. Moreover, lenders such as NatWest offer ‘green mortgages’ which are cheaper – but only for EPC ratings of A or B.
By 2025, builders will be banned from fitting conventional gas boilers in newly built homes and the installation of new gas and oil boilers in existing homes will be proscribed in 2035. The government wants 680,000 heat pumps to be installed each year in British homes by 2028. Just 60,000 new heat pumps were installed in 2021 in the UK, while in France 400,000 new units were installed.
If gas and electricity prices are soaring, with the energy price cap due to be revised again in the autumn, consider the plight of the three million British households which rely on oil for their central heating and hot water. The price of oil has risen from 40 pence per litre two years ago to 65 pence in mid-February − and then to around £1.15i now. Heating oil is not subject to a price cap.
Wood burners and biomass
Homes that use wood burners to keep warm face a shortage of wood pellets, most of which were hitherto imported from Russia. About 200,000 wood stoves are purchased in the UK each year. The price of wood pellets has risen to £385 a tonne. The UK Pellet Council is urging the government to increase domestic production of wood pellets to reduce reliance on imports. Thetford Power Station in Norfolk, run by Melton Renewable Energy, is one of only a handful which uses locally sourced wood pellets derived from Thetford Forest.
An alternative to wood pellets, which produce in-home pollution when burnt, is coffee logs. Recycled coffee grouts converted into ‘logs’ are said to burn 20 percent hotter and longer than kiln-dried wood. Each Bio Bean coffee log contains grouts from about 25 cups of coffee.
The MGT Teesside power plant, which is set to become operational this year, will burn wooden pellets to power 600,000 homes. But, even before the shortage of wood pellets manifested, the plant was criticised as being costly and inefficient. Once operational, it will produce electricity at a cost of £147.45 per megawatt hour. So, it is both expensive and its environmental credentials are questionable.
Rich pickings – and poor
It seems that Odey Asset Management is up by over 30 percent this year given its bet that oil and gas prices would spike. Even as environmentally minded asset managers sold out of the unloved oil sector, the Odey stable of funds piled in. Crispin Odey sees parallels between now and the 1973 oil-price shock and foresees that we are entering a period of stagflation.
Inflation is likely to outstrip wage growth; thus, the Resolution Foundation estimates that household disposable income will fall by four percent this year. That, in my view, is optimistic.
The new frugality
Much of the ‘green’ agenda has been not so much about practical policy as about virtue-signalling. The debate has become childishly binary. Renewables good; fossil fuels bad. ESG (environment, social and governance) good; everything else bad. One thing we have learnt of late is that we need a vibrant defence industry, even if (in fact, because) its weapons kill people. The price of liberty is eternal vigilance. We must revitalise our North Sea oil-and-gas industry, licence fracking appropriately and educate people about nuclear power.
One thing that we can all agree on is that we shall have to be more economical with our energy resources in the future. By turning down the thermostat, walking to the supermarket, taking staycations and even by wearing thermal underwear we can diminish the impact of Russia’s chokehold on our energy supplies – and reduce CO2 emissions to boot. I predict a reduction in the maximum speed limit from 70 mph to 60 mph. I also foresee the return of a frugality of a kind our grandparents knew – and that is not necessarily a bad thing.
Putin showed contempt for COP26 and has always regarded Russia’s status as hydrocarbon superpower as a club with which to beat others (as well as to enrich himself and his acolytes). But in forcing Europe to wean itself off Russian hydrocarbons, Putin has done us all a favour.
Putin is losing the war, which he launched against the better judgment of most Russians. But it is too early to say just how this drama will unfold, despite the faint prospect of a negotiated settlement.
We should be careful what we wish for. If Putin is forced out in a palace coup, his replacement, defence minister, General Shoigu, might be no more palatable. Alexei Navalny is not going to be freed anytime soon. Russia will most likely remain a resentful and unstable giant, lurching from one geopolitical crisis to another, for the foreseeable future. But the great western powers have been in the business of containing a restless Russia since the early 18th Century. There is nothing new here, which I will explore in more detail soon.
In a new essay, the historian Francis Fukuyama, author of The End of History, predicts that Putin will lose and that populists everywhere who expressed sympathy for him will be fatally undermined. Eric Zemmour and Marine Le Pen are ‘toast’ (as I shall also explore in more detail shortly – I’m off to France next week); and Macron is now certain to be re-elected, come 24 April. The chances that Trump might make it back to the White House in 2024 have receded.
My best bet is that Ukraine will survive – though Russian forces will remain in the Donbass and, of course, in Crimea. The reduced country will be allowed to join the EU but not NATO and will be, de facto, neutralised. It will take a decade to rebuild. But Russia will suffer even more.
There is so much to discuss at the Master Investor Show tomorrow at the Design Centre, Islington. I just can’t wait. If you can’t attend our first in-person Show for three years , you can register for the livestream.
See you there.
Listed companies cited in this article which merit further analysis:
- Uniper (ETR:UN01)
- Drax Group PLC (LON:DRX)