I have nothing to add here, but congrats to JP Morgan Research for this:

Hot New Unobtainium Just Dropped

With lithium, nickel, cobalt and other battery materials prices collapsing everyone is now concerned about phosphorus. The reason is clear enough: lithium iron phosphate batteries require it.

There is a good solution here aside from mining and it is 💩. As most high school chemists could tell you Adenosine Triphosphate is the energy currency of life and there is a lot of it in all plant matter and waste. Much of it is released in sewage and can be recovered via struvite (magnesium ammonium phosphate) deposition - a good piece by Veolia is here. The recovered material can be used as fertilizer which in turn frees up more material for batteries. If you really wanted to you could use the fertilizer to extract the Phosphorus and use it in batteries. Either way this attempt to fit up a widely available product that is mostly washed down the drain as the next unobtainium is deeply silly. We could instead pollute waterways less and have more material for batteries at the same time. Sounds good to me.

Thinking About How to Manage Entanglement with China

This is a great piece by Matt, worth reading in full. There is a certain model and set of patterns to China’s growth and there should be a similar set of counter patterns to manage the adverse side effects of that growth in particular China’s new green gluts summarized well in this WSJ piece.

Energy Modelling for Shocks in the Mid Transition

I took part in a talk Phenomenal World on oil and geopolitics in the Mid Transition - a term used for the period when fossil fuels are starting to flatline or fall but are far from out of the economy. I really enjoy these formats because sometimes things come to me or become clear that are less so when working very narrowly on a problem.

There is an enormous body of work modelling energy transitions and decarbonization for various economies, regions, sectors and the like and it is by and large very good and impressive. It is also, generally speaking:

• Not graphical or sensitized to fuel transport, sourcing and logistics. A massive exception here is electrical grid modelling which is very well attuned to this but as grids are national or regional affairs the modelling stops at the grid’s edge.

• Because of this, not sensitized to the kinds of geopolitical shocks that tend to create the largest energy shocks.

I think some of this is a legacy of the 1970s and how people thought about what an energy crisis was back then: running out of oil, overpopulation and the things that occupied the Club of Rome and animated the film Soylent Green.

The problem is that this frame of thinking - outright long term scarcity of goods - does not seem to fit what we have seen. Substitution effects are strong, alternative energy technologies are available and yet we still have shocks like the Ukraine invasion and could well have more depending on how toxic the Middle East gets.

Modelling in this space needs to consider not just networks of production - how much coking coal it takes to make steel, and how much steel is required for construction - but also networks of distribution of those basic commodities. The world did not run out of gas when Russia throttled flows to Europe but Europe had vastly less available gas and particular gas at a particular price. Similarly the shocks from sanctions on Australian coal did not destroy any output but did create logistical problems. For commodities that have low value density and complex global supply chains like oil, gas and coal these logistical details are very important and not managed well by canonical models like MARKEL-TIMES and other core models at places like the IEA. For an international energy agency to provide more useful and timely information a turn to these considerations is long overdue.

Chinese Power Demand in October

Strong, particularly in Southern China and particularly in those sectors that make up China’s new investment focus. Quoting www.sxcoal.com here, bold highlights mine:

Total electricity consumption in southern China's five provinces and regions, including Guangdong, Guangxi, Yunnan, Guizhou, and Hainan, reached 1,319.5 TWh from January to October, marking a 6.8% year-on-year increase, according to China Southern Power Grid Co., Ltd.

The high-end manufacturing sector continued to play a vital role, with electricity usage maintaining a high growth rate of 12.7% year on year. In automobile manufacturing, electrical machinery and equipment manufacturing, and other related industries, up 15.6% and 16.1%, respectively.

Notably, the electrical machinery and equipment manufacturing industry, as well as the computer, communication, and other electronic equipment manufacturing industries, experienced rapid growth, both exceeding 12% in growth rate. The power consumption of low-carbon transition-related photovoltaic equipment and component manufacturing even surged to 43.3%.

Two caveats here - due to COVID peaking around this time last year some of these year on year numbers will look stronger than normalized numbers will in six months but the growth in key export sectors like EVs, solar and the like are very strong. Whether this can be maintained will depend on whether China can continue to export or dump this output abroad, something many people are now noticing.

China now has an emerging problem in that these industries have grown so fast it is not clear that demand within China can keep up and exports are coming up against more and more trade friction. Similarly China’s reserve accumulation continues despite stronger outflow as noted by Brad Setser.

One option for China would be to turn all its Belt and Road Initiative lending and reserve accumulation into assets that provide financing for purchasing its surplus of solar, storage and EVs in emerging markets. There is a clear opportunity here for China to team up with local banks in say, Nigeria, and provide securitization lending to allow a much faster and more affordable roll out of solar plus storage. China gets more non treasury issued USD assets, China continues its green export spree, the Global South decarbonizes faster. What is not to like, assuming one is not an energy export dependent country in the Middle East? China can move from pushing its surplus onto developed market consumers whose governments are pushing back to pushing it on global fossil exporters who can do precisely nothing. I see no problem here.

There is plenty of news on this. I first started talked with Simon Holmes a Court years ago after meeting this company. Back then I thought there really wasn’t that much that was new here, that it would not scale down fast enough in cost and had all the usual challenges of being small, not hot enough and requiring a pressurization vessel. We were long the SPAC on the basis that a bunch of nuclear bros would pile in which worked, and then short on the fundamental prospects. Both sides worked but I am now out of this - no position. This is sad day for nuclear fans but ultimately, I think this business lacked ambition - I am much more bullish on the disruptive potential of unpressurized nuclear that uses hot salt or the like - Moltex, Copenhagen Atomics and others seem a lot more prospective, in my opinion as well as process improvements to larger designs.

Food Without Agriculture

Can we produce food with energy? Yes! This is no great surprise to those who enjoy physics and chemistry but throw enough energy at a problem and you can probably rearrange atoms to your preference, cost viability aside. What is surprising is that the production of fats here does look viable and more importantly, competitive on cost and carbon with highly carbon intensive sources of fats like palm oil. Consumer acceptance is to be determined - no doubt the various lobbies would decry this as deeply "unnatural" - as if an Oreo was not.

The folks working on this stuff have a vaguely Dr Strangelove tilt to their work but someone has to work out how to survive a nuclear holocaust and I guess it is them.

The appeal to this stuff is that anything that can displace fats at lower carbon than palm oil can displace deforestation. There are far easier wins like reducing ethanol and biodiesel use but more options means lower costs and greater resiliency.

US Thermal Coal Looking Dire Again

US coal stocks are high and burns are dropping fast. This can only mean one thing: it is the time of commodities cycle where Peabody goes bankrupt. Kidding, that isn't likely due to its vastly lower leverage but things are looking grim in US coal with cheaper gas and renewables coming in and stocks as high in terms of days of use as during mid COVID. Natural gas production also remains very robust - it is hard to see how we do not see significant deflation in utilities costs over the next six months even if fixed and rate-based components drift up.

Lithium Meltdown Will Slow if Not End

Data from SMM and others indicate that downstream destocking of lithium is moving quickly though there remains a substantial stock at spodumene converters. Chart below from Albermarle results.

One particularly constructive development is that a large source of incremental tonnage in China, lepidolite is now losing money. The wild card on supply remains salt lake supply from CITIC Kunlun and others which is still going strong and likely to increase. A longer journal article on the geochemistry is here.

An American CBAM?

This act is starting to gather support and a general picture of bipartisan consensus on something similar to a Carbon Border Adjustment Mechanism is forming in the United States. There are always issues of design and scope but this does seem to be a step in the right direction to avoid carbon leakage. Aaron Crosby notes some of the many issues here. There also seem to be carve outs for friends of the US or those in trade agreements. A good thing as it will ratchet pressure to reduce emissions elsewhere. I regret to say in the absence of the platonic ideal of global carbon taxes and trading this is the only way out. The design is a lot more complicated than a CBAM but at the corporate level in companies that export to the US the message is clear: cut your emissions.

One major hangup here will be the carbon accounting which countries that have a long history of poor disclosure on financial accounting are likely to fight. For those of us who remember how ineffectual the PCAOB was with Chinese ADRs this stuff could be watered down far too easily or stymied by poor disclosure and monitoring in China, for example.

• China’s hydropower installed base the largest in the world and is not just a substantial share of power generation in China, but globally.

• It is like most renewables somewhat variable and subject to the vagaries of weather and has been particularly so the last two years with very weak rainfall and low output. Hydro capacity utilization (utilization hours) can swing much more violently over longer periods than wind and solar - it was down 25% at one point in July or in overall generation share terms it went from ~17% to 13% of total generation.

• Hydropower is a major driver of Chinese imports of coal and gas due to China’s grid topology. The provinces in China that are part of the Southern Grid do not have substantial coal resources of their own and their imports swing wildly based upon hydro power performance.

• Rainfall has picked up materially recently and China’s hydropower output based upon current and forecast weather is likely to improve a great deal.

• The implication here is that China has built a large stockpile of coal recently just as the weather turned implying much weaker fossil import demand until the weather changes again or those inventories are worked off.

• This is why China’s thermal power generation likely peaked in 2023 - a return of normalized hydropower output combined with continued brisk install rates of renewables and slower industrial output imply that there isn’t enough growth in power demand to go around for thermal to grow anymore.

China’s Hydropower Sector Size in Global Context

China’s hydropower sector is the largest in the world by a significant margin as can be seen below.

India is large and growing too but China is here now. Annual hydropower output in China has been around 1000 TWh per year for the last few years which translates to 4% of global electricity output.

Looking at a plot of output by province monthly you can a few things. Firstly, output is dominated by a few provinces - Sichuan, Yunnan and down river of those two, Hubei. The rest are comparatively a rounding error.

It is hard to pick out with the seasonality above but looking at a seasonality decomposition for the above the picture is more clear. Blue represents the trend, orange seasonality and residuals in green. After steady growth things fell apart for aggregate output in 2022 particularly in Hubei and Yunnan.

The data is even more striking when you look at the utilization hours of hydro - how many hours of use you get for all the hydro capacity China has.

The trend term completely collapsed from mid 2022. This was due to weather and in particular a combination of a very hot summer in Eastern China and and very weak rainfall in Sichuan and Yunnan that you can see below. I have a longer dataset for this and as you can see the seasonality of rain is strong but the weak trend (blue) is clear too. 2020 was strong but current levels of rainfall have been the lowest since 2011 especially in Yunnan though they have improved markedly recently.

So rainfall causes hydro output to go up - not a controversial finding, but can you predict hydro utilization hours from weather data? You can but it is a bit of an art because unlike purely physical phenomena there are the decisions made by China’s hydropower plant operators. I have some more granular data for the Three Gorges Dam from other sources and you can plot the net flow (water inflows minus outflows, both in cubic meters per second) versus the height of the dam’s upper reservoir above its lower reservoir a good proxy for power output using the potential energy equation for gravity (mass * gravitational constant * height).

There is a clear seasonal pattern here - let the “battery” drain down into the summer rains, recharge it and run the summer river flow and then store for the winter which is sensible and optimal and there is a massive literature on dynamic stochastic optimization: basically asking the question about how best to utilize hydro power given uncertain rainfall, power demand, and other energy sources. It is vastly more useful but related to the recently much maligned dynamic stochastic general equilibrium (DSGE) models in economics. Daniel Kuhn at EPFL wrote a good paper on this recently and there are some excellent open source contributions in Julia in particular from Austrian utilities and other hydro heavy girds. It is very interesting stuff but I am not wading into it here. The takeaway is that you can model the weather but modelling hydro strategy is harder.

Forecasting data backwards and forward using weather data you get something like this when targeting Yunnan hydro hours - back cast data predicts bigger summer flows than there were, but using old data to forecast under predicts summer flows. All predictions made using Linear Tree Regressor, XGBoost and an Elastic Net.

Adding in lagged hours solves this mostly though and looking at the XGBoost importances what matters is the prior months hours and rainfall.

So we can use weather data and China official data to get a very good estimate of hydro hours and thus hydro output - dam levels of key water bodies in the Yangzi River Basin are not that important. This is good because weather data is less likely to get pulled by a Chinese authority worrying about energy data security. A key part of doing any analysis in China is making your models not just statistically robust, but robust to getting the rug pulled on your input data.

What is also notable here is that the model is forecasting a massive return in hydro output which began in September and is continuing right now. Forecasts from the ECMWF models imply more wet weather inbound for December through March though forecasts out this far tend to be less accurate.

Why Hydro Matters - and Not Just in China

China’s hydro power output is heavily skewed to a number of Southwest provinces and undershot most of this year but recovered rapidly in August and September continuing into October.

Key river flow are all highly correlated but key reservoirs including the Three Gorges Dam have made a remarkable recovery now after a very bad 2022.

This matters because these Southern Provinces are connected to China Southern Grid whose provinces import most of the thermal coal imported into China. Image below from the Gosens-Turnbull-Jotzo paper.

A positive hydro shock at the margin acts as a demand reduction for coal but one whose impact is heaviest in the provinces that import the most foreign coal. For a range of coal growth scenarios at the national level we estimated which coal sources get squeezed out and the pain is mostly in the South. Given the hydro supply shock is in the South this is likely to be worse.

How big is this likely to be? Simply enormous - a normalization of hydro hours implies another ~440 TWh of output from hydro in 2024. China’s electricity output in 2022 was 8388 TWh. Even with a post COVID bounce to ~9000 that would be more than 4% of total output - combined with wind and solar expansions 2024 will need a massive increase in power for thermal power output to not decline and likely substantially. Given the location of the output increase the Indonesian coal sector is in for some lean times and China’s coal burn has likely peaked this year, which is something to celebrate. It is hard to see a deflating property bubble and slowing construction of housing and assorted energy intensive production going any other way. China’s other capital expenditure boom in clean energy will only drive this harder - offshore wind has not taken a backwards step in China.

Taking a further step back, China reducing its fossil imports represents another frontier for Chinese mercantilism, albeit something I am emphatically in favour of for environmental reasons. This will drive China’s trade surplus up and likely lead to a combination of much reduced fossil imports and lower fossil prices as well as China continuing to export its surplus production. Last week’s flip in the rates market is a sign of more to come: a decarbonizing China with much reduced fossil imports reducing price pressures in fuels but not stepping away from exporting goods as much as it can. This could we provide scope for tightening sanctions on Russian LNG as Chinese imports fall but more broadly this is a very deflationary fact pattern.

Michael Pettis pointing out the challenges of China’s push into more manufacturing stimulus and a not dissimilar thread from Adam Wolfe who points out the issues with manufactured goods deflation meaning the “cost disease” implies China’s surplus cannot inflate indefinitely.

I look at this in an applied rather than theoretical complex and I think the example of solar and the recent turmoil in inverter companies I mentioned last week is illustrative here. China can overproduce and induce deflation but at some point volume and market share gains become constrained by either global market size and demand elasticity for the product or retaliatory trade actions. This has happened with solar - China cannot dump into the US for solar panels, but can for solar inverters though I suspect that will run its course in time. Similarly for electric cars Europe is gearing up for retaliation on what is perceived Chinese dumping and given the financials of Polestar that’s not a tough case to make. The problem China now faces is that without a bottomless property bubble to pump it has very few areas it can grow without a trade response aside from domestic decarbonization - which is also happening quickly.

China’s efforts in foundational chips have been picked up by Silverado so now the question in looking for good shorts is - what is China going after next? For good longs the question is: what is priced for China dumping death that is about to feel the warm embrace of protectionism?

Part of China’s credibility problem is that after going after Australia, Lithuania and others it is highly unlikely that any country is going to feel comfortable having a high degree of dependency on China for anything going forward. 40% market share might be ok, 70% will not be ok. This really caps how big China can get in any export category without a radical change in its foreign policy and tone. The problem, as Pettis notes, is then domestic demand but Xi’s recent exhortations for women to spend more time at home barefoot and pregnant are unlikely to work and remind me of South Park.

Climate Politics and Aesthetics

Essential, a pollster in Australia ran an interesting poll on the relative support for decarbonization and different forms of renewable energy and infrastructure. The good news is support for further action on climate is strong and for most forms of energy the support remains strong. The problem in Australia, as in many places is transmission which seems to be deeply unloved.

Wars In the Middle East Are Not What They Once Were for Oil

Oil markets are weak despite everything going on and I think there is a good reason why. China seems to have gorged on stockpiling but has hit some limits and refinery runs for November are reported to be 8.5 million barrels down from 9.5 million in the prior month. To add insult to injury, China’s imports have been weak since mid September when export quotas were surprisingly not increased. China seems to be exporting more diesel - but not as much as last year - and has recently curbed crude imports materially. The apparent strength in commodity imports despite other weak indicators seems to be catching down to reality. As we lap China’s covid lockdown comps of Q4 2022, I expect growth to be much more modest if not perhaps negative from here. With even Indian growth flattish this does not bode well for the new year though the China SPR bid may be jostling with the US SPR bid $10-15 lower.

CHIP Wars Move to Analog and “Foundational Chips”

Silverado has a report covered here in bloomberg outlining how China is now dumping into sectors of the semis market that historically has sticky customer bases with high switching costs and good margins. Texas Instruments has long been seen as a “quality” name in semiconductors with much lower volatility than commodity memory players like Micron, Samsung or Hynix. That seems to be breaking down now, and violently. Onshore China producers of these chips have already gone into full price war mode and can be seen in the relative performance of Silergy.

The China overproduction hammer now seems to be coming for some previously safe names in US semis.

China’s Capex Shift and Its Consequences

China’s deliberate deflation of its property bubble and pumping up of its output of green technology has had some clear first order effects: weaker metals prices and much cheaper solar panels and batteries of late as well as a squeeze in inputs to the green tech boom like lithium though this deflating. What is more less well appreciated is how China producing a surplus of batteries and power semiconductors is now leading to dumping of solar plus storage, everywhere because the upstream surplus creates greater competitiveness downstream. Sungrow and Growatt are discounting heavily in Australia for inverters and panel prices are back to $0.15/W. This is leading to some fairly crazy discounting - 6.6kW and inverters for ~A$3,000, throw in a Huawei battery for another ~A$7,000 and my modelling of the annualized free cash flow yield from reducing a power bill is in the low teens. Australia’s distributed solar boom is only just getting started on this math, even with interest rates where they are. The two largest non-Chinese residential inverter producers seem to be finally “getting it”:

This is likely to continue crushing gas burns globally and, barring a generalized Middle East conflict, the price of fossil fuels will go down as this picks up. What is particularly interesting is how European solar manufacturers that produce Uyghur Forced Labor Act compliant panels are now selling into the United States which is rapidly eroding the cost of US trade actions on Chinese panels. So long as Europe remains open to Chinese imports the surplus in China is dumped in Europe and then Europe sells into the US. The spice must flow, after all. The question of course is - at what point does this become an economic security issue? China has a well-established track record of cutting off supply when it is displeased with trading counterparties so what sort of share of Chinese imports are acceptable and how should that be enforced?

This is likely to continue because China is producing so much solar its grid currently cannot take all its output - a good post from David Fishman here outlining how Guangdong is now grid constrained for more distributed solar. David may not share my politics but he is a first-rate analyst - pity he insists on staying on twitter, aka the bad place.

The Diesel Shortages Might not Last Long

One persistent and enduring problem from the Ukraine conflict has been elevated diesel prices and crack spreads. Russia produces heavier crude that has generally flowed away from Europe due to sanctions but, as I outlined in a previous piece, China does not seem to be buying that crude then selling the diesel. This problem might not last long however - diesel vehicle sales in Europe are in free fall and the auto mix shift is happening quickly. Whatever China does with its lake of diesel it might not matter that much as this process continues.

Norway is the bellweather here and diesel is having a particularly precipitous decline there:

Swiss data is very good (well, except for vote counting of late) and has helpful data on the stock of passenger vehicles by year. The diesel share of passenger vehicles fell from 29.6% to 26.75% from 2020 to December 2022. At this clip apparent diesel consumption in Europe is likely to weaken enough to make the Ukraine war matter a lot less, and soon.

China Hydro - Its Back and It Matters (a lot)

China’s hydro drought appears to be breaking. Latest data from the Yangzi River Basin Authority show a sizable improvement in rainfall and river flow along with dam levels. Three Gorges Dam in particular seems to be back to being full:

Hankou, a monitoring station gives some sense of just how bad things got the last two years. Thirty year normal dam levels are in blue, 2023 in orange and 2022 in pink. 2022 was an unmitigated disaster with very high power demand and low rainfall leading to much lower reserves which did not really recover until the last few weeks. This all now seems to be turning around.

Perhaps more importantly the ECMWF forecasts are for a wetter Q1. All caveats that apply to weather forecasts apply here but it seems that 2024 is shaping up as a more normal hydro output environment.

China hydro utilization hours could rise ~20% which combined with more capacity would imply much lower coal burns especially as renewables take more share. IEA forecasts of China power emissions peaking this year look plausible.

This is fairly amusing as China seems to have panic imported a lot of coal the last few months just as the weather turned leaving them with significant inventories they will not be able to work down that quickly.

We have all been stopped out by risk management at the bottom or top at some point, but it is seldom you see it happen to the world’s largest power grid.

This is acutely important for Chinas’ coal imports because:

• Most hydropower connects to China Southern Grid.

• China’s south is where most coal imports go.

Big hydro years tend to be bad for thermal coal - while we will not know for sure until seasonal rainfall picks up next spring this is shaping up to be one of those years.

Wait - this sounds very deflationary!

It is. In mid 2021 people who focus more on commodities and upstream inflation drivers were generally of the view that central banks were wildly offside of inflation developments:

• Analog supply chains breaking because of COVID in Southeast Asia in turning damaging auto output ex China

• China’s coal crunch

• Services wages exploding in the United States

This tape seems to be running backwards right now and rates are very materially higher. Infer what you will.

“The first rule of fight club is you do not talk about fight club. The second rule of fight club is you do not talk about fight club.”

Pricing authorities and alt data providers do not dare provide SPR estimates in China and investment banks are similarly reticent and I understand this is due to the fact that the SPR is considered to be very sensitive. It is also very hard to measure exactly: much like the United States’ SPR the oil is stored in underground caverns which do not lend themselves well to satellite imagery. There are excellent data providers who will give you a good idea as to the quantity of above ground storage. Those providers are not free, but then again trading oil with a structural data disadvantage is not either.

So, can we know anything about China’s SPR size? Quite a lot actually thanks to a little accounting.

China imports crude, exports very little crude and reports monthly refinery “runs” or how much crude goes into its refinery system to produce diesel, gasoline, petrochemicals and the like. So simply enough:

Imports - Exports - Refinery Runs + Oil Production = Change in Storage

This can then be accumulated monthly over time to get a picture of overall stocks of crude in China. Blue line is the back solve, orange line is a data provider disclosing what they can see.

That is… quite a lot. So much that if you look at global stockpiles of crude including this back solved number the overall picture of global stocks looks very different.

Which looks very different to data from some more bullish folks like Eric Nuttall.

The key here is “directly observable”. China’s SPR is not directly observable. In that respect China’s SPR is a bit like a black hole in astrophysics - you can’t see it, but you can see its impact on nearby matter through its gravitational force. Regrettably, when one of the world’s largest importers is so secretive you have to resort to indirect methods to find the data through mass balance accounting.

So, China’s SPR is very big - but what does this mean for oil markets? You can see how China uses its SPR through its quite wild swings in oil imports over time:

China clearly built this stockpile very aggressively in 2020 when prices were low, backed off imports when prices were high in early-mid 2022 (also when China was in some state of lockdown), opportunistically bought more in Q2 2023 and now seems to be backing off very quickly. China’s SPR seems to be broadly used to manage a range for oil and given its size it has a lot of capacity to do so.

The more interesting mystery in China crude and products is demand for oil products.

This is all calculated in a similar manner:

Apparent Demand = Refinery Runs + Imports - Exports

Aviation Kerosene looks totally normal. Covid lockdowns and reduced flights reduced demand in early 2020 and then again as China lost control of Covid in 2022. Gasoline had similar dynamics - nothing much to see there. Diesel, however, is just bizarre. China’s diesel demand was in secular decline pre Covid due to moving coal transport from trucks to rail and a move from diesel to gasoline for light delivery truck and bus fuel power trains along with a general trend to gasoline and electrification in passenger vehicles. To see diesel demand this strong with so much construction equipment idled or working less hours due to a real estate slowdown is strange. It especially does not line up with traffic measurements of trucking volume.

Alternate data providers estimate China has in the order of 200mm barrels of diesel and growing. So what is that for? The usual suspects have their views which are somewhat predictable and Taiwan blockade related and China has recently called for more secrecy on energy issues which is not entirely helpful to the case that this is not a big deal. What makes this especially odd is that China has not raised its export quotas for oil products for the fourth quarter. China normally dumps the inevitable surpluses that emerge from a production oriented model into the market: electric cars, solar panels, batteries, steel and normally diesel. China’s prodigious surplus from its Covid lockdowns and high refinery runs last year were what kept diesel prices from exploding upwards last year.

China is infamously opaque but in crude it has proved to be a moderating force via its SPR buying low and selling high to keep prices in a reasonable range but something else seems to be happening now with diesel. It is a little like Singapore’s Monetary Authority managing a currency band - interventions happen but only at the extremes of the range. Once again, you know them by the change in the order book not by public pronouncement or timely disclosure. Crude behaves like a managed currency but diesel appears to be experiencing some kind of structural break.

If you have any good ideas why a country would want to have in the order of 60 days of inventory in an oil product that has a finite shelf life, let me know in the comments. One takeaway for me from a markets point of view is that China either needs to sell a lot more diesel abroad, cut imports sizably or some secret not very good third thing.

The problem is, Inner Mongolia does not have the population nor the power demand. China has been trying to remedy this over the years by pushing more heavy industry inland to Inner Mongolia and Xinjiang - putting the demand where the cheap power is, both coal-fired and renewable. Nonetheless, more people live in the East and increasingly these people have air conditioning which means you either need to build staggering amounts of transmission to the East at high cost which China is doing and have a functioning national power market that can utilize that transmission with which China has less success thus far. This is improving and more a matter of market design and incentives which can be fixed much faster than building the power lines in the first place.

Another option if solar is cheap enough is to just put it where the people are. Happily, solar has only gotten cheaper and even assuming average prices on grid it is very competitive with coal now. However, I think the comparison to coal is a misleading one because solar is variable and when it produces and how that interacts with seasonality of power demand matters a great deal.

Look at the example of Guangzhou. Firstly, you can back out the seasonality of cooling and heating demand from renewables.ninja and what is clear is that there is strong seasonal cooling demand in summer and not much in winter - nothing new for anyone who has lived in Hong Kong.

Now using the Global Solar Atlas you can model a 10kw residential solar system and see how many hours of use you get by time of day and by month:

The peak solar output months match the peak air conditioning demand months. This makes it much less likely that a large amount of distributed solar would destabilize the grid or lead to seasonal excess supply. Drilling down to a daily resolution using a weather API you can see that cooling degree days (a measure of air conditioning demand) and cloud cover are inversely correlated in summer months: when there is a lot of unobstructed sun Guangzhou is hotter but this is also when the solar would work best. This is great and makes it seem very likely that policy makers facing a warmer climate and higher air conditioning loads will lean into distributed solar very hard in Southern and Eastern China.

So solar in China’s coastal regions works well because it correlates well to actual demand. The question of course is who loses out on this development? To understand that we need to look at the grid as it is today and for this I am going to lean very heavily on a publication by CREA produced by Water Rock called “Resolving near-term power shortages in China from an economic perspective”. A standard load curve is produced in their report which is below:

The loser is gas - and in particular LNG imports for power burn.

It is incredibly difficult to track China’s distributed solar output - there are official figures for installed capacity above 6MW output but nothing below that. You have to guess - though educated guessing using location and plant sizing and design data is possible combined with weather data albeit difficult. What we can get some broad estimates of is Guangdong’s power mix assuming this level of torrid solar and wind build out continues. Using very sane assumptions I get to thermal demand dropping ~50% to 2028 - even more if you assume solar ramps even harder. This also assumes 4% demand growth which is probably heroic in a country that has largely built consent around a peak in steel capacity and a structural slowdown in real estate.

You could run a similar analysis for different coastal provinces and if you are in energy or LNG trading you probably should because this is where the power burn is.

For coal producers this is similarly not great.

If you are in the national security field then it needs to be seen as an assumption that China is moving towards energy independence in provinces that depend on shipping - speed may vary depending upon growth and hydropower but the trend is very clear.

At this point you might note the rise in coal imports the last few years and to that I will say - let me talk about the China and global hydro cycle in the next piece.

This exercise in modelling yet more coal and other things led to me to the realization that there is not really any good public modelling of China’s grid in the here and now. This is a serious gap not only in academic literature but for anyone in the business of energy trading or investing. China is still the world’s largest LNG importer and coal importer: no other country’s power grid dynamics matter more for global fuel balances. In addition, there is enough public information out there that things are happening very quickly on this grid. Firstly, China is installing solar as a staggering rate. According to Rystad China will hit a terawatt of solar capacity by 2026. Where that solar goes matters on the margin as you can see from a map of what capacity factors solar has in China but only on the margin - even at a modest 15% capacity factor this is enough to make up over 17% of China’s power demand and represents a doubling in three years. A country in the midst of a structural real estate slowdown and outright demographic decline is unlikely to have material demand growth in electrical power. This would imply that China is going to start burning less thermal coal and LNG on the margin and soon.

China is also building a similarly boggling amount of energy storage - it is hardly an option not to with this level of solar penetration. Battery storage installations are substantial in power terms but less so in energy terms (hours of storage) but China’s pumped hydro rollout is very material with respect to both with close to 200GW expected to be completed in the next five years.

On paper all this should lead to China decarbonizing quickly. A paper modelled what it would take to completely decarbonize China by 2050 and came up with the following numbers. On current wind and solar installations China should be over 1/3 of the way there by the middle of this decade - and this paper assumes bullish power demand growth that does not tie with what we now know about the real estate sector. Peak demand of 1.9TW compared to 1.2TW today looks downright delusional. Yet even then the progress is heartening. Joseph Webster at The Atlantic Council has noted that China’s solar is going into regions close to the coast and the pumped hydro is similarly placed - this should lead to a quick displacement of both thermal coal and LNG imports for power burn.

This paper also models daily power output by source in the 2050 scenario and suggests that even using these implausibly high power demand numbers that China would need ~3TW of solar and 2TW of wind with daily output profiles as below. This all looks plausible at this point if the solar installation and production numbers are to be believed.

The problem of course is that none of these figures tie with current data. China has 490GW of solar installed as of July according to NBS and China Electricity Council data, it generated 25.9TWh in that month. That represents a capacity factor of ~7% in the middle of summer for the total but around 13-14% for utility and tracks annual variation so - the utility data is not terrible. Data for distributed solar is not included and it seems that nobody knows or if they do, it isn’t published and even academic papers in China just estimate this based upon provincial location and demand. It is also somewhat unclear how this is counted into demand which normally distributed solar would detract from. [NB this par updated after David Fishman pointed out a miscalculation].

The stakes are sharper than pontificating about what 2050 looks like or the carbon budget. For countries that are massive fossil gas and coal exporters the current rate of renewables and storage build out is enough to break global balances and soon. Tracking China’s volatile hydro output has been useful for energy traders for years but the exact size, scope and location of the renewable buildout now matters in the short run too. The growth in solar output based upon installed capacity data is now as big as the deviation in hydro output in a bad hydro year. In the medium term or a few years this could permanently break the outlook for key exports of thermal coal and LNG something which matters a very great deal to a place like Australia let alone countries with even less diverse exports and particularly those which have committed the original sin of borrowing in US dollars.

The reason grid modelling matters here is that not just the aggregates matter but where the capacity for renewables and storage goes in and how well it is connected to other parts of the country. Let me explain: if China puts 3TW of solar into Inner Mongolia and then there is no transmission capacity to use it then curtailment rates explode and the power cannot be used. In this inefficient configuration Shanghai still imports LNG and coal and China can add ghost utility PV to its ghost cities. Per the Atlantic Council piece and official data this is not what is happening, and we know from the paper that displacing LNG would only require an incremental 2.5% coal burn and that China is thinking hard about an LNG blockade. Webster is astute to think about how these changes might attenuate the Malacca Dilemma if only because China is quite clearly thinking about it too.

Instead, China is putting a lot of solar, wind and storage where the demand is. China’s LNG imports are comparatively weak and not improving - something consistent with Eastern grids that are using renewables and storage for peaking power. Things seem to be changing quickly and are consistent with a deliberate effort to reduce fuel imports in turn achieving greater self-sufficiency and decarbonization. It is remarkable that only academics seem to be focussed on this.

To that end if anyone has a good source for hourly resolution data for provincial output by generation source and demand, please get in touch. This seems a remarkably large and consequential market to leave unexamined for multiple reasons: global fuel balance, inflation, security as well as the climate.

This was a bold prediction at the time. China had more or less entirely shut its border with Mongolia over COVID controls and the Russia shock was well under way leading to major dislocations across commodities. Coking coal was trading around six hundred dollars per tonne in seaborne markets and higher in China and it was wholly unclear whether there would be dry bulk shippers to move Russian product. If Russian and Mongolian coal stayed out there was no clear limit to how severely the market squeeze. Twitter’s #coaltwitter had a good laugh at the paper. We modelled what would happen if Russia and Mongolia exited and the results indicated that the model did not solve for given Chinese steel demand implying that whatever price you could nominate for a given demand there was not adequate supply.

Times have changed since. Firstly, Russian exports were never interrupted and instead readily found their way to willing buyers in China, India and South Korea.

Australian, Canadian and US producers somehow could not manage a volume response to record high prices, which should lead to some questions as to how management teams of these businesses are paid: if they got lucky on a price shock but could not capitalize on it operationally then are they really worth paying bonuses to?

Secondly, following China’s about face in COVID related policy Mongolian exports have exploded. Commodity data services that focus on seaborne freight like Kpler do not report this but the volume uptick is very substantial. Data from Mongolian statistics is below.

Chinese imports by rail from Russia are also substantial but… they are harder to verify as both countries have been more reticent to report their trade data. There are regular news articles in Chinese state media but getting the data is challenging.

China is at the nexus of this supply expansion, so how are prices for imported coal tracking? A lot lower.

Australian import prices in particular are getting hit hard. What is notable is how poorly coking coal has performed versus other materials since China’s reopening. While many materials bounced on hopes of a China reopening and a return to investment led growth it is coking coal that has performed the worst because unlike other metals it is undergoing a substantial - yet underappreciated - positive supply shock.

With all that it would seem to be a bad time to be approving or starting new mines and yet the bullwhip effect in commodities remains alive and well. Companies like Alpha Metallurgical are expanding output, others are raising guidance and just this week the Australian government approved a new coking coal mine at what appears to be precisely the worst time to do so. This process is far from over: Mongolian rail projects I have previously written about are nearing completion and existing rail expansions are already allowing greater flow from Mongolia at lower cost. Barring a radical return to investment and real estate led growth it is not clear what can drive a recovery in the coking coal market from here. It is no great surprise to me that China’s metallurgical coal imports upon resumption of trade with Australia have been meagre.

For investors in this space substantial stock buybacks have buttressed companies’ equities despite a slide in prices. Buybacks come to an end and coal contracts roll off leaving businesses with costs, maintenance capex and, for the foolish few, expansion capital expenditures into much weaker markets. Mongolian producers with cash costs going to $60 or less per tonne are likely to get by albeit at lower margins. US producers with all-in sustaining costs close to current spot (~$110 cash cost, $15-20 maintenance capex) are likely to get into trouble again.

But What About Thermal?

Thermal coal has two things going for it right now. Firstly, residual tightness in gas markets due to Europe’s loss of Russian gas supply which I and other have written about extensively. So long as burning coal remains cheaper than gas, it has some support from coal gas switching. This will abate over the next twelve months as US gas export supply increases but for now it helps.

Less well known and appreciate is that China’s horrific heat wave and drought in 2022 has left China with materially lower hydro power reserves going into what is forecast to be a very hot summer. While China has been gradually restricting access to power and hydro data the level of the three gorges dam says it all. China will have to backfill that missing hydro with coal imports for its Southern Grid and the surge in Indonesian imports suggest this is happening.

A heavy rainy season combined with US LNG could crash this market in due course - but for now it seems major thermal producers will not suffer as much as metallurgical coal producers. Longer term forecasting of climate and its impacts on China’s hydrology should be a focus for any coal company though I suspect they will not do that because they could not bother to cover Mongolian rail or metallurgical exports which is far easier to do.

In summary: it is back to the bad place albeit at different speeds in coal. Most producers have used the various shocks from 2021-2023 to reduce debt or diversify out of coal. Those who have chosen to double down and increase output are in for some very lean times and equity issuance as debt markets remain almost completely closed to coal producers.

The standard answer “warm weather” is only part of the picture according to the IEA in this report Europe’s energy crisis: What factors drove the record fall in natural gas demand in 2022? – Analysis - IEA. Renewables, fuel switching and efficiency played almost as large a role. There will be more to come this year as recent earnings calls indicate that supply chain issues that bedevilled heat pump supplies have now abated. With the symbiosis of heat pumps and solar, European energy demand could fall for households very quickly from here. This could happen especially quickly as European market specific products get rolled out, like this heat pump which is specifically designed for retrofits of district gas heating in apartments.

Europe still has a lot of the inflationary impact yet to digest but with gas prices having fallen to 2021 levels the energy driven components should wash out over the next six months. From 20242-2025 US LNG export capacity expands rapidly. I think it is fair to say that energy coercion by Russia has failed and becomes less of an issue from here.

Clayton Christensen’s Low End Disruption Comes for Lithium

Recent news on sodium batteries fits the “Low End Disruption” paradigm whereby a slightly inferior product enters the low end of a market and then improves or scales its way to dominance. Sodium is now being used in lower end Chinese EVs and is likely to make inroads very quickly into ebikes and stationary storage. Despite slightly inferior energy density as outlined in this paper the answer primarily lies in the electrolytes which freeze at a lower temperature and catch fire at much higher temperatures. A more thermally robust technology needs less active safety features and can be a much more densely packed “dumb box” for storage. This is ideal for home storage where fire risk is very high stakes and the relative savings on battery pack management and cooling can make a much more cost competitive product - as much a third of the price of a Tesla Powerwall today.

This does not mean lithium is going to zero or anything like that - decarbonization is a big enough market that it is unlikely materials get squeezed out. However, it does indicate that fears of materials shortages acting as a constraint on decarbonization may be overplayed.

The Great Alt-Meat Bust

I have stayed away from this space in VC and was involved in some public markets shorts. This is not because I think Beyond Burgers and the like are dumb - there are a lot of vegetarians and flexitarians and I used to be one - but that as business models they seem problematic. Many people who stop eating meat just lose their taste for those flavour profiles over time and there is no shortage of other options. There seems no “edge” in these products and the advantages to larger consumer packaged goods conglomerates with their shelf space and distribution allowing them far better unit economics seemed a prohibitive barrier. No doubt many of the likes of Impossible now rue takeover offers they may have turned down.

These insights seem obvious now especially to those who invested in this space. It seems VCs are now focussing on upstream investments in agriculture which seems smart: Pivot Bio looks like a very real business to me with a clear value proposition as opposed to marginal meat proxies.

In the Wealth of Religions Barro and McCleary outlines a paper by Laurence Iannaccone of a club model of religions that “thrive by insisting on extreme behaviour and sacrifice to promote homogeneity and commitment among members. The sacrifice and stigma screen out free riders and retain the enthusiastic participants who promote individual and group interests.” One example cited of this stigma includes non-conformist religious practices like those of the “early Pentecostals in the United States featured members making animal sounds such as barking, howling, hooting like an owl and chattering like a frightened monkey…. these enthusiastic worship services drove the less committed away. Consequently, the quantity and quality of within-group religious goods increased.”

There are a lot of people who make fun of various religious groups on twitter of the more extreme or fringe Christian variety. The benefits of the group cohesion within these groups cannot be readily denied - the branch stacking in the Victorian branch has been widely reported as in South Australia. Increasingly if you want to get preselected in the Liberal Party you do not necessarily have to be a member of one of these religious groups but you probably need their indifference at a minimum. To that end those claiming the Liberal Party has been hijacked do have a point: these groups do not necessarily represent a majority but a highly cohesive minority of 25-30% can exert effective control, as any investor in Asian listed but still substantively family controlled equities can attest.

PRGuy @PRGuy17

BREAKING: A Victorian Liberal MP is tonight sounding the alarm on the “extreme cult” hijacking her party to “infiltrate, impact, impel” — subverting democracy and the law. Cathrine Burnett-Wake says Pentecostals are taking over to revert assisted dying and abortion law. #auspol

9:27 AM ∙ Sep 21, 2022

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Why do people join these groups? For the in-group goods, namely solidarity more or less no matter what which can be awfully useful in political life and life in general especially if you have a tendency to sleep with your staff while espousing family values (form an orderly queue former ministers of the Morrison government). Having people who will back you up more or less no matter what you do can be very useful, and the more fundamentally malign and immoral you are the more useful it is. One extended analysis by Berman of these religious groups and clubs asked why they are so effective at violence in the case of clubs in the middle east:

Berman found that the mutual aid model is most effective in countries or regions with inefficient if not failed economies. Radical religious groups that engage in violence, such as Hamas, the Taliban, Hezbollah, and al-Sadr’s militia, thrive in inefficient economies as they rely on members who have poor outside alternatives to joining the group. Should outside options exist, these groups ensure that they destroy them. That is why many of these groups have a scorched earth approach to warfare.

The systematic undermining of any other factions and the like is very much part of the program here and allows these clubs to control a party. If the party controls government, then it can dole out jobs for the boys, staffing roles and all manner of goodies to group members. If you are a person of middling talents and ambitions both political and monetary then joining the club seems like a good choice. This is perhaps why we see a lot of “family values” types being caught out not engaging in what that term is generally understood to mean - they made a calculated bet to join something they never really believed in.

A key feature of all this behaviour is a deep alienation with the existing order at a doctrinal level: “the religious terrorist perceives himself or herself as engaging in the destruction of a system with which he or she does not identify. The problem lies with the enemy, not with the sect.” The religious club generally believes that the state of things is irretrievable by any incremental or organic process, the rules do not or should not apply to them and that a core objective is subverting or replacing those rules and norms. It is utterly opposed to any form of institutional conservatism.

To that end it is best to look at these movement and their political behaviour and conduct as more like Bolshevik parties as extensively analysed by Philip Selznick in “The Organizational Weapon”. His characterization of Communist or Leninist subversion applies readily to the current milieu of religious right groups within the Liberal Party:

Communist subversion is of another order. The difference lies in the central aim of Leninism: the concentration of total social power in the hands of a ruling group. This is not the only goal of bolshevism, but this search for unlimited power decisively shapes the behavior of the communist parties. Whether or not we say that bolsheviks seek power for its own sake, or in order to further some more ultimate aims, makes little difference.

Similarly:

Nor is it to be expected that communism will adapt itself to the constitutional order. To be sure, other movements, as they have gained influence and a stake in the status quo, have altered their aims. But the problem is not one of goals alone, but of methods that have placed their stamp upon the character of this movement and are sustained in action wherever bolshevism exists. These methods are inherently subversive because they represent an unrelenting search for power in areas and by devices which know no constitutional restraint. The continued use of these methods holds communism to the revolutionary line.

I suspect that at this point the Liberal Party is too far gone on this account. The branches have been stacked, the organization fundamentally cannot be pulled back from control exerted by these more extremist groups and worst of all for all involved it appears much of the Australian public has figured this out. Selznick’s comments about Bolsheviks can well apply to religious culture warriors:

Leninism views politics as omnipresent. As a consequence, bolshevik strategy has identified vast new areas of political potential in what are usually thought to be nonpolitical special-purpose social institutions and mass organizations. This theory of power has increased the sensitivity of bolshevik strategy to unconventional methods of gaining influence. Exploitation of these devices has helped to keep the communist movement from adapting itself to constitutional methods; in this way, it has rejected the path of accommodation taken, for example, by most sections of the international socialist movement.

And in that regard in like of recent reporting they forgot some important lessons of Leninism:

The most general of such implications is the subordination of propaganda to the needs of organizational strategy. If the struggle for access or legitimacy demands concealment of aims, then the communists will not hesitate to hide them.

The Age @theage

"We need to save the Liberal Party." An Australian right-wing Christian conference has been urged to flood the country’s Liberal parties with members to gain long-term influence.

theage.com.au‘Long march’: The right-wing Christian plan to infiltrate politicsA recent two-day annual conference in Brisbane drew hundreds with the goal of “arming Christians to influence culture”.

8:27 PM ∙ Mar 6, 2023

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The only way to recover is to lose and lose so brutally and comprehensively across every state and territory that the various hangers on and enablers realize that the club can no longer deliver the goods to the in group because it is now unelectable. At that point the party likely shrinks and something else emerges because it is going to be very hard to unstack a party which has been occupied by such a disciplined and focussed vanguard. This is why I expect the Liberal Party to shrink and probably cease to be a major party barring some radical reform and changes. Anything that accelerates that process is indisputably a good thing.

Tough words and uncomfortable truths no doubt for some readers but there is a clear distinction between a small counterinsurgency and when it is time to get on the last chopper out because it is now very much over for the party as a moderate or Burkean conservative force. As reasonable as some people may sound if they do not control the branches their opinions are as valuable as South Vietnamese generals in 1974.

To that end I have four potential surprises for 2023.

1. Maybe we do not need as much lithium as we thought?

For governments, producers and consumers working out how much to produce for emergent technology inputs is hard, even more so if lead times are long as they are in mining. It might seem obvious that lithium is going to eat the battery space today but it was also “obvious” that Nickel Metal Hydride batteries would eat the market in the late 2000s and early 2010s. The Nickel Metal Hydride technology was used by Toyota in the Prius and used significant quantities of lanthanum, a rare earth element which had a vertiginous rise before a collapse as lithium chemistries displaced it.

Some technologies that looked a long way off have recently been sending out test cells in applications where lithium is currently the default. Sodium is the most interesting on this count: volumetric densities are getting to the point where they are compelling for lower specification transport applications, but better safety and a reduced bill of materials make them really appealing for home energy storage and some stationary applications like server racks. Faradion looks very real now, and Natron and others are shipping products to niche markets already.

This is a huge problem. One the one hand we might see cheaper batteries with as-good-if-not-better performance in a lot of applications. This creates existential uncertainty around how much lithium we might need. If you think about the usual volatility of the metals and mining sector and then imagine an overlay of possible technical obsolescence that is a recipe for some incredible volatility and likely dramatic over and undershoots in market balances.

It is also a policy problem: in this context it is unlikely the sector gets enough capital if other options do not perform or we are going to have an absurd surplus caused by an otherwise beneficial technology change. Predictions of cobalt balances have been radically revised as the cobalt is pushed out of lithium-ion batteries, there is good reason to believe that it is not the last of “unobtainiums” to get substituted out especially as prices have risen six to seven since 2020.

One “unobtainium” that appears to be becoming more obtainable is vanadium, and it is also used in batteries. More and more projects attached to oil refineries that recapture spent catalysts are coming through, mostly associated with AMG NV, which should allow for more and more stable supply. By products get produced almost no matter what and so long as refineries are looking to reduce their heavy metal residues there should be a lot more vanadium available.

2. Renewables to hydrogen becomes a thing because of the maritime fuel industry.

Hydrogen has had something of a slow start compared to batteries in decarbonization and has suffered from real technical challenges as well as some ridiculously partisan hype and pump cycles in the media and PR. A more realistic appraisal of its prospects is here from Michael Liebrich and on the whole, 2022 was a good year for hydrogen on a number of levels.

System Level Efficiency Improvements: Companies like Hysata are radically improving the performance and cost of electrolyzers allowing for much cheaper hydrogen from renewables and various efforts are underway to improve combustion.

Real, scalable customers: Efforts by Maersk and others to develop a proper maritime e-fuels supply chain are turning into real projects. Most of the attention seems directed towards ammonia and methanol as fuels - methanol being partially a “drop in” option for diesel. The advantage here is that many of these projects can scale well as brownfield expansions, and Maersk is clearly interested in offering green fuels as a product to customers of shippers - “tick this box and pay this amount to use zero carbon transport”. From here consumers and in particular consumer goods brands can upsell clean transport to customers. Having this kind of modular and very scalable customer base bodes well for marine transport and could readily be applied to aviation e-fuels in time. We are going to need a lot more renewables and electrolysers for this.

3. Is the weird reddit meme of solar driving up silver demand to impossible levels being displaced by better technology?

Quite possibly as Sundrive goes from startup to cell records. According to this article they can displace the copper in solar cells and thus get past any purported silver shortage. This is not an exciting development for copper bulls though, the amounts used are relatively low per GW compared to the size of the copper market (~25 million tonnes). A terawatt of solar production is not going to even add .1% to demand.

In addition to reducing manufacturing cost, Sundrive’s replacement of 25 tons of silver with 13 tons of copper per GW can reduce the embodied emissions of HJT modules by around 6 kilotons of CO2 equivalents (CO2e) per GW. This reduction is due firstly to the lower mass of copper required per cell; but also the lower emissions intensity of producing copper compared to silver.

4. Weather will continue to be a source of volatility.

The safest bet of all and barely controversial but worth remembering that in a less stable and changing climate system the future will continue to drift from the past, in somewhat unexpected ways. The emotional rollercoaster of watching European gas storage the last 12 months is likely to continue though as Europe builds up much bigger buffers than anyone hoped for the horrors of the geopolitical energy shock do appear to be going away though the climactic energy shocks are nowhere near done.

Inventories can suppress a lot of volatility and so can headroom in power capacity as renewables are installed rapidly in Europe and in the US as projects held back prior to the IRA get built. French nuclear getting its act together is another welcome development. I would expect this year to be less crazy but I doubt a day comes where weather models aren’t updated daily for anyone tracking fuel balances anytime soon.

For energy services I have not seen much written so here are a few basic pointers. Energy services have a big weighting - almost as high as gasoline which is what most poeple think of when considering inflation.

The marginal price of power in the US is mostly gas. One year forward power in Houston is in green, the 12 month gas strip in pink and EIA power prices paid by consumers in yellow, CPI electricity in blue. So, gas prices and gas balances rule the roost here - both for pipeline gas services and marginal cost of power.

So, how are gas inventories looking? Pretty excellent. Storage levels look great after a deranged summer that pushed power prices and gas prices to $10 per mmbtu. Prices are now about half that and inventories are building fast. Eyeballing the chart we should be seeing outright deflation over the coming months.

That is all well and good, but what about longer term forecasts? Happily EIA short term energy outlook reports oblige. A massive increase in renewables from the IRA bill as well as classic “the cure for high prices is high prices” dynamics would indicate that gas demand is likely to go backwards over the next 12 months for domestic demand with limited LNG export demand coming before 2024. The only part of the country that is going to experience higher prices is New England which imports LNG and due to the Jones Act cannot buy LNG from the United States. On top of that, they shut down nuclear plants and refuse to build pipelines to Appalachia to reduce gas flow constraints. One might say, if one was mean, that if you outsource your energy policy to the Sierra Club you deserve the prices you get good and hard. I am not mean, so I am not saying that - but many people do say things like that and they are not factually incorrect as far as I can tell.

Energy services inflation should come off and quickly except where infrastructure cum maritime regulation cum political constraints bind. This is good news but also a little lesson in the weakness of the structural inflation narrative. If you make bad enough choices time and again you probably can have inflation - but ultimately that is up to your state and its particular neurological nematodes and not some hand wavy macro phenomenon.

Gas storage levels are high and continue to grind higher with gas prices now back to mid year lows and falling further. Expiry on the October TTF contract is going to be interesting - what happens if storage is at close to its limits as was the case for oil in April 2020? I do not expect this to quite trade at a negative price but a very mild weather forecast and high storage levels can lead to strange things happening.

The steepness in the curve arguably already constitutes “weird things” and we are likely to see more before we are done. Weather for Europe is forecast to be mild for the next few weeks so that is *interesting*.

Looking out beyond the next month or two demand response is really taking off now in Europe as outlined in this Politico piece. Some of my initial despair at Europe’s prospects earlier in the year centred around the lack of demand response which in turn appeared to be as much consumer and policy inertia as chip shortages for heat pumps and solar inverters which have only recently eased. No more - we are seeing vertical adoption of consumer technology to structurally reduce gas use and, combined with very strong messaging and incentives from governments it is now showing up in the data. There are a number of dashboards here but what is particularly encouraging is that households are now responding almost as well as industry in reducing demand. If this can continue along with the current weather forecast this winter does not look that bad and gas prices should move towards a stable level albeit materially higher than before the Ukraine invasion, likely around 100 euro for TTF. For markets and confidence though seeing that the “top is in” is very important - so long as businesses and consumers can get some confidence around that as the key driver of inflation in the EU a lot of good can flow from there.

For that reason I am sceptical of people calling for sustained energy inflation going forward. In Europe inflation dynamics are almost single factor at this time, and if that factor is being fixed then the prognostications of Russel Napier do not make much sense to me. Prices are set at the margin and if Europe’s power and heating markets are on a path to marginal pricing from a scarcity pricing regime then the price is going down from here - at least 50% lower for gas for example. There are no other major gas suppliers to cut short of a complete explosion in the Middle East and the great US LNG deluge begins in earnest shortly, as well as the tantalizing possibility that EDF in France might not be as much of a gong show going forward.

Lauri Myllyvirta @laurimyllyvirta

France's EdF is aiming to put ~20 nuclear reactors back online by January. They've been closed for inspections and repairs, mostly because of corrosion issues. If this plan succeeds, it will make a big contribution to reducing coal& gas use over the winter. Graph by @EsalaAntti

3:54 AM ∙ Oct 15, 2022

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A certain kind of Cassandra - very Tooze and Polycrisis-thought adjacent - seems to think that the energy mess will towards some kind of parallel where all the problems of fossil capital will remain but with new commodities and the same extractive dynamics and conflicts. I’m sure nothing is going to change in commodities, and I do agree with Thea Riofrancos that financialized capital’s home is in commodities - just that I am yet to work out how this is bad or how we get around it. As someone said it better:

Where I wildly disagree with this line of thinking is in the orders of magnitude involved. Annual vehicle sales are 90 million, give or take. Assume 50kWh per battery, and around 850 grams of lithium carbonate per kWh. No recycling, no tech improvement, full market penetration, no savings from autonomous vehicles or the like and it is 3.8 million tonnes of lithium carbonate equivalent - market price assuming today’s lithium price of $60k works out to $230bn, or the dollar equivalent of 23 days of global oil consumption. Assume more normal lithium pricing of $20,000 and you get 8 days of current run rate oil consumption for a year’s worth of lithium vehicles at 100% market penetration. This is existential for commodity trading houses longer term: they can sell more lithium, copper and nickel but the core businesses they are in are big, lucrative and going to shrink and there is no certainty that lithium is not going to disappear into vertically integrated supply chains that do not need freewheeling intermediaries or “financialized capital”. I’ve always found the commentary around this deeply aestheticized and as far as I can tell “people with Bloombergs and lots of exotic passport stamps bad, people with lab coats good”. Even the most cursory analysis suggests the Bloomberg people lose on the transition. An extremely dull future awaits of energy flows being largely local or in grids where the best meteorologists and machine learning engineers rake the table. Most people at trading houses see this and they do not like it, happily they are making more than they ever had right now which puts these existential issues outside the next bonus cycle.

This math for lithium stands before we consider really disruptive things such as: maybe lithium isn’t it for grid storage, or even autos? This is the latest from the Sadoway lab - if we are going to use primarily sulphur and aluminium for batteries they will be laughably cheap. A tried and tested way to make money in materials science is to “do it better, with more available materials and less energy” - this is all three if commercialized. Over the last few years cobalt demand estimates have been crushed by developments in cathode chemistry due to cost and performance improvements in simpler chemistries - I am sceptical that this is the last time that today’s “unobtainium” becomes tomorrows chopped liver. Maybe new nuclear works, even if at low levels of total energy provided simply for stability and security reasons? Perhaps we can do a lot more pumped hydro than we thought? All the while the solar wafers get thinner and more efficient and use less materials…. the preponderance for everyone now calling for longer term structural energy inflation when papers like this are coming from Oxford which take account of these dynamics seems deeply unwise if you are doing anything but playing quarterly revisions.

When thinking about potential growth I often come back to a paper by Steven Keen and Philip Ayres on the role of energy in production. It is a neat little paper which introduces exergy - useful energy - into the production function.

It would be a radical departure from current practice to measure GDP in terms of exergy. But we believe that, not only is this redefinition consistent with acknowledging the crucial role of energy in production, it also provides a solid basis on which many of the criticisms of the concept and measurement of GDP could be addressed.

On this basis the EROEI (lifetime energy out for a technology vs energy to make it) of energy technologies is crucially important. I am working at a desk with a laptop that sips energy compared to desktops when I started working. Similarly, EROEI of renewable technologies now by many measures exceeds that of marginal fossil sources. Combine the learning curves of solar and compute and you can get the sort of results coming out of computational architecture to design “solar exoskeletons” where you can get embodied energy of built structures down 37-80% and operating energy demand down 24-48% versus standard methods today. People think you can’t throw GPUs at solving an energy shock but in the medium term you really can if those GPUs are used by civil and chemical engineers and not to mine shitcoins. Overwhelmingly people seem to have confused a shock with a change in trend at this time despite zero evidence that is the case aside from prices having gone up. Making a petrostate - one of the largest in the world - a pariah is consequential but if this shock ends in a mere two years there is a lot of optimism and hope to be drawn from that. Perhaps long before the last barrel of oil is refined and burnt the political leverage and power of these states may be in decline. There should be some kind of remapping of the psychological literature on mid-life crises to states - it seems to apply well to recent Saudi behavior, for example. It may be that the energy transition elicits increasingly unstable behaviour from those who are losing their leverage. That is a shame but just another reason to push harder towards a more stable and secure world.

• China has no thermal coal shortage. Inventories are high, output is high and yes, hot weather means more air conditioning demand but that is not enough to significantly drain stocks of coal.

  

• China’s self inflicted metallurgical or coking coal shortage is over. There are two reasons for this: China is importing from Mongolia again and will soon be one of Russia’s few customers left. You can see this in data when you combine shipping volumes and Mongolian export data. The big squeeze is over. Add to that the implosion of their real estate sector and this market is moving towards oversupply.

• As such, there is really no pressure for China to do this. They are fine, coking coal prices are falling and China’s domestic thermal prices are now around 875 yuan per tonne - or $130 per tonne. The spot price of equivalent coal from Australia or delivered to Rotterdam is $450. The idea China is going to import in that context is laughable and Australia’s chief business correspondent at the national broadcaster should do better.

So what is happening here? Let me hazard a guess:

Australia and its miners adjusted quickly and well to China’s trade actions. Broadly, China failed to coerce Australia. But Australia’s mining-lobbying nexus is powerful and also very bad at market research and they want more customers even if those customers are unlikely to ever come back. China would ideally like to offer Australia something in exchange for other things it wants - my guess would be pending takeover approvals for strategic assets in minerals - but knows that they are in fact offering nothing. The treasurer is from Queensland, a large coking coal mining state and probably gets an earful from miners all day every day. Add to that the Department of Foreign Affairs and Trade, which has a weak economic research function probably doesn’t understand these dynamics and wants to make itself relevant by doing a deal - any deal - to burnish its importance.

The real question in my mind is: how stupid and captured is Australian politics and will they go for this? If Australia does such a deal it gets nothing and ultimately looks very stupid and we have no idea what is being offered to China in exchange. Verrender and the like should stop publishing lobbyist talking points and start asking what the likely shape of such a deal is and whether it is in the national interest.

For China, none of this matters. They are going to have two more or less exclusive suppliers of coking coal and they win either way. Good for them. But it is up to Australia’s government to see this as it is and not get distracted by empty offers.

A Negroni is a tasty cocktail made with three ingredients and which is simple to make: gin, Campari (or Aperol, if you want something less boozy) and vermouth. An oil refinery also has three primary inputs: heavy oils, lighter oils, and natural gas. Simple enough: if you have them all available in the correct ratio you can make Negronis and if you have two or more you will probably be pretty buzzed. However - if you do not have the ingredients in the right ratios you can either make less Negronis or bad Negronis. In oil terms this might mean the kind of oil refining seen at times in Syria in the photo below, in alcohol terms this might be the kind of concoctions high school students make with their parents liquor cabinet. Either way this is not advisable, safe or good.

In addition, a Negroni can only exist at a time and place. If you have a bottle of Campari and you are in Park Slope, your friend in Red Hook has a bottle of gin, and your other friend in Manhattan has a bottle of vermouth, you do not have any Negronis until you meet up and mix the ingredients.

Currently, Europe has Campari (light oils) in adequate supply and a shortage of gin (heavy oils) and profoundly acute shortages of vermouth (gas). Their primary vermouth vendor turned out to be a violent psychopath, they aren’t buying from him anymore and due to a snowstorm they cannot get additional supply quickly. The gin (heavy oil) shortage is a bit more nuanced - it does exist but strangely the global supply of gin seems to come from places that were “cancelled” years ago (Venezuela, Iran) as well as the violent psychopath. However if they do buy from those long-cancelled suppliers, they may in turn be cancelled by the Campari supplier, the United States and perhaps the secondary Campari supplier, Saudi Arabia. This is why we have less Negronis.

To further complicate this, the bar where they might go to consume Negronis has a barman - lets call him Exxon (a parental abuse case right there). Exxon can only make so many Negronis per hour and there is now a shortage of capacity to turn ingredients into Negronis. There is another bar in Chinatown but it is very exclusive and owned by Sinopec and does not seem keen on having large numbers of people flood their bar having turned it into a more exclusive venue from a high output dive bar a few years ago. Sinopec needs to return to being a dirty Shandong themed dive bar and apparently does not want to. Who can blame them? On the other hand, where will everyone get their Negronis if Exxon is not expanding?

Those are the key contours of the oil market disruption:

• Not enough bar staff: refining shortages

• Not enough ingredients, in the right ratio, in the same place: heavy oil shortages, and acute gas shortages in Europe

• Everyone not talking to each other at times and being weird for inscrutable reasons due to long held grudges: welcome to geopolitics.

Thematic investing occasionally spills over into commodities. Sometimes a big picture technology change or shift like “electric cars” or “shale” lead to a large number of investors piling in or out of a product exposure - long or short - with decidedly mixed results. There have been successful waves of this including people who saw the battery and lithium boom early on and also those who saw the disruptive impact of shale on oil pricing dynamics and how it would apply severe pressure on US coal fired power and related assets. There have also been recent mishaps including the crowded positioning in copper around a longer term EV and renewables thematic or investors in lithium during a China EV policy induced bear market and supply shock from early 2018 to mid 2020. The problem with this strategy is that commodities are volatile and the customer does not care about long term prospects: they want to buy metal or rock, turn it into something and sell it for a spread and the product is completely undifferentiated. Strategic stockpiling is remarkably rare and most people in the supply chain buy something today they will put on a boat and sell less than 90 days later. The long term is not the business they are in and substitution is high. The slow rate of being able to make more stuff means that most of the volatility is not in volumes but in price and margins.  

An astute reader might point out that “that short term orientation does not apply to large capitalization mining companies” but, sadly, it does. Most investing appears to be pro cyclical because the value of the companies move with spot prices as do analyst estimates. Being contrarian in commodities is hard: maybe you are right, but can you stay funded and survive? The relative decline of commodity oriented private equity due to down cycles in commodities like oil being long enough to put both the businesses and the financial sponsors out of business is a profound challenge here. A telling example from the lithium cycle is Alita Resources which failed due to defaults on their off takes, went into bankruptcy and is still stuck there with a Chinese state linked buyer that cannot close the transaction due to FIRB rules and an administrator / liquidator who will not open up the transaction to competition for reasons unknown. At the time it failed with US$40mm in debt and was producing 80,000 tpa of spodumene fetching under $400 per tonne or well into the first quartile of the cash cost curve. To put it simply: it fell over when barely any company in the space was making money with not much debt - normally a good “loan to own” scenario. Lithium now now trades for over $6000 according to a recent auction. At the time value investors were nowhere to be found, nor strategics like Galaxy Resources which had a mine nearby. The cycle is brutal and heroes tend to be hard to find at the bottom. To try to tease out grinding structural trends in this kind of volatility is a choice, and in my honest opinion not a high risk adjusted return one. Investors who are not taking mid term market balance considerations to mind tend not to last.

Copper

Recent misadventures in copper are very much a case in point here. There are a lot of reports from investment banks indicating a bright future for copper demand: increased renewable energy needing more copper cabling, electric motors needing wound copper wire to make electric motors, batteries needing copper foil - the list goes on. These are often passed off by commodities research teams without much push back - so here are some of mine:

• Batteries: What about flow based chemistries for bulk power storage on the grid? What if vanadium flow, new thermal storage technologies and industrial heat process technologies take a significant share here? What about pumped hydro which uses very little copper at all?

• Power lines: The assumption here is that solar and wind are produced in remote locations and require extensive cabling. That is plausible for wind but for solar what happens if a lot of incremental build is on existing buildings or in smaller projects close to customers? There are a lot of tonnes in projections for this and not a lot of clear assumptions about what is required especially if renewables are integrated with storage to better utilize line capacity.

• Electric Motors: motor design has a huge impact on copper requirements - there are sharp tradeoffs between rare earth consumption and copper consumption. The most bullish estimates for both cannot be right according to this presentation by IDTechx.

Projections nonetheless still look good - there is an incremental 30kg of copper in an EV versus an ICE vehicle and if you assume we get to 50 million EV sales in 7 years or so, that is a lot of copper even if you assume reductions in foil thickness and various other innovations. A long and thorough analysis can be found here but half a kilogram of copper per kWh is about right for now.

   All well and good, but where is demand today? For the United States the answer remains building (~45%), electronics and cars. 

An excellent paper did a full inventory of the copper in use in Conneticut and came up with an even more detailed breakdown. While this paper is old (2007) it shows just how much of the copper is tied up in things that happen around new home construction: wiring, plumbing and installation of air conditioners. 

These estimates may now be high. PEX piping is replacing copper in most plumbing systems, CAT 5 cable is being replaced by fiber cabling and airconditioners use a mix of copper and aluminum and have been reducing copper intensity for years. 

For transport intensity is already high and tied to auto ownership - though this will go up with electrification. 

Home appliances are big but once again like for buildings the most intense uses are heat exchanges like washing machines, refrigerators and air conditioners. For manufacturing while not broken out here the story is the same: anything that uses process heating or cooling requires copper. 

And finally in the infrastructure category we have electricity transmission and distribution and some applications that are disappearing fast like phone lines, coaxial TV cables and the like that will soon be returned as copper scrap. 

In total, this study shows what copper demand has been driven by: urbanization and penetration of appliance ownership. EVs will matter but as an impact on supply and demand they pale in comparison to the fits and starts of Chinese real estate and grid capital expenditure and to a lesser extent housing construction in the US and Europe. Chinese building completions - the time when the wiring goes in and people put in their appliances - are collapsing. This is not the the time to be long an industrial metal heavily exposed to building completions when it is at the top of the cost curve with no supply response likely anytime soon. For a long time China was riding an adoption curve for these appliances but now it appears to ebb and flow with real estate. 

This ties with the Euromonitor data showing that air conditioning and refrigeration are now more or less fully penetrated and are going to show much slower growth.

For copper this is an even bigger problem: as anyone who owns an air conditioner in the tropics knows (me) an air conditioner does not last forever but the recycling rates are high. China will continue to use more and more post consumer scrap putting more and more pressure on copper imports over time. Electric cars might well offset most of this in a few years but extrapolating prior growth would be unwise. 

If you wanted to construct a better model of prices you might:

• Look at lead and lag relationships with building starts in China and elsewhere

• EV sales

• Appliance sales data especially air conditioners and refrigerators

• General industrial and manufacturing capex

• Where prices are in terms of cash costs and to what extent miners are investing in new output

• (really clever) tracking scrapping rates and how much consumer scrap displaces newly mined copper

At the current time China completions are down and not bouncing much, EV sales are strong but not large enough and appliance sales having been massively pulled forward by COVID are languishing and unlikely to speed up due to market penetration. Industrial capex is good for now but could decline and heat pumps, while a great structural tailwind are not going to fill the gap anytime soon. It is not wholly surprising that in a major downturn in Chinese real estate copper prices might be weaker and with the the spectacular ramp in US mortgage rates that might continue for a time.

Commodities do have measures of how cheap or rich they are based on value, but those measures predictive value depends heavily on how readily you can arbitrage time: as we saw in March and April 2020, oil can trade for less than zero if there is nowhere to put it. Copper is more like a financial asset - higher value, easy to store and no doubt “value investors” will appear at some point. They will likely bring detailed supply and demand estimates and the cost of that production into their thinking and not Cathie Wood thematic approaches. They do this not for ideological reasons but because that seems to be what works.

1. China’s input costs need to fall for external reasons, or margins need to fall for domestic producers due to lower demand. 

2. China then exports the surplus abroad. 

3. There is capacity for the world to import. This seemed obvious before COVID the logistical nightmares of the last few years but a combination of freight capacity and free trade allows this to happen. Shipping rates for containers from China to the US are now cheaper than they were a year ago according to Freightos so this applies once more - see below.

   

Lower Input Costs

Steel

China now is buying more coal from Mongolia and its coking and thermal prices have now dropped to levels last seen prior to the Ukraine invasion. This trend is not stopping in fact recent news of automated borders, rail and the like indicates it will continue. Steel in a blast furnace takes two principal inputs: iron and coke from coking coal. Both have dropped recently but coking coal has a genuine supply shock incoming from Mongolia and for seaborne, reduced imports. This is taking a simple cost index for steel much lower and depending on how much China’s real estate sector slows iron could well follow leaving steel prices back at prices last seen in 2015-2016. For now China steel futures in yellow are tracking costs lower and North American European prices are following.

A lot of things are made of steel, and a lot of those things are made in China or compete with China prices. Update your priors on the cost of infrastructure projects and cars accordingly. 

Plastics and Chemicals

China helpfully has a liquid futures market for key plastic resins that make up much of global plastics production that can be readily compared to international prices. Something is clearly going on right now: China prices are collapsing, US prices are up, but not absurdly so and Europe is suffering a terrible price shock because gas is a key input. The underlying cause is the Ukraine invasion: China can import cut price gas and crude from Russia, the US uses local gas and crude and Europe pays obscene prices for whatever Russian gas it can still get. Prolypropylene goes into everything and has wildly different prices globally which as not happened before (Europe in yellow, US in white, China futures in orange). 

I would be shocked if China did not export a lot of plastics until this arbitrage closes. Europe needs the supply and the less it produces domestically until it has more LNG importing capacity, the better it can survive this winter. The upshot is that plastic prices go down and track the Ukraine shock less and China’s domestic costs more with significant impacts on producer prices and in time, consumer prices. 

China has a major opportunity here to signal a diplomatic switch which astute China watchers are seeing in some personnel changes in the Chinese government. China has a genuine oversupply of refining capacity and until 2021 was a major exporter of refined products like diesel and gasoline. The pain at the pump in the US is as attributable to genuinely tight crude markets as it is to a squeeze in refining capacity especially in Europe which has led to Europe importing those products from the US in turn spreading the pain. This can be seen in the “crack spread” or the difference between refinery outputs - gasoline, diesel and the like - and oil, the refinery input. Below are retail gas prices in yellow in cents, futures prices for gasoline in orange and gasoline without the crack spread in white. A normalization in spreads would take gas down to 310c or so - or barely above the pre Ukraine conflict pricing.

If China were to want to signal that is not on a unity ticket of economic warfare against the West in conjunction with Russia then expanding fuel export quotas would be a good way to do it. Gasoline and diesel prices could fall 15% or more providing substantial relief to economies that are major importers of China’s exports - in turn providing some stabilization to its own economy. If not it would be wholly reasonable for the EU and US to conclude China is committed to a campaign of gray zone economic warfare against them in conjunction with Russia. It is not hard to conceive there being even further strategic disengagement with China if that were the case.

China has an opportunity to show where it sits now: it can be militarily disengaged with the conflict while trading with everyone, an enviable position to be in and something the west should tolerate since China is clearly buying Russian exports at much lower prices now. Unlike Saudi Arabia which may or may not have much spare production capacity, China’s refining capacity is known and underutilized and its export quotas are lower than they were previously. It is hard to say no because unlike Saudi Aramco capacity the Shandong Teapot refiners are not a state secret.

Other Metals

China’s relatively slower cadence of growth is pushing copper prices lower in turn lowering the cost of key inputs for the energy transition. Far be it from me to determine China’s housing policy but a country whose population has peaked and whose key homebuying cohort is shrinking quickly does not need a housing construction boom. Below you can see the size of the classic homebuying cohort of young adults - it is shrinking quickly, and fertility rates are barely over 1 in most of China according to official data and alternative sources show numbers even lower - check Yi Fuxian’s work for examples. I cannot rule out China backsolving for growth using apartments, but I can support China backsolving for growth using renewables which structurally reduce fossil imports and energy inflation.

Coal

Thermal coal prices are higher than they have ever been as Russia makes up 300 million tonne of a 1.1bn tonne export market. China has responded by mining more of its own and importing vastly less - this year is tracking to have the lowest imports in well over a decade and the imports China is taking are from Mongolia and Russia which are otherwise lost to global markets. Australias output is still recovering but the big squeeze on thermal coal is likely to stick as Asian countries switch to burning more coal than gas. Not much joy here as yet but if China were not importing vastly less than last year coal would probably be a lot higher. 

Is China Going to Export the Surplus?

Thus far things are looking positive. China is importing more coal from Russia and Mongolia and investing in making that easier. Similarly, it is exporting less from Indonesia in yellow below and exporting more steel in white below. Trade data for plastics, aluminium and other products that may be in surplus due to China’s real estate slowdown will be telling over the coming months. In normal circumstances this might be seen as bad and an excess capacity problem but today that is not the case. These are energy intensive products and they displace fuel demand elsewhere. China should get a free pass this this shock is over. This will also helpfully smooth the impacts of China’s real estate slowdown for China domestically - something they are concerned about.

In marked contrast to last year China is a very beneficial and benign influence on inflation dynamics now. If this can be maintained through this winter as LNG export terminals are built in the US and import terminals and FSRUs are built in Europe this is likely to moderate the inflation shock markedly. This in turn is going to give Russia vastly less leverage: Putin likely has one shot on goal to break Europe’s will this winter and if he fails he will likely never again get a chance. China could push its foreign policy back towards highly commercial self interest and impartiality, something that would be very desirable if it wants to retain good relations with Europe. One way or another we are going to see where China stands on this invasion through energy policy and one can only hope we see a return to China looking after China’s interests and not those of Russia at the expense of its own. 

In the US the Fed is moving towards a level of rate hikes that would imply a recession or at least a savage slowdown in turnover of housing, autos and anything else that might require consumer borrowing. In terms of measures to reduce energy demand or facilitate substitution not much is happening. the DPA has belatedly being invoked to make heat pumps, it seems nobody had a plan for solving shortages in refining capacity despite having a lot of plans for how to help Ukraine respond to the invasion and there is some objectively unhelpful stuff being done around cutting gas taxes. Despite the ground work for sanctioning Russia and gaming out a Ukraine invasion had been done months and months prior the Pentagon clearly was not speaking to Energy or Commerce who could have done a few things well in advance:

• Evaluate likely oil and products shortages: to the best of my knowledge nobody has done a graph model working out what shortages emerge if different countries are sanctioned or certain routes become unsafe or uninsurable. This is a joke and may force me to write another paper. In the meantime - people are wondering whether $3bn is took much to keep a refinery open during an oil shock? I am finding it very hard to understand very serious people these days.

  

  Matthew C. Klein @M_C_Klein

  $3 billion seems like a small price for the U.S. govt to pay up front (or guarantee, whatever) to get that kind of capacity back online in exchange for a cut of the upside

  

  Laura Sanicola @LauraSanicola

  Valero's CEO said earlier this year that it would cost $3 billion to get Lyondell's 263,776 barrel per day Houston refinery- set to be idled next year after failing to find a buyer- to get the plant to "Valero standard". This was a direct reason Valero did not purchase the plant. https://t.co/09OW35sCrD

  9:20 PM ∙ Jun 15, 2022

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• Work out response time of shale and how to speed up drilling as the risk emerged - rather than dumping SPR supplies in November. Employ America has a great piece on this and to the best of my knowledge nothing has happened yet. Doubling SPR release and buying the back end of the WTI and Brent curve til it trades flat would be a hell of a flex and likely work well. Heck, the Fed could spend less time on rates and more time on having a target for 3-18 month crude carry.

• Looked at ways to speed up alternative LNG sources and landing capacity for Europe: mobile regasification platforms (FSRUs) could be secured as an option for a lot less than the cost of current inflation. These things cost about half a billion dollars - that insurance seems shockingly good value until we are much further along the path of decarbonization.

So we now find ourselves with a choice of recession or “unanchoring expectations” and other things that are very bad to monetary theorists. I do wonder about this stuff: how much of the end of 1970s inflation was Volcker and how much was the end of the Iran oil embargo, the start of the Texas oil boom and all Jimmy Carter’s demand side measures starting to bite? I’ll leave this fight to others but I think finance people give too much credit to central bankers and not enough to the starting position of countries facing a shock with regards to their power grids and transport fleet. And on these things the US has done very little and continues to do very little despite having a large domestic energy sector with short cycles from drilling to production. This is absolutely not a “recession we had to have”.

Meanwhile in China

I wrote a piece last year on how a combination of an anti-corruption campaign, a hot summer, low hydro output and a red hot economy led to rolling blackouts and power cuts in Guangdong. China learned from that mess and onshore coal futures retreated quickly as mine output was increased quickly in advance of winter. China is now sitting on record coal inventories and hydro power output is very strong this year with coal and power prices largely regulated into an orderly range.

The climate implications of leaning harder into coal are dire but China is also expanding wind and solar much more aggressively along with pumped hydro in a more recent development. It is likely China will burn a lot of coal and have what seems like an excess of coal plants but the power mix is still drifting to be cleaner over time. It is also unclear what can bring China back to its torrid pace of energy consumption: real estate is moribund and the exports goods boom has ended with global consumption swinging back to services post COVID. There is every chance this decarbonization accelerates on lower overall energy demand.

For transport over a quarter of passenger vehicle sales in China are now EVs and that no doubt will grow. The implications of this are as follows:

1. Chinese imports of energy are likely going into a more or less structural decline, especially if we look at imports excluding Russia and Mongolia. I’ve written about Mongolian rail and the like, but in the event the conflict ends China is already working on new pipeline capacity to Russia. “Friend shoring” is not just for the rest of the worlds viz China. This has distinctly bad security implications for any other countries on the East China or South China Sea - they would be well advised to make a similar rush for decarbonization and energy security if they do not want their strategic position to erode.

2. China’s domestic inflation is becoming increasingly disconnected from the vagaries of global fossil fuel markets, and their trade surplus will grow. This makes some of the anticipated losses from moving production out of China less of an issue and makes the country much less vulnerable to capital outflows.

3. China is again competitive in energy intensive exports at a time when there are shortages. Chinese exports of coke for steel making, steel and aluminium are up sharply the last few months and I would guess they are going to go a lot higher yet this year. An energy shock abroad affords China the demand to make its dismount from excessive real estate construction a lot more smooth. Construction can slow so long as upstream impacts are limited. So long as hot rolled steel costs 100% more in the US and Europe than it does in China, that is quite easy to manage.

Not every country is China, but Western Australia has done the right things. Its grid is already ~35% renewable, it has gas reservation so power prices are manageable and is planning an exit from coal using storage and particularly pumped hydro. The China playbook is not exclusively available to China.

That concludes my complaint. There are better options out there and they are not being taken, and it disappoints me. China gets plenty wrong but this material capacity building is something they get, and something that has real implications for inflation and consumer welfare. I wish it was taken more seriously among the Anglosphere political class. Perhaps this is the shock we needed for that change to happen.