Energy prices spiked in September and October, sparking fears that higher energy costs would tank global economic growth and equity performance. Whilst increased energy prices aren’t great for consumers, they aren’t automatically bad for equities. Fisher Investments UK believes forward-looking markets have likely already priced in the effect of higher energy prices. In our view, shortages would have to be more drastic or long lasting than currently expected to cause a global equity bear market – a fundamentally driven market downturn of at least -20%. Data since the initial autumn price spikes suggest energy shortages may not be as bad as initially feared, which could be bullish for equities moving forward.

A Deeper Look Into Energy Price Spikes

Energy prices were already somewhat elevated entering 2021 as economies reopened from COVID-19 lockdowns and pent-up demand proved stronger than anticipated. Weak European wind power generation and low natural gas inventories added to elevated energy prices in the summer and autumn, eventually raising concerns that the continent might not have enough fuel to heat homes and businesses this winter. According to the International Energy Agency, low wind conditions caused the European Union’s (EU’s) wind generation to decline in 2021 – its first annual decline in decades.i

Europe’s lack of wind power generation drove up the demand for natural gas, which was already experiencing low inventories. At the end of November, European gas storage was about 23% lower than the same period last year.ii Naturally, prices reflect the shortage. However, fears reached fever pitch in early October when Dutch near-term gas futures – the European benchmark – notched a record-high €100 per megawatt hour on October 5, up from just €15 at the end of 2020.iii To make things worse, Russia began curbing natural gas supply to Europe – a move some speculate was intended to pressure the EU to approve the Nord Stream 2 pipeline from Russia to Germany.

Meanwhile, higher gas prices drove countries to look for substitutes like oil and coal for power. Brent crude prices eventually felt the pinch, hitting €74 per barrel on November 23 – up 77% from the beginning of the year.iv Coal prices also spiked when China unofficially banned Australian coal imports due to a political spat.

Markets Respond to Price Signals

Basic economics says too much demand and not enough supply (aka a shortage) leads to higher prices. Whilst shortages are difficult to endure in the near term, higher prices widen producers’ profit margins – a powerful incentive to increase output. Recent data show producers globally are doing just that.

Politics – particularly regarding Russian gas delivery to the EU – seem to be delaying a quick supply response for the EU’s natural gas shortage. In response, the EU and other would-be buyers, like China and the UK, have looked toward other energy sources to bridge the gap. China has ramped up its own coal production, causing its thermal coal prices to tank – down 52.7% from October 20 to November 10.v Further, as of November 2021, coal was meeting 15% of European power demand, up from less than 10% in Q1 2021.vi

In the US, shale drillers are responding to stronger oil and gas prices. US oil rig count is up from 172 in mid-August 2020 to 450 as of November 5, 2021.vii Total US production is approaching 12 million barrels per day (bpd), nearing the pre-pandemic record 13 million bpd.viii These substitutions along with improving European wind power generation have also helped benchmark natural gas prices settle a bit – down -18% from October’s peak on November 30.

This situation is still developing and Fisher Investment UK believes it bears monitoring, but recent data suggest economies globally are adapting and supply is gradually rising to meet demand.

A potential bullish sign for investors

We don’t dismiss the effect higher energy prices can have on individuals and businesses. However, what matters for long-term investors is that the situation looks a better than feared, which could actually benefit equity prices.

Equity markets are forward-looking. As investors weigh potential outcomes and trade equities based on their expectations, they effectively price those projections into markets. Equity prices move on the difference between reality and expectations. Whilst investor’ expectations can (and have) been wrong plenty, big headline fears like today’s rising energy prices tend to be efficiently reflected in equity prices. Markets seemingly priced in the worst-case outcomes when energy prices spiked in September and early October. If economic reality proves even a little better than feared – as some of the data suggests – it should positively surprise many investors’ expectations, likely benefitting equities.

As the situation unfolds, Fisher Investments UK reminds long-term investors to focus on their long-term goals and resist any urge to make reactionary portfolio changes. Higher energy prices may be uncomfortable on a personal level, but don’t let that discomfort or fear lead you astray from your optimal long-term investment strategy.

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Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.

Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.

i Source: International Energy Agency, as of 12/1/2021. Renewables 2021 – Analysis and forecast to 2026, revised December 2021.

ii Source: Gas Infrastructure Europe, as of 12/1/2021. https://agsi.gie.eu/#/historical/eu.

iii Source: FactSet, as of 12/1/2021. Dutch TTF Gas Price in EUR, 12/31/2020 – 12/1/2021.

iv Source: FactSet, as of 12/1/2021. Brent crude oil spot price in EUR, daily, 11/30/2020 – 11/30/2021.

v Source: FactSet, as of 11/10/2021. China Thermal Coal Price in CNY, 10/20/2021 – 11/10/2021.

vi “Big Winners From Natural-Gas Crunch: Coal Power Plants in Europe,” Joe Wallace, The Wall Street Journal, 11/17/2021.

vii Source: FactSet and US Energy Information Administration, as of 11/10/2021.

viii Source: US Energy Information Administration, as of 11/23/2021. Weekly US field production of crude oil, 2/21/2020 – 11/12/2021.