The Growing Divide Between Monetary Policy and Energy Reality

Powell’s fight against inflation threatens to throw the U.S. economy into a recession. Meanwhile, a perfect storm of energy-related supply shocks stand ready to exacerbate the pain felt by households and businesses.

Justin Nugent

This article was last updated on 10/05/2022.

Key Points

  • Central banks at home and abroad use blunt tools like rate hikes to hammer demand, actively weakening the economy
  • If the Fed gets its way:
    • Roughly 4 million jobs will be lost
    • U.S. GDP growth in 2022 will be a flat 0.2%
    • The economy may spiral into a recession
  • This isn’t as nefarious as it sounds
  • The Fed believes that by causing pain for households and businesses today, they can prevent sticky, long-lasting inflation tomorrow
  • It’s a good plan on paper, but there’s one major problem: If the price of energy roars back to its previous highs, this winter could be catastrophic for a newly cash-strapped consumer

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Energy Prices Plummet

Last week’s Fed-fueled selloff was brutal for the stock market, sending the S&P 500 back to its June-low. No corner of the market suffered more than the top performing sector of the year, energy. 

1D and 5D returns for S&P 500 sectors. Data sourced from FinViz

But it isn’t just energy stocks. U.S. gasoline prices have fallen for 13 weeks in a row, from roughly $5 to $3.70 per gallon on average. At the same time, oil prices hit an eight-month low on Friday, with West Texas Crude falling to $78 dollars a barrel. At $85 a barrel, Brent futures aren’t far ahead. As usual, institutional buyers took advantage of the upcoming Fed speak as a chance to make some bearish bucks. 

Bearish put spreads bought in the U.S. Oil Fund on Monday, before Friday’s >5% drop. 
Source: Market Rebellion
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Why are energy prices plummeting? 

Energy Isn’t Just a Part of the Economy, Energy is the Economy

The economy revolves around the price of energy. From chemicals and fertilizers, to packaged foods, to retail, to airline ticket prices, energy’s effect on the economy is far-reaching. That’s part of why the war in Ukraine was such a major issue for the global economy. Before the war, Russia was responsible for supplying 8-10% of the world’s petroleum. Since then, daily Russian exports have fallen by 580,000 barrels — and by February, increasingly stringent sanctions are expected to bring that figure to 1,180,000 barrels. While Ukraine’s cogent counteroffensive had some wondering if peace was on the horizon in Eastern Europe, Putin’s latest decree has put those hopes to bed. Adding fuel to the fire

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“Gas will never flow through the Nord Stream 2 Pipeline”

At least, that’s what German Minister Stephan Weil had to say

“Germany can never rely on Russia for energy supply again, and the Nord Stream 2 gas pipeline project will never go ahead.”

Stephen Weil

The Nord Stream 2 was intended to help alleviate energy supply issues in Europe. It was fully constructed prior to the Russian invasion of Ukraine and needed only to receive regulatory clearance. However, Germany suspended the pipeline following Putin’s order for Russian troops to enter Ukraine. As the invasion dragged on, energy supply issues only worsened in Europe — with Russia targeting the biggest pipeline for gas from Russia to Europe — the Nord Stream 1.

Nord Stream 1 Recap

  • On September 2nd, Russia’s Gazprom shut down the Nord Stream pipeline. 
  • The state-owned energy giant (the largest company in Russia by revenue) was expected to reopen the pipeline just hours before the reversal. 
  • However, following a G-7-backed plan to put a cap on the price of Russian oil, Gazprom unexpectedly shut down the pipeline due to “a leak detected in a turbine”. 
  • According to Siemens Energy, a company that produces gas turbines, leaks like this do not normally affect the operation of the turbine. 
  • More likely, this was another move in a series of attempts from Putin to put pressure on Europe. 
  • It wouldn’t be the first time that Russia has limited the flow from the Nord Stream pipeline.

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Since June 2022, the flow of natural gas has been steadily decreasing. Today, it remains at zero. Source: Nord Stream

Now, Germany is looking elsewhere to satisfy its energy needs, and America is stepping up to the plate. As it stands, the U.S. is now the largest supplier of liquefied natural gas in the world — and the majority goes to Europe. Still, as Germany scrambles to hunt for new sources of energy, some fear that the damage has already been done. The IMF estimates that the gas shortage will reduce German GDP by -1.5% in 2022, -2.7% in 2023, and -0.4% in 2024, with no gains to come in subsequent years due to deferred economic activity. Add in Europe’s sky-high inflation (which the IMF estimates could rise by as much as 2% in 2022 and 2023), and that’s an ominous scenario. 

It doesn’t just affect Germany, either. The energy shortage is a global phenomenon, and these issues are further complicating the problem. That’s why some believe that this Winter is going to be a stark test for the Global Economy. 

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“Oil Will Return to $120 a Barrel This Winter”

That’s a quote from Amrita Sen, Chief Oil Analyst at Energy Aspects. Sen believes that demand for oil and gas isn’t going anywhere, but that a series of coming events could tighten the supply.

A Problematic Timeline

  • In March, the Biden Administration began releasing a million barrels of oil each day from the United States’ strategic petroleum reserve
  • This move was intended to loosen supply and soften prices
  • The SPR supply currently sits at nearly a four-decade low
  • On November 1st, 2022, those SPR releases will come to an end

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Stock of crude oil in SPR. Source: EIA

Making matters worse, on October 5th, OPEC+ rolled out a two-million barrel per day production cut — further putting pressure on the price of oil.

The timing couldn’t be worse. On December 1st, the EU is set to roll out a ban on Russian crude. Both of these developments come just weeks before a Winter that some have forecast to be “unreasonably cold and snowy”, with the potential for “record-breaking cold temperatures in some areas.” And while oil and gas often take the center stage in the inflation conversation, there’s another, potentially bigger problem forming.

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Electricity: The Next Front in the War on Inflation

We said it above — energy has a grip on almost every sector of the economy. Case-in-point: The soaring price of electricity. Roughly 61% of electricity is generated from fossil fuels (like coal, natural gas, and petroleum). This has contributed to the rally in electricity prices since April 2020.

Average Electricity per Kilowatt-Hour in U.S. Cities Since Covid-19. Source: FRED

This adds to the economic wall of worry facing low-income consumers this Winter. 

Electricity accounts for as much as 46.7% of all residential heating expenditures. Source: NEADA

As a whole, winter heating costs are expected to rise 17.2% year-over-year.

Winter heating costs, 2020-2023, YoY. Source: NEADA

According to Mark Wolfe, director of the NEADA,

“The rise in home energy costs this winter will put millions of lower-income families at risk of falling behind on their energy bills and having no choice but to make difficult decisions between paying for food, medicine, and rent.”

Mark Wolfe

To some, going without heat for a few nights may not sound like the end of the world. That brings us to the crux of the issue: A glaring misconception about the danger of lacking heat during the cold seasons. 

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Why the Energy Shortage Matters the Most For Lower Income Households

The energy shortage is about far more than the price at the pump. Soaring prices coinciding with a Fed that’s trying to raise the unemployment rate, weaken the consumer, and lower the average wage is a recipe for disaster. The inability to afford heat has been a silent killer of America’s lower-income class for years. While it doesn’t get the same level of coverage as death by heatstroke, it’s a serious issue — one that would be exacerbated by the perfect storm of events described above. 

This is something that CNBC’s Worldwide Exchange Host Brian Sullivan has frequently drawn attention to. 

“More Americans have died in the past 40 years from cold weather than from hot weather. Sometimes people have to choose between heating and eating.”

Brian Sullivan

It’s a heartbreaking dilemma. While there’s still a chance that central banks around the world can land this plane somewhat softly, it’s likely to arrive with some collateral damage. And as usual, collateral damage most often comes in the form of pain for the most impoverished people.

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