It seems that the gas problem The old continent still has a leak to close... Gas shortages, rationing and possible blackouts are shaping up to give us a harsh winter for Europe. Governments across the bloc are working to fill gas tanks in case Russia disrupts the flow of gas, but we will likely only have enough gas for two or three months. So, now that summer is ending, it's a good time to think about the five big consequences that are likely to occur this winter, and how to prepare our stock investment portfolio for them...
1: The consumer suffers while gas producers benefit.
Gas price growth may be good news for gas producers, but not for European consumers and industries. And what's worse, it is a problem with worldwide effects. For example, let's look at the Dutch gas price (TTF), the reference price in Europe. Their prices have increased sevenfold since the war between Russia and Ukraine began in February.
The lack of pipeline gas in Europe also means that the bloc has had to turn to other energy sources, such as liquefied natural gas (LNG), to supplement reserves, causing its price to be four times higher than its recent four-year average. Europe may be able to avoid blackouts this winter, but it will only be able to do so by outsupplying other countries, and that means LNG prices will likely continue to rise for longer. With these higher energy costs taking a toll on household budgets, it might be prudent to avoid investing in European consumer discretionary stocks for a while. Let's better consider investing in European gas producers like Equinor, Royal Dutch Shell o BP.
We can also make our investment in shares in companies that benefit from the strong demand for LNG, such as chesapeake, EQT Corp, Antero resources, Goal LNG o Cheniere energy.
2: Europe's industrial sector takes a hit.️
Gas rationing sounds ugly and it probably is, especially for energy-intensive industries such as chemicals, automobiles, paper and steel. In the following graph you can see the use of gas by each industrial sector in relation to its contribution to economic activity in Germany.
These sectors have already seen notable growth in their spending due to rising electricity prices, but could take an even bigger hit to their bottom lines if rationing forces them to reduce production. This will lead to a decrease in profitability, since fixed costs would remain the same, but spread over fewer goods produced. Furthermore, in the case of industries that compete on a global cost curve (chemicals, paper and steel) an increase in the price per unit will make investment in shares of these European industries less competitive compared to those of their Asian and American counterparts.
Therefore, it would be best to avoid European manufacturers of chemicals, paper and steel. Better to position ourselves on American chemical manufacturers such as Dow, lyondellbasell y Huntsman. With these we will likely benefit from a growth in chemical prices as European supply is affected. A good strategy would be to position ourselves short in stocks of European chemical producers and long in stocks of American chemical producers.
3: A European recession is approaching.
Falling consumer purchasing power, rising costs for industrial sectors and risks of production cuts point to slower economic growth and greater inflationary pressure in Europe. The economists of abrdn They say a European recession is likely this year. They estimate that growth will suffer a drop of 1,5%, but that the impact will be greater, 4,5% if Russia completely interrupts gas flows. And they estimate that increases in gas prices will add more pressure to inflation this year, and much more next.
The energy crisis could destroy the EU's growth prospects. Source: Bloomberg.
A recession in Europe would not be good for investing in European stocks, so it may be better to look for assets in the United States. However, if we really want to be exposed to Europe, the safest opportunities are in more defensive industries such as pharmaceuticals and food and beverage, where demand and production would be more isolated even in the event of a blackout.
4: The euro weakens, and remains weaker.
Throughout 2022 the euro has weakened greatly against the dollar, and is likely to continue to suffer. Of course, the European Central Bank (ECB) has started to raise interest rates and is likely to continue raising them. (Higher rates often benefit a country's currency by increasing investor demand.)
However, the ECB has been slow to raise rates and is relatively limited in how much it can raise, depending on how the economy responds. The ECB is caught between a rock and a hard place. Right now it must keep inflation above the region's average at bay and keep a strong economic recession at bay. A recession would deeply weaken the euro, aggravating the inflationary pressure we face in Europe by raising the price of imports for consumers and businesses.
5: There is a permanent destruction of demand.
The longer the gas shortage lasts, the greater the risk of permanent demand destruction as consumers and industries adapt to an environment with higher energy sector prices. Furthermore, the end of Europe's dependence on Russian gas will lead to a rise in gas prices across the bloc, reducing Europe's competitiveness in the manufacturing sector and reducing investor interest.
And at the same time, we could see new business investment and manufacturing shift to regions with lower energy costs. For example, new business investments in the petrochemical sectors could follow the lead of European refining by moving to cost-advantaged regions such as the United States, where industries benefit from lower gas prices.